Second UK refinery collapse puts focus on survivors

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Gary Clark:

Hello, and welcome to the Platts Oil Markets podcast by S&P Global Commodity Insights, where today we'll be talking about the refinery landscape in Europe and the Atlantic Basin, in the context of the announced insolvency of the UK's Lindsey Refinery on the Humber River between Grimsby and Hull.

I am Gary Clark and I manage the EMEA Clean Refined Products Price Reporting team based out of London. I'm joined by Elza Turner, who reports on refineries, and Kelly Norways who sits on our downstream news team. Welcome all.

Refinery News has been dominated over the last two years by the ramp-up of the Dangote Refinery in Nigeria, which is primarily focused on producing gasoline to meet West African demand, but is also exporting the likes of diesel and jet fuel to Europe and all over the world. However, it's a singular success in the outlook for refineries with the competitiveness of other refineries in the Atlantic Basin, particularly in Europe in question, such as the older, less sophisticated 108,000 barrels per day, Lindsey Refinery, which filed for insolvency on June the 29th. Let's talk about the Lindsey Refinery first before opening up on broader ramifications. So maybe going over to you, Elza, what's the status at Lindsey? Is it still operating?

Elza Turner:

First, Gary, you mentioned the Dangote refinery was in the news the last few years, but in the meantime we had other new refineries starting elsewhere. In the Middle East. We have three new refineries. In India we have constant expansions. Maybe they haven't all come to fruition, but still they're underway. New refineries in China, also in India, one we are looking forward to this or next year. So the competition is quite fierce, it's not just coming from Dangote.

Lindsey Refinery. It filed for insolvency. Now, it stopped loading products for a while, that is we know for sure. As far as we understand, there are some operations in the refinery, whether it's at full run, full capacity or not, it's not very clear. The whole thing was quite a bit of a surprise, including apparently for the government, which said that it's asked Lindsey Refinery owners if it was all right, and it seemed that its situation changed quite rapidly from being sustainable to being unable to pay the debts.

So, we hit some disruptions with supply across UK retail stations immediately after these thing happened. The following week, seems things are getting back to normal. So the refinery is in some stage of operation, but as I said, it came first as a surprise, second at a bad time following the closure of the Grangemouth Refinery in Scotland, which is not that far geographically from Lindsey. And Grangemouth commenced holding its units back in February, end of January. By April, it had stopped processing crude. So, we have in a matter of less than half a year, two refineries in the UK, Grangemouth and Lindsey, facing some sort of problems.

Gary Clark:

That's understood. And I mean, I think that given these issues, you mentioned Grangemouth as well. What's the significance for the UK, Kelly, and where does that leave the country's fuel sector?

Kelly Norways:

Yeah, so if we do see a closure of Lindsey, that would leave behind just four refineries in the UK, and this is part of what we've seen as a relatively long-term trend. There's already been shutdowns, Milford Haven and Coryton in previous years, for instance. And Lindsey, even under Total Energy's ownership before it was sold to Prax, which is this UK independent, had halved its capacity.

So you've already seen these kind of competitive threats start to weigh on how great a refining footprint there is in the UK. And really, what that's doing is just tipping the country more and more into its status as a net importer for some key fuel supplies. So already, the UK was importing about 50% of its diesel and roughly two-thirds of its jet supply, that's going to become even more of a greater requirement to pull on international suppliers to draw that middle distillate product that we're in such short supply of. And that's why Grangemouth was really such a blow, because this was one of the few refineries in the UK that was geared towards producing diesel and jet. It had a hydrocracker, which meant that it was explicitly set up to produce those products.

Lindsey, perhaps one of the reasons why it was a bit more exposed was because it was kind of geared towards gasoline, which we export as a country on a net basis. So, that's one of the reasons that it was looking a little bit more fragile in the lead up to all of what we've seen in the last few weeks.

So really, it tips the balance on that front and it comes down to what the government wants to do, in terms of its energy security policy. So there's been some comfort level with tipping towards becoming an importer of crude. We've seen policy in the North Sea and how that's evolved. But I think more and more the question will be about what the industrial policy is and what they want to do with refining.

In Grangemouth, there was this big EY backed study from the government which investigated future prospects for the site, how they could potentially look at new projects like plastics recycling, biofuels, and I think they were looking at maybe using wood chips to produce biofuels or maybe e-fuels, which is one of the more scalable, long-term solutions. So I think it poses an existential question for the government about to what extent they want to hang on to a domestic refining industry or if they want to push into other new fuels and to the extent to which it can do that. So already, we've seen a massive surge in the imports that have been coming in, that jumped to record levels in recent months. And at the moment, we should mention that the government is saying that they are looking at a potential sale of Lindsey, but it's just whether they can find a willing buyer or not and how things move ahead there.

Gary Clark:

Yeah, I mean, there's a lot of interesting themes there, right? You mentioned energy security, Europe, UK, net short diesel, net short jet fuel, importing those products, and we're still seeing refineries in the UK and elsewhere in Europe under threat. Right? So-

Kelly Norways:

And actually, I should just mention there quickly to name-check the refineries that are still in the UK. What that means, and Elza will know this more than me, but what that means is that you're seeing a bit of a race to jump in for the remaining players that are bigger and a bit more competitive to be able to start ramping up their own production. And Elza, maybe you can go into that.

Elza Turner:

Yeah, I just wanted to, while we are still in the UK, to say that there are some positive news also about refineries in the UK. We have Fawley, which announced a very big upgrade project last year aimed at increasing its ULSD diesel production, and recently, it said that it's commencing the startup of this project. So, this means that there will be some sort of respite for the UK supply. On the, Stanlow also recently increased its capacity as a result of also some upgrades and some energy transition projects. The Valero and Humber refineries look all set up and in good shape to supply the UK market. So as Kelly says, it is now for the government really to see what they will do with Lindsey, because Grangemouth is definitely closing, is not going to remain a functioning refinery.

Kelly Norways:

And it's probably worth touching on the sheer level of capital investment that's being pumped into some of these projects. So if we take the Stanlow example that's managed by EET fuels, they're vowing to invest 1.2 billion US dollars in decarbonizing that site and cutting its emissions by 95%. And really, that's a bet on the UK's industry being protected and being able to survive because what they're doing there is trying to avoid these huge carbon taxes that we're seeing coming over the hill.

And to put some numbers on that, it was the UK lobby group, Fuels UK that said that it's something like 400 million pounds at the moment, that refineries are having to spend in decarbonization taxes and other taxes associated with running. And that's at the moment, under the current UK ETS system where they're only having to pay for 40% of their emissions, that's only going to go up and up and up. So, these companies are really banking on the government kind of stepping in to protect them from imports that are potentially higher emissions and produced at a lower cost. So, it's a bit of a gamble on that front as well.

Gary Clark:

So, I mean, that's understood. So in one aspect, it's not all doom and gloom, right? There is investment within at least the UK refining sector, right? And also, potentially we're speculating that the industrial strategy might support the cost of emissions for refineries going forward.

So Elza, at the beginning, you mentioned these and we've talked a little bit about these kind of new super refineries. I mentioned Dangote, you mentioned a lot of expansion in India. How is that affecting the general refinery landscape in Europe?

Elza Turner:

Well, we've hit quite a few waves of closures in Europe already. The last one was during COVID. The previous one was, if I remember correctly, 2010, 2012. For the moment, we don't have obvious candidates for closures. Of course, analysts, including the International Energy Agency, they always say that if margins deteriorate, there will be more room for closures. One sign to look for is if refineries postpone maintenance because maintenance is quite an expensive undertaking. And strangely enough, Lindsey said that they finished maintenance earlier this year, which makes it really very confusing about what happened there and why they suddenly filed for insolvency after having a maintenance. Because one of the problems with Grangemouth was that it was having problems with some of its units, including the hydrocracker, and probably that weighed the scales for not continuing operation.

Just to say about Europe, for instance, we have the Gelsenkirchen Refinery in Germany. It was supposed to reduce its capacity, but recently they actually, even though the refinery is currently under sales procedure, they said that the latest plan is not to reduce the capacity. So margins have been good for quite a long while, not as good as last year for instance, but they have not been bad. And it's for the moment, maybe we are not facing immediate period of closures.

But as I said in India, I'm thinking that it's maybe around seven refineries that are carrying on expansion projects, so they're expanding their capacity. They're going to process more crude, which means they will be producing more products and these products have to go somewhere, have to find the market. There is a new refinery in India which might be facing some delays in its startup, but it will start up. We had a new refinery in China, we have more projects in China, so it's all probably a matter of time.

Gary Clark:

So, absolutely increasing refining capacity in east of Suez markets there on various timescales. Right? But Kelly, if I could come to you, what are our research colleagues saying about margins going forward?

Kelly Norways:

Yeah, so I mean, I think a lot of this will hang on how quickly we see this wave of closures happening. We've been talking for years about this long lead time about seeing refineries phase out of the global system and this last decisive wave of contraction in an industry that's typically been cyclical. Now you're seeing a long-term shift towards electrification in western countries, you're seeing fuel efficiencies that just mean that we don't need as much refining capacity. So, we've been expecting this margin pressure. But if you see closures happen sooner than we expected, it might mean some relief for the smart players that can hang on and are able to produce at scale. They're geared towards the right kind of products for their markets. They're close to the end users, let's say in Asia or the Middle East.

So based on the latest numbers that we had from our analytics team, I think in Q3 we were looking at gasoline crack spreads averaging around $13 per barrel. And on the diesel side, that should be something like $15 per barrel, based on our latest house view. Both of those crack spreads are $2 per barrel higher than what we saw last year. So you're seeing things look relatively firm for the moment. Obviously, if you have geopolitical shocks, like if there's major clamp down on Russia, if you have another disruption to the Strait of Hormuz or another jump scare around flows from the Middle East, that could prop up margins again. And we've seen this recent strength in the ice gasoil structure, low inventories in northwest Europe.

So, all of those factors will mean that refiners are then looking and thinking, maybe if I can hang on a little bit, that could be in their interests. And I think that's kind of why this Lindsey closure caught people by surprise a little. It already looked like it was a bit exposed as a big gasoline player as a smaller refinery, but this is coming at a time where margins have broadly held up. So, I think that's one thing.

Another thing, you mentioned Dangote, that's a big player, particularly for these smaller European gasoline producers. Obviously, Dangote is a Nigerian refinery where its whole MO is to produce as much gasoline as possible, so that will exert some pressure. But we've seen some issues with their startup, there've been issues on their main gasoline unit, and it's possible that they might have to do another turnaround later this year. So, all of those factors will be things that refiners are looking at very closely.

And I think when it comes to thinking about long-term survival, it really is now looking at things like petrochemical integrations, looking at really understanding your local market and what the profile is in terms of distillate splits. Ideally, if you can produce petrochemical feedstocks like naphtha, that's helpful in the long term, even if things aren't looking ideal at the moment. So, that's kind of the lines along which at least Europe's refiners will be thinking. But a lot of this is just moving in line with demand resilience. I think Europe is one of the areas where we're seeing gasoil demand start to decline. By most estimates, it's already peaked pre-2020, so Europe is an area that's exposed, and in countries like the UK, we've already had this imbalance between being long on gasoline and needing distillate. And I think that's really materializing now.

So potentially, we'll be one of the Guinea pigs for what this contraction looks like in years to come. Other markets like North America might also struggle, whereas, yeah, some of these bigger low-cost refineries in places like the Middle East and Asia potentially are looking like they're in a better position right now.

Gary Clark:

Yeah, I mean, those broad macro trends are quite clear, right? Rising refining capacity in east of Suez markets. At the same time as obviously we're going through the energy transition in Europe and elsewhere, and that has a certain amount of pressure. And we have to see on refineries in Europe, we have to see how industrialist strategy is going to play out in all the various countries going forward.

Elza Turner:

And as Kelly said, also refineries that also have petrochemical operations are in a much better position to face the future.

Kelly Norways:

One thing that I was just going to say there, I don't want to be too doom and gloom about the transition, but one thing is it's easy to think about policies as being set in stone, but if there's anything we've learned from recent years is that really isn't the case. If you look at these landmark policies that will really influence our demand habits and patterns, so I'm thinking things like the phase out of internal combustion engines where we've seen policy flip-flops already. Is it 2030? Is it 2035? Is it being brought back earlier again? Those kinds of things will really influence how refineries perform and how resilient this demand is. Already in the US we've seen policy rollbacks, which have materially influenced long-term forecasts from big players like the IEA. So that's definitely something that we'll be watching, as I imagine the rest of the industry will be.

Gary Clark:

Okay, so a lot of food for thought there, absolutely, when we are discussing the refining landscape complex. And it's clear that the trajectory for refining margins going forward isn't necessarily going to be linear, as you mentioned this Lindsey insolvency being somewhat of a shock to the market. So the changing landscape for refinery operations is affecting import and export dynamics for refined products in Europe clearly, and all over the world, with implications for both prices and energy security. The recent closure of Scotland's Grangemouth Refinery, and the Lindsey insolvency are symptomatic potentially of a broader trend as we've discussed.

So, thank you Elza and Kelly, and thanks for listening. Keep up to date with Platts Live, the professional platform built exclusively for the energy industry, and have your say and join the conversation at Plattslive.com.