Key fact

Demand for refined products is growing at around 6 per cent a year in some Middle East countries

Source: MEED

The global oil refining industry is so closely entwined that if something happens in one country, the consequences can ripple across the world and affect the balance of the whole industry in a matter of days.

A huge increase in demand for gasoline in Mexico, for example, will mean that US refiners need more oil to feed their plants on the Texas coast.

Light sweet crude oil is the product of preference for most refineries. And this year, the civil war in Libya has caused a shortage. As a result it has driven up price of West African light sweet crude, which means that refining margins have started to become tighter.

There is still strong demand in the Asian market, which is keeping the refining margins high

Jonathan Leitch, Wood McKenzie

As margins tighten, any refinery located in an area of low demand or that makes a limited amount of products is going to suffer badly. In this instance, European refineries have suffered from narrowed margins, while the Texas refineries have enjoyed good differentials. As part of the Asian market, Middle East refining margins have largely stayed strong.

Role of crude price benchmarks

The benchmark used to buy oil is as important a factor in determining margins.

“In 2011, you are seeing a wide differential in crude prices that use Brent or WTI [West Texas Intermediate] benchmarks,” says Jonathan Leitch, senior analyst with UK energy consultancy Wood McKenzie’s downstream team. “In some cases this has been as high as $25 a barrel, which means some refiners in the US have had access to very cheap crude.”  

With the recent [political] developments across the Middle East, it is unlikely subsidies are going to change

John Tottie, HSBC

The Middle East is affected by the same factors as the rest of the global refining industry, but is also driven by extremely strong regional demand for refined products, which is growing at around 6 per cent a year in some countries.

Most of the refined products that are produced in the Middle East are either used domestically or exported to Asian markets such as China, Japan and South Korea. 

“It is difficult to separate the Middle East market from the rest of Asia,” says Leitch. “It depends on which crude benchmark you use and what products each refinery produces.” Product mix is also important and can mean the difference between strong and weak refining margins.

The oil refineries currently operating in the Middle East are split into a mixture of simple and complex.

Simple refineries basically boil crude oil and then separate it into different products such as naphtha and fuel oil at different temperatures. Many of the older facilities in the region were built in the 1960s and 1970s and are simple refineries that make a limited amount of products.

“When margins are tight, simple refineries struggle because they do not make a diverse portfolio of products,” Leitch says.

Margins at complex refineries
($ a barrel)
2011 Global margins Singapore margins
Jan 4.21 5.41
Feb 3.25 4.98
Mar 3.62 5.51
Apr 4.08 5.03
May 5.55 5.52
Jun 4.13 4.22
Jul 5.33 5.60
Aug 6.28 7.77
Sep 2.71 5.55
Source: Wood McKenzie

The majority of the newer facilities are complex refineries. These plants take the refining process further by having a cracker that breaks down the molecules of the crude oil and allows the refiner to make a more diverse set of products. Jet fuel, diesel and higher grades of gasoline are all produced by complex refineries. Diesel and gasoline suit the demand of the local market and therefore offer the best possibilities for good margins.

For complex refineries, the margins are known in the industry as the crack spread.

When a refinery is making a diverse set of products, it is vital that it makes the correct proportion of different products that maximises its crack spread. Being attuned to both the local and international market for products is essential to be able to adapt quickly and this can also affect the spread significantly.

Maximising crack spreads

A recent example of how crack spreads can be maximised was the planned maintenance shutdown of the cracker at the PetroRabigh refinery on the Red Sea coast of Saudi Arabia.

The shutdown meant that more gasoline and diesel had to be imported into the kingdom, which kept refining margins high. This meant any regional refinery that planned for this outage could maximise their respective crack spreads if they produced more gasoline and diesel at that time.

“The [shutdown] at PetroRabigh helped margins in the Middle East region,” says Leitch.

The shutdown was temporary, but a more permanent aid to keeping the margins high in the region is government subsidies. 

Government subsidies play a significant role in the Middle East as most nations in the region sell gasoline and diesel at prices well below the 2011 global average of $1.24 a litre.

Prices can be as lows as $0.12 a litre for gasoline. Cheap fuel prices are a key element of governments’ oil wealth distribution strategies. This in turn has resulted in huge growth in fuel consumption.

Consumption of gasoline in the region’s largest economy, Saudi Arabia, is growing at around 7 per cent a year, which is good news for the region’s refiners, less so for the environment.

“There is a surplus of jet fuel in the Middle East, so that is usually exported,” says John Tottie, energy analyst at the UK’s HSBC. “But all the diesel and gasoline produced could be used on the domestic front, even though some refiners still export.”

Oil pricing mechanism

In most other economies, the prices paid to the refiners are based on retail prices, but due to the high subsidies in the Middle East, the amount paid in most states is based on the Singapore oil price.

The money the refineries in Saudi Arabia receive from Saudi Aramco is based on the price that is paid in Asia.

This has meant some good margins for refiners, as the Asian market has been performing strongly in recent months due to increased demand in key emerging economies such as China and India.

“There is still strong demand in the Asian market, which is keeping the refining margins high in that area,” says Leitch.

“They are adding a lot of extra capacity in China, however, so the margins will probably not [continue to] rise in line with demand growth.”

The future outlook for refining margins in the Middle East will be affected by global economic factors, as well as local ones.

The impact of Greece’s debt problems on neighbouring economies might affect Chinese exports to Europe. This could lower demand for gasoline and diesel in China, which in turn could affect margins on the Asian market.

The local issues are all dependent on the government subsidies. If they remain in place, demand will increase, which is good news for the local producers of refined products.

“With the recent [political] developments across the Middle East it is very unlikely that subsidies [for refined products] are going to change drastically,” says Tottie.

“Governments across the region will want to keep the political situation stable.”

All of the new capacity that will come on stream in the next five years will be complex refineries and they will make a wider range of refined products.      

The new refineries are also all being developed to process heavy types of crude, which means that they will not be drawn into price wars for the lighter blends if global oil demand rises.

New refineries are expensive to build, however. A world-scale complex refinery with a capacity of 400,000 barrels a day costs up to $10bn to develop.

New investments

This means any investment decision is based on a diverse set of factors including the prospective refining margins. But the business case is not completely dependent on them.

In many GCC states, where new refineries are either being built or planned, other factors such as adding value to oil resources, job creation and providing feedstock for downstream industries play a key part in the investment decision.

The proposed $7bn Jizan Refinery, for example, is being planned by Saudi Aramco as a means of bringing wealth to a relatively impoverished area of the kingdom.

What is unusual about the region is that it finds itself in a position where it has abundant feedstock, as well as burgeoning growth markets, both locally and in nearby countries such as India.

In the long term, the newer complex refineries in the Middle East will be well positioned to make decent margins from their products.

In an increasingly chaotic world, maximising their product base is the only definite way that oil producers and refiners can properly manage their business risk.