Over the past decade, the thirst for fuel in emerging economies has mirrored their spectacular economic rise, shifting growth in demand for energy from the West to the East. The changing dynamics of energy demand have, in turn, affected the downstream petroleum sector, increasing the share of new investment flowing to emerging markets. Four out of five of the largest refinery projects realised over the past five years have been built in countries outside of the Organisation for Economic Cooperation and Development (OECD).

However, the demand growth in emerging markets will only partially offset slowing global consumption, which in turn is rendering the outlook for the industry somewhat cloudy. A boost in capacity in China and the Middle East combined with a shifting outlook for energy demand means cost recovery for new projects will not be as straightforward as it once was. Opportunities remain, however, in markets with growing demand and underdeveloped or ageing infrastructure.

GROWING DEMAND: Demand for energy in emerging economies is now greater than that of developed ones in the West. According to the International Energy Agency’s (IEA) “World Energy Outlook 2012”, demand in OECD member countries rose from 29.81bn barrels of oil equivalent (boe) in 1980 to 38.38bn boe in 2009. Over the same time period, demand in the rest of the world rose from 21.85bn boe to 48.14bn boe. According to the IEA, overall energy demand in 2035 will have grown by an additional 40%, with some 90% of this increase coming from non-OECD countries.

The economic crisis that began in 2008 has only exacerbated this trend. Global energy consumption fell around the world in both 2008 and 2009 as global GDP contracted. While demand in Europe and North American has since stagnated, growth has continued in non-OECD countries. According to BP’s “Statistical Review of World Energy”, global oil consumption rose by 600,000 barrels per day (bpd) or 0.7% in 2011. In OECD countries, however, growth decreased by 1.2%, the lowest level since 1995 and the fifth annual decline in six years. Outside the OECD, consumption increased by 1.2m bpd, or 2.8%. In 2011, China was leading the way with demand up by 505,000 bpd, or 5.5%. Middle Eastern energy demand also increased, rising by 1.8%. African consumption growth declined by 1.4% for the first time in five years, due in part to slowdowns in North Africa, but overall the continent’s long-term trend is broadly positive.

THE SHIFT: The demand shift in the developed economies of Europe and North America is a consequence of the sustained growth of emerging economies coupled with a change in the composition of OECD economies. According to the IEA’s “Oil Information Statistics 2012”, oil supply per unit of GDP in North America has more than halved since 1971. Europe has seen an even sharper decrease in the energy intensity of its economy. Moreover, government policies to decrease carbon emissions coupled with consumer preference for more fuel-efficient automobiles has furthered dampened OECD oil demand.

Amidst the changing demand trends, global refinery capacity has continued to grow. According to the IEA, since 1990 the annual refinery output across Asia, excluding China, has almost doubled from 1.4bn to 3.3bn barrels in 2010. Output in China alone quadrupled from 781m to 2.9bn barrels per year. According to Seth Kleinman, global head of energy strategy at Citigroup, “China’s decision to designate refining as a strategic industry has led to a massive increase in capacity, rendering the country a net exporter of fuels.” Over the same time period, output in the Middle East rose from 1.4bn barrels a year to 2.3bn barrels, often via greenfield projects of impressive size.

MARGIN PRESSURE: Growth in refining capacity combined with weak demand has led to a glut in capacity, putting pressure on refining margins. Because of large fixed costs of refinery construction, high utilisation rates are required for profitable operation. According to BP, the global average refinery utilisation rate fell to 81.9%, the lowest level since 2009. Low utilisation rates caused problems for refineries during the economic crisis in 2008 and 2009 as crude prices tumbled, putting further pressure on margins and forcing closures across Europe and North America. Despite relatively low crude prices, the price rebound for refined products eased the pressure in 2012.

Increased capacity is scheduled to come on-line in the next few years, tempering the outlook for the global refining industry. According to David Bleasdale, executive director of consultancy CITAC Africa, “a positive outlook for refining requires continued growth in demand in Asia and an assumption that China does not overbuild capacity, leading to supply and demand imbalances. If history is any guide, however, refiners often overbuild; the current cycle does not look any different.” In addition to China, both the US and the Middle East are growing their export capacity. Refineries along the US Gulf Coast have increased output in line with growing margins due to cheap electricity from low gas prices. New refinery complexes in the Middle East will add hundreds of thousands of barrels a day to global capacity as they come on-line later this decade.

NEW CONSTRUCTION: Despite downward pressure on margins and continued capacity increases, construction of new refineries has continued. According to Petroleum Economist’s 2012 new construction survey, 10.5m bpd of distillation capacity is under construction or planned with a reasonable degree of certainty worldwide. This is slightly down from the 2011 survey, which listed global construction capacity at 10.8m bpd. The 2012 figure consists of 32 new refineries and 16 expansions. Asia-Pacific accounts for 31.5% of new capacity; the Middle East is next at 29.3%. New construction in Africa makes up 10.4% of the global total.

MODERN REFINING: Economically viable refining projects depend on a variety of domestic and international factors to be successful. For domestic-oriented refineries, large inland demand, limited low-value exports and a source of good-quality local crude all contribute to economic margins. For those refineries seeking to export products and compete on a global scale, large capacity, integrated petrochemicals facilities and a cheap source of local crude that matches demanded output products are important. Cost-effective financing is also integral to viability given the large fixed costs of modern refineries. Success depends not only on financing and construction costs, but effective operation and machinery that matches the input and output slates with supply and destination demand. “To be viable in today’s economic climate, you need to have excellent logistics and be able to extract every molecule of value from feedstock,” said Bleasdale.

MIDDLE EAST: About one-third of current or prospective construction of new refining capacity is situated in the Middle East. In recent years, governments in the region have increased spending on the downstream sector, aiming to add further value the region’s large upstream petroleum sector. Investments have been made in new refineries, expansion of existing refineries, as well as petrochemicals plants and liquefied natural gas (LNG) transportation terminals. In 2011 there was about $25bn of new construction activity in the oil and gas sector. In 2013 the total is forecast to rise slightly to $27bn, down significantly from 2009, when governments in the region poured a record high $52bn into oil- and gas-related construction activities.

DRIVING INVESTMENT: New investment in refining capacity in the region is being driven by several factors. First, demand is forecast to continue rising dramatically, due to economic and demographic growth and the continued existence of large subsidies that discount the price of petrol and encourage its use. According to the IEA’s “World Energy Outlook 2012”, oil demand in the Middle East is forecast to rise by about 50% in 2035, from 2.19bn boe to 3.14bn boe in 2035 under its new policies scenario.

Second, many states, in particular Saudi Arabia and the UAE, are building refineries with the goal of exporting refined products to markets in China, Africa and Europe. The $7bn Jizan refinery, for example, with a capacity of 400,000 bpd, should begin construction in 2013. The refinery will process Arabian heavy and Arabian medium crude from the Manifa oilfield. The refinery is an integral part of Saudi Aramco’s push to expand its export capacity. Located on the Red Sea coast, the refinery provides easy access to both European and African markets. The output of the refinery will be diesel fuel and petrol. As refined products fall outside of the quotas set by the Organisation of Petroleum Exporting Countries (OPEC), exporting refined liquids can increase foreign exchange earnings beyond what is permitted by the quota-setting organisation GREEN EYE: Another motivation driving investment in the refining sector is the desire to increase environmental quality of outputs by lowering sulphur content. Many of the refineries in the Middle East are ageing and do not have the technology to achieve strict new European standards for refined liquids. Firms are investing in hydrotreaters in order to produce the low-sulphur fuel demanded by Europe, and increasingly developing world markets. Work to convert the Yanbu refinery, for example, a joint venture between Saudi Aramco and the Chinese company Sinopec, follows a similar trajectory. The 400,000-bpd refinery is undergoing a full conversion to enable to production of ultra-low-sulphur fuel from Arabian heavy-grade crude oil. Like Jizan, the project is situated on the Red Sea, facilitating exports of diesel fuel and petrol that meet the stringent environmental standards of Europe.

Despite growing domestic demand, the economics of many of the new Middle Eastern projects will face a more competitive global market. According to Kleinman, “The economic potential of refinery investment in the Middle East is uncertain, as overall demand for both petrol and distillates will likely disappoint. New refineries in the Middle East are reliant on the state and partnerships between state-owned oil firms and global companies for financing. On the positive side, the large scale and modern technology of the refineries in the Middle East, combined with the fact that they are part of massive integrated energy complexes, could increase their competitiveness on a global scale.”

AFRICA: The dynamics of refinery finance and construction in Africa differ from most regions in the world. With a rapidly growing demand for energy due to a decade of strong economic growth and an emerging middle class, capacity in many African countries is not sufficient to meet domestic demand. Nigeria, for example, despite being the sixth-largest exporter of crude in the world, imports over 70% of its refined fuel needs and its refineries operate at roughly 70% of capacity due to underinvestment and poor management. This is not unusual: refineries in sub-Saharan Africa are often plagued by small capacity, low utilisation rates, high demurrage costs, poor maintenance and management, and configurations that are mismatched to both crude inputs and demand outputs.

Similarly, construction of new refineries is difficult in the African context. Fuel subsidies, which are prevalent across the continent, have destroyed margins and limited downstream investment. In 2011, for example, Ghana released a tranche of bonds equal to nearly 1% of GDP to help settle arrears from the state-owned Tema Oil Refinery (TOR) that had built up as a result of the artificially low tariffs. Moreover, the lack of low-cost financing has hindered investment in refining capacity in the region. “Investment in Africa remains difficult, as scale remains small and the investment climate is opaque,” notes Kleinman. The consequences of the lack of investment are visible across the continent: ageing refineries with little secondary refining capacity.

Total nameplate capacity in Africa is just 3.2m bpd and secondary refining capacity is only 23% of the distillation capacity. Consequently, many African countries import a large quantity of their fuel needs, using up valuable foreign exchange reserves. Furthermore, the lack of hydrotreaters at most African refineries has led to refined products with very high sulphur content, and this poses both health and environmental threats.

LOCAL CHALLENGES: Domestic and international political factors compound the difficult investment environment. High trade barriers and small populations with low demand make it hard to build economically viable refineries. “Since 2000, there have been over 100 announcements of new refinery projects in Africa. The only projects that have been realised, however, are the Chinese-built refineries in places like Sudan, Niger, Chad and Algeria,” said Bleasdale. “The role of governments is to create an enabling environment for investment by providing long-term fiscal stability and credible guarantees of subsidy payments and tax credits. In many African countries governments also have a role as shareholders in their national refinery — a role that carries the responsibility for capital planning, financing and longer-term strategy.” Consequently, successful projects require the state to play this role well.

Despite the difficulties, there has been a degree of new investment in the downstream sector in Africa in recent years. Ghana, for example, has announced plans to be a net exporter of refined products by 2015, with the Federal Ministry of Energy and Petroleum stating it planned to increase output from 45,000 bpd at the country’s solitary refinery to 60,000 bpd in the medium term via upgrades to TOR, and eventually 120,000 bpd, following the construction of a second refinery.

Most projects elsewhere on the continent currently under construction have been built with the participation of foreign companies. The Chinese National Petroleum Company (CNPC) has been involved in five of the seven new refinery projects over the past few years. For example, in Sudan the CNPC is currently in the process of building a $1bn, 100,000-bpd refinery. CNPC also controls a large portion of the 500,000-bpd crude export capacity in the country. In Chad and Niger CNPC has begun construction of two 20,000-bpd refineries to process crude from fields in which CNPC also has a controlling stake. However, it is not all Chinese involvement. Angola’s Sonangol, the national oil firm, is planning to build a 200,000-bpd refinery near Luanda. The $8bn facility will be equipped with full-upgrading capacity. The construction of a 400,000-bpd full-upgrading plant in South Africa has been promoted by PetroSA at Coega. The $13bn project would be used to displace imports of refined fuels.

Plans have also been floated for new refineries in Gabon, Equatorial Guinea, Congo and Uganda, but half of the announced projects in the past decade have been in Nigeria. With a large market and growing demand, Nigeria requires upgrades to its refining capacity. The country’s four functional refineries, at Kaduna, Warri and two at Port Harcourt, operate at between 60% and 70% of capacity. Money has been committed in the federal budget to overhaul the country’s existing refineries. An extended shutdown is planned in 2013 for one of the refineries at Port Harcourt, and a similar maintenance plan for Warri is scheduled for 2014.

Overall, however, new refinery construction has been hamstrung by fuel subsidies, which the government tried unsuccessfully to eliminate in 2012. Subsidy payments are often delayed by six months or more, putting significant strain on operating cash flow and limiting new construction. Consequently, Nigeria imports over half of its refined fuel needs. The improvement of Nigeria’s macroeconomic environment, however, should generate opportunities downstream. In an interview with Bloomberg in mid-November 2013, Diezani Alison Madueke, the minister of petroleum resources, said the government plans to begin privatising the four refineries before the end of the first quarter of 2014.

NORTH AFRICA: North of the Sahara desert, there has been greater success. Headline financing was secured in 2012 for Egypt’s $3.4bn Mostorod refinery, which will be Africa’s largest if it is completed. A mix of equity and debt provided by international and local banks, in addition to multilateral investment agencies like the African Development Bank and International Finance Corporation, went ahead and funded the project despite the political unrest. In Tunisia, talks have resumed with Qatar Petroleum for a $2bn refinery at Skhira, which would have a nameplate capacity of between 120,000 and 130,000 bpd. The plant would supply the domestic and European markets. In Algeria, a 30,000-bpd expansion is planned for an existing refinery at Skikda.

BEYOND ECONOMICS: Stagnant global demand and increasing capacity in China and the Middle East will limit the growth potential for refinery construction in the near future. As a consequence, new export-focused projects will be difficult to realise, as margins will come under pressure with increasing global capacity. Investment will continue, in particular in countries with growing and captive inland markets. Furthermore, given the economics of the industry, most investment will likely be driven by state interests and their partners.

Refineries are an attractive investment. “There remain reasons – beyond the purely economic – for governments to invest in refining capacity. Security of supply, technology capture, employment, ease of tax collection, improved pricing rateability and the consistent quality of products are all factors that support the development of domestic refineries,” Bleasdale said.