Clarissa Dann: We’re in the midst of what The Economist has called the most serious energy shock since the Middle Eastern oil crises of 73 and 79. There are shortages and fragility everywhere you look. And the International Energy Agency estimates that annual investment in clean energy needs to double to USD 5 trillion a year to reach net zero. Against this backdrop, we return to the theme of what this means for commodity producers and refineries and also how they’re financed.
Hesham Zakai: The world’s refineries are mainly concentrated in places such as the US, India and South Korea, but they depend on commodity rich countries for their inputs. Today we see a substantial increase of oil flows from Russia to Asia Pacific. So what does this mean in terms of the competitive position of Chinese and Indian refineries? Where does this leave Europe and the West?
Anastacia Davies: Global investment in the refining sector is decreasing. We anticipate over the next decade there’s going to be about $300 billion invested in new capacity, and that’s about half the level of investment that we’ve seen over the last two decades. So all in all, expect less capacity coming online. A lot of new capacity is going to Asia and sort of what we call east of as the Middle East and particularly China. These are big refineries, about over 300,000 barrels a day of throughput capacity or more. That helps them use economies of scale and reduce costs. Another major trend, a lot are geared towards petrochemical and petrochemical feedstocks.
Clarissa Dann: Thanks, Anastacia. Sandra, what are you seeing?
Sandra Primiero: We are seeing that refining margins are going up dramatically and specifically in Europe. We are confronted with shortage of supplies of oil and some refineries suffer from that as well. Maybe not the ones in the Nordics, which kept the oil also from the Nordics. But if I look at my home country, Germany, the couple of refineries received a lot of oil from Russia and faced constraints about oil supply right now. And that is a big concern, which paired with the lack of investments that you, Anastacia, have mentioned and the political tensions drives prices up. So if we speak from the perspective of refineries and oil producers, both experienced very good times right now in terms of very high margins. Question is just for how long and at which price promote economic and political perspective globally.
Anastacia Davies: A lot of refineries, especially in Europe, in the U.S., are experiencing huge amounts of utilization. In the U.S., refinery utilization is over 90%. And that’s something that’s going to maybe become a pain point as this conflict extends. So the U.S. has been tapping a strategic petroleum reserve for U.S. refineries. But as that started to diminish, they’re not able to receive, especially the grade of crude they’re used to refining. And that’s going to put some pressure on those refineries. There’s a lot of demand for refined products in the market that’s going to be exacerbated as this conflict continues. And it’s not clear where those supplies will be able to come from.
Sandra Primiero: Some of the countries which before send their oil to other countries for refining, are also investing into refineries. Speaking about Nigeria, for example, they will go live with a very sizable refinery. Other countries in Africa are considering, such as Angola, but are not there yet. The question is for how long do we really globally and in which region globally needs so much refined products from oil? And what impact has the current political situation on everything around substituting oil and gas products with renewable energy sources?
Anastacia Davies: We anticipate demand for road transportation fuel peaking in 2027. Granted, that doesn’t mean it’s going to disappear. We actually don’t think that that sector can get to net zero without additional policy support. There will be a pretty long tail and it’s being eaten into by things like electric vehicles, by things like biofuels. And so therefore, most of the growth is going to be coming from other products. If we look, for example, at some of the new refineries going in in China, we anticipate that about 30% of their output will be feedstocks for petrochemicals, compared to about 10% of the normal refinery today. So they will be well positioned to meet that market.
Clarissa Dann: Just turning to the U.S. refining market, President Biden did sort of call for them to reduce the profit margin, didn’t they? But is that really going to happen?
Anastacia Davies: Unfortunately, it’s not the refinery margin that’s really driving up the cost of these products. Most of the refineries in the U.S., as I mentioned, are operating pretty much at full capacity at the moment. There’s not much more that they can do to alleviate the price of the pump. They can’t actually produce any more supply. They can try perhaps to bring back refineries that have been shut down or trying to increase capacity. But even solutions like that, there are significant costs and they take a while. So they won’t be able to help alleviate the price this summer on the longer run. Also, it might not make sense because, as we mentioned, the demand for these products long term is probably going to wane.
Clarissa Dann: What about the European refineries?
Sandra Primiero: We see at least some of them invest heavily into becoming less carbon intensive. And for those I see a good future. It depends a lot on how the political environment evolves. But generally, I would assume that those refineries will now take the high refining margins and invest them into modernization CapEx. Have the best chances in the long run.
Hesham Zakai: Carbon reduction processing of biofuels from the research conducted at Bloomberg, and yet, is this the future of refining? Is this where you see it going?
Anastacia Davies: In the U.S.? Biofuels are really a hot market. We see a lot of conversions of existing refineries, and this is very much policy driven. Things like the Blender’s tax credit, the low carbon fuel standard in California. Making it more cost effective and attractive. In terms of the margin for shifting to biofuels, we mentioned the reduction in demand for road fuels, growing demand for petrochemicals. Another component where we see oil demand being very persistent is hard to abate things like aviation fuel. So this is an area in which a form of biofuels or renewable jet fuel that can sort of be a drop in barrel and displace existing oil barrels might be a way to sort of decarbonize the sector in a way to utilize the strength the refineries already have in producing new fuels.
Hesham Zakai: And Sandra, as opposed to some of the market participants. Deutsche Bank works with whether it’s commodity producers or off takers. This is something that’s going to have an impact in terms of the financing that they can receive and their investment prospects, the pricing margins.
Sandra Primiero: What we see is that they, of course, need financing for the higher price with uncertainties around supply chains. And this is not only true for refineries, but I think for every processor they try to increase the inventory levels and they are forced to do so and need financing for that. So that can be an unsecured lending. It can be a boring base structure in the commodity market. Very common, as you know, and is super important for lenders to finance that if we want to cope with this relatively challenging situation overall.
Clarissa Dann: Given the economic challenges are saying all around the world, do we really think governments are going to stick to all those pledges they made at COP26? Or will there be a bit of wriggle room?
Anastacia Davies: You can see it in President Biden’s actions that he has this sort of pool both ways, right? He came in on a pledge of being a very green president, of stopping oil drilling on shore and federal lands. Now, there’s talk about what’s he going to do for the five year plan for offshore oil drilling and how much land will he offer for lease sales. There is this dichotomy between trying to reduce margins on one hand for oil producers, refiners also trying to ask them to increase their production. On the other hand, long term, I don’t know if countries will stick to these pledges, but they certainly should, because current events show you there is volatility when you are so tied to global oil markets and to the geopolitics that comes with that. As other suppliers, renewable fuels tend to be much closer to home produced locally. That can reduce that dependance and therefore decrease that risk global commodities bring to your bottom line.
Sandra Primiero: The sanctions on Russia was quite a bit of a wake up call, at least as a German, I can say that are now even more aspirations to become less dependent on imported oil and gas while we are still very much dependent, I believe Germany has in the first half year 2020 to now have 49% of energy coming from renewable energy resources. And I believe that there is a new willingness also in the population to support investments into renewable energy sources.
Hesham Zakai: What would you say, Anastasia and Sandra is the most optimistic outlook for commodity producers and refiners. How can they possibly position themselves with that in mind?
Anastacia Davies: There is going to be continued demand for this sector long term, even in an ESG world, even in a net zero world. And there’s a lot of opportunities for the skills that these sectors provide. So we talked about refining things like biofuels might be a very good use of their skills and they’re well positioned for it. Even production things like carbon capture, utilization of carbon as it becomes a commodity is something that the oil and gas sector and even the mining sector will be particularly well adapted for.
Sandra Primiero: The producers and the refiners can be part of the solution. The price environment is so favorable for them in the current environment and the margins are high and if they use at least parts of that not only to make super high dividend payments but also reinvest into modernization CapEx, invest into diversification of energy sources, and have a very ambitious ESG agenda. I think then they are not only perceived as part of the challenges from an ESG perspective, but really also part of the solution.
Clarissa Dann: Hesham, AnastaCia and Sandra, thank you.
Hesham Zakai: Thank you for having us.
Anastacia Davies: Thank you.