Over the past few decades, the region’s energy sector has undergone deep structural transformations, but one trend remains dominant: the desire by oil-exporting countries to build more refining capacity. This is in part to meet the rapid increase in domestic demand for petroleum products driven by high population growth, improvements in income levels and low energy prices, but also to create more value-added through diversifying exports away from crude oil towards refined products and petrochemicals.

Following a sharp increase in refining capacity during the 1970s and 1980s, growth stagnated for most of the 1990s due to falling government revenues, low refining margins and low petroleum product prices in the domestic market, which reduced the incentive for national oil companies (NOCs) and state-owned refiners to invest in new capacity.

Across the Mena region, $49bn is committed to downstream projects under execution

Since the early 2000s, however, the rapid increase in domestic demand and higher revenues have shifted the attention of many Middle East oil producers back to refining. In the past few years, many countries in the region have announced ambitious plans to increase their refining capacity. If implemented, these projects could turn the region into a leading hub for exports and trading of refined products, competing not only in the crude market, but also in more specialised products markets.

Some of these projects have already come online, with most of the increase concentrated in the GCC. For instance, the completion of Yasref and Satorp in Saudi Arabia and Ruwais in the UAE has added some 1.2 million barrels a day (b/d) of new refining capacity in the past few years. Phase 2 of the Ras Laffan refinery in Qatar was completed last year, doubling the existing capacity to 292,000 b/d.

In the medium term, Saudi Arabia is expected to add a further 400,000 b/d once the Jizan Refinery comes online, and the Sohar expansion in Oman should add another 116,000 b/d to GCC refining capacity by 2018.

Across the Middle East and North Africa (Mena), $49bn is already committed to downstream projects currently under execution, with a further $54bn planned over the medium term.

Trading hubs

Establishing a key position in the products markets would provide Mena producers with a strategic opportunity to develop the trading industry and form regional trading hubs. So far, NOCs in the region have almost exclusively relied on their trading arms or subsidiaries to buy and sell their refined products, bypassing the traditional oil traders such as Switzerland-headquartered Glencore and Dutch Vitol. In 2012, Saudi Aramco established the Aramco Trading Company (ATC) in place of its product sales and marketing department to handle the sales and purchasing of all petroleum products. Since its establishment, ATC has been an active player in the products’ market, competing with the international oil trading houses.

Other examples include Oman Trading International, a venture between the government of Oman and Vitol (although media reports have suggested Oman wants to take full control of it). Plans are under way in the sultanate to construct the world’s largest crude and petroleum products storage facility, with a capacity of 200 million barrels.

The UAE has increased tank storage capacity in Fujairah from 2.8 million cubic metres to 7.4 million cubic metres over the past 10 years and is keen to boost its status as a global trading hub by increasing its port capacity to 14 million cubic metres by 2020.

While in principle this could open opportunities for the private sector and international trading houses, the current trend indicates a greater concentration of trading activity in the trading arms of NOCs and their joint-venture partners.

Challenges ahead

But with opportunities come challenges. With growing concern over environmental sustainability and public health, the refining industry is under pressure to improve the quality of gasoline and diesel. Also, the new refineries in the Middle East (as elsewhere) have been configured mainly to produce diesel to cater for the anticipated increase in demand from Asia, particularly China.

However, China’s economic rebalancing away from manufacturing towards consumer goods and services has changed demand patterns in the country, with diesel demand flatlining while gasoline demand continues to grow. This has turned China into a net exporter of diesel.

The new refineries in the Middle East will be the ones that survive in this tough environment

With US exports of distillates surging to record levels, Russia upgrading its refineries to produce higher volumes of distillates and Indian refineries ramping up their production, the competition in the products market, particularly in the diesel segment, has become more intense. This is squeezing margins and may force some of the least efficient refineries to close. Although shutting refining capacity could prove to be a lengthy process as factors other than profitability enter into the decision.

The new refineries in the Middle East will be the ones that survive in this tough environment, but the key question is whether they will be able to achieve high returns amid stiffer competition and changing regulations.

Faced with increased competition in global products markets, subsidised prices in local markets and overcapacity in global refining, it is a good time for governments to carefully re-evaluate their downstream strategies. They have to show that these new refining projects are adding real value and are opening new opportunities, such as in trading, and are not solely driven by the pressure to meet ever-increasing domestic demand.