Falling oil prices have deeply affected oil and gas upstream, with many projects shelved or put on hold globally.
For much of the downstream sector, though, the current environment also provided cheaper feedstock (crude oil) and a sudden stimulus to demand.
Overall, sinking oil prices have served as a shot in the arm for the downstream sector in the short term. The fundamental challenges for the refining industry, however, remain.
The market is set to remain oversupplied in the coming years. This could only be alleviated if low prices persist and a large portion of planned refining projects are cancelled.
Nevertheless, even in the case of persisting low crude oil prices, several questions exist on the degree to which demand could increase in the medium or long term.
Efficiency and substitution (biofuels, natural gas, and electric vehicles) may limit the demand growth upside. Furthermore, in many Asian countries fuel prices remain regulated and the impact of lower oil prices on demand could not be immediate. Or, if these countries decide to remove the subsidies, (as India and Indonesia have just done) prices could even increase, adversely impacting the demand.
Based on this, we expect that refining margins will remain under pressure for the medium and longer term, largely because of overcapacity and relatively slow demand growth.
In the Middle East, refiners have reaped significant benefits from the temporary overall improvement in margins. For GCC countries that have invested heavily in the downstream sector (such as Saudi Arabia), higher downstream margins have provided partial relief from the drop in crude oil revenue.
Still, the increased exposure to an oversupplied refining sector (to which the Middle East contributed significantly) requires regional players to improve their ability to compete more aggressively in the market – scale, supply advantage and location may not be the only attributes sufficient to ensure satisfactory returns anymore.
We identified four key opportunities for Middle Eastern downstream players:
• Focus on operational excellence.
• Build strong trading capabilities.
• Expand internationally in refining.
• Advocate for subsidies reduction or removal on refined products.
In the first place, Middle Eastern players need to focus on operational excellence, which still lags behind international best practices. Limited pressure on reducing personnel (because of NOC employer roles), subsidised energy and security of supply considerations are among the reasons for the efficiency gaps that still persist in the region.
In our experience, a systematic profit improvement programme can result in a margin improvement of between US$1 and $2 a barrel, acting on technical levers such gross margin optimisation, energy management, maintenance and auxiliary operations. It also acts on soft levers such as organisation and culture that hardwire desired behaviours in employees that are required to make the change and the gains sustainable over time.
Besides manufacturing efficiency, Middle Eastern players should also improve the way in which they market their products. Regionally, oil and gas companies should strengthen their trading capabilities and make additional investments in logistics assets in markets spanning Asia, Africa, and Europe, to help them efficiently dispose of the growing export product volumes from domestic assets and secure the necessary products for their domestic markets.
A strong trading arm could make the argument for domestic self-sufficiency at all costs less compelling, and provide an alternative to additional large grassroots domestic refining investments – often driven by the need to satisfy the local demand for gasoline, but resulting in large export volumes of other products, diesel in particular.
In the current environment, Middle Eastern producers should increase their presence in international refineries. In addition to causing a steep fall in oil prices, the oversupply of crude has triggered a fierce battle for market share among producers.
Investments in refining assets in key markets secure the placement of volumes and curb the need to slash crude official selling prices to defend market share. Although it may seem counter-intuitive in an over-supplied market, investments in refining assets can still be economical if purchased or built at the right price. These opportunities exist because of the low trading multiples of refining assets in mature markets, or the incentives provided by developing countries in Asia or Africa seeking to attract partners with crude and capital to develop domestic refineries.
Finally, today’s low-oil-price environment presents an opportune moment to eliminate or reduce subsidies on refined products – a major burden on regional government budgets and oil downstream companies’ bottomline. The UAE has made the first move, linking gasoline and diesel to international market prices and creating an example for other countries to follow.
Mirko Rubeis is a principal for the Middle East at The Boston Consulting Group.
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