It is in every oilman's mind now that one of the basic reasons of the current oil price environment is the world refining capacity and quality or the lack of it.
The worldwide crude distillation capacity as reported by the authoritative Oil & Gas Journal is 82.4 million barrels per day (bpd) at the end of 2004.
Similarly, the conversion capacity, which is the ability of a refinery to turn unwanted heavy products into light marketable products, is reported to be 27.5 million bpd or about 33 per cent of distillation capacity. Given the expectations of future oil demand, there is obviously a need to build new distillation and conversion capacity in many regions of the world and conversion may have to take precedence over new distillation capacity.
It is a known fact that refineries are very expensive to build and the profit margin is so low particularly when surplus refining capacity was available some years ago. Therefore, investors have shied away from them for this reason alone or in addition to the difficulties of obtaining permits particularly in the USA where the last new refinery was built almost 30 years ago.
However, some oil producing countries in the Arab Gulf region are taking the lead in announcing large scale refinery projects in Saudi Arabia, Kuwait and Iraq and perhaps Iran.
Saudi Arabia and Kuwait are perhaps encouraged to expand their refining industries by the current improvement in refinery margin and the revenue from the export of oil in the last couple of years in addition to the experience gained from their refining operations in the past. Iraq is a different story, as we shall see later.
Given that most of the crunch in refinery capacity is in the USA, Saudi Arabia tried to encourage partners to build new refineries to the tune of one million barrels a day. There was no enthusiasm for such plans because permits are very hard to obtain and it was reported that to prepare the papers for such permits would need about $100 million.
Thereafter Saudi Arabia announced that Aramco would seek partners to build a modern 400,000 barrels a day refinery in Yanbu to process heavy crude and to export gasoline to the USA, low sulphur diesel to Europe and fuel oil and naphtha to Asia. The refinery is expected to cost four to five billion dollars and even the private sector may participate in its financing.
It is not yet clear who will join Aramco in this venture but India's Hindustan Petroleum Corporation has shown interest and offered Aramco a reciprocal stake in its refineries in India.
The current refining capacity in Saudi Arabia is close to 1.75 million barrels per day excluding the two joint venture refineries with Shell (0.4 million bpd in Jubail) and ExxonMobil (0.32 million bpd in Yanbu). By modern standards these refineries are simple despite the fact that the conversion to distillation capacity is about 21 per cent.
Aramco therefore, has embarked on a wide-ranging programme to upgrade its refinery in Rabigh (0.4 million bpd) by adding capacity and introducing treatment and conversion units to produce high grade products in addition to a new petrochemical plant integrated with the refinery. This project is a joint venture with Sumitomo of Japan and is likely to cost some $4.3 billion.
A similar consideration is under study for Ras Tanura and Yanbu refineries. I believe that when all these projects are realized, the total investment may be close to $15 billion. The Saudi strategy in refining seems to be centered on processing heavier crude feed, introducing more conversion capacity and integration with petrochemical plants as it seeks to upgrade the industry and capture higher margins.
Kuwait is also considering a new 600 thousand barrels a day modern refinery and is seeking foreign partners for it. The refinery is likely to cost five to six billion dollars and front-end engineering design is already awarded to Flour Corporation, the US engineering company.
Kuwait is also modernising its three existing refineries by the addition of further conversion capacity and the replacement of old distillation units. The current refining capacity in Kuwait is close to 0.9 million bpd and the conversion capacity to distillation capacity is a good 31 per cent. If Kuwait did not need large quantities of fuel oil for its power generation conversion capacity would have been much higher.
In Iraq, "sobs flow here" as we say in Arabic. In the last fifteen years the Iraqis have not been able to invest in refinery capacity or upgrading due to wars, sanctions and finally the invasion and occupation in 2003. Iraq's refining capacity is close to 0.7 million bpd and conversion is very little at 5 per cent. These refineries are operating at 60-70 per cent at best and Iraq is importing large quantities of petroleum products to satisfy an increasing demand though some of the products are smuggled to neighbouring countries.
However, even if refineries utilisation improve, Iraq will continue to import light products for some time to come given the demand outlook as a result of the need for reconstruction, economic growth and high and unprecedented import of vehicles.
Therefore, the Ministry of Oil is considering building two new refineries with a total capacity that could be around 0.45 million bpd and a high degree of conversion. The first refinery would be 0.15 million bpd, which is known as Central Refinery due to its location south of Baghdad. This was a project of the late 1980s and could not be constructed because of sanctions and the Ministry is supposed to finance this project from its own budget.
The second refinery could be 0.2 0.3 million bpd and the Iraqis are discussing this project with many companies to secure some kind of a deal to finance this project through a joint venture or even a complete build, own and operate arrangement. It is very difficult to imagine investor's enthusiasm for this project given the economic and security conditions in Iraq.
But the Iraqis may eventually rely on their "crude oil power" to offer investors some form of a lifting agreement or the development of a new oil field where the refinery investment could be subsumed in the overall economics of the agreement. No matter what terms the Iraqis finally offer, it would be much better than importing on a large scale highly priced petroleum products from the international market with the attendant problems of delivering these imports to consumption centres.
The outlook for the refining industry worldwide promises to be good with investment in this sector estimated at $300-400 billion to the year 2030, according to the IEA with the Middle East accounting for $100 billion of that. The appreciation of products prices over those of crude oil will make margins relatively higher than previous periods. In the last few years margins have been over $5 per barrel in well configured complex refineries and it looks that this is the time to push the above cited projects and others forward.
The reluctance of the industrial countries to build new refineries may signal the return of resource based plants and allow the oil producing countries to play even a bigger role in the international market.
The writer is the former head of the Energy Studies Department at the Opec Secretariat and is currently working as an adviser.
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