LONDON, Aug 12 (Reuters) – Oil firms that invested in complex refineries to process the most difficult crude and in theory generate big profits have inadvertently forced up the cost of feedstock, wrecking the economics of their plans, especially in Europe.
An increase in the cost of high quality lighter crude, which began about seven years ago, first inspired investment either in complex new plants or in adding cokers and residual hydrocrackers to existing refineries so they can process heavier oil.
What the refiners did not predict was the extent to which heavy crude costs would be driven higher by increased demand from more complex refineries and the plunge in refined products that followed the end of the oil market rally last year.
As profit margins have diminished, some new projects, particularly in Europe, are likely to be shelved, raising the prospect of supply tightness when demand recovers and as heavy crude supplies are expected to outstrip availability of lighter oil.
â€œThe first wave of large investment in conversion capacity and new complex refineries is coming on line in 2009-2010. Whatever was planned for 2009-2010 is going to come on, cancellation/postponement more likely to affect projects scheduled from 2011 onward,â€ BNP Paribas oil analyst Harry Tchilinguirian said.
â€œThe economics are more challenging as profitability of more expensive complex operations is eroded when the discount between the medium/heavy grades narrows relative to light grades.â€
Light, sweet crude, with low sulphur content, gives a high yield of high value products such as gasoline, diesel and jet fuel.
Heavier, sour crude, which includes more sulphur that has little commercial value and requires longer processing, historically traded at a deep discount.
The medium heavy, sour Russian benchmark grade Urals, for instance, traded at discounts of about $7 a barrel when Brent and U.S. light crude futures hit a record high above $147 in July last year.
But since July this year, it has traded at near parity to lighter North Sea streams, including Brent and Forties.
Another of the variables relates to the Organization of the Petroleum Exporting Countries (OPEC) as the groupâ€™s output cuts have reduced the amount of heavier crude available.
Thomas Oâ€™Malley, chairman of Europeâ€™s top independent refiner Petroplus, told a webcast last week the narrower gap between light and heavy differentials would continue to constrain complex refiners.
â€œWe may see three years of contraction of heavy light spreads … coker builders in the last couple of years are not happy builders,â€ he said.
Some analysts have said European refiners might have missed out on the cost advantage of a wide light-heavy spread once and for all.
By contrast with refiners in the United States, which has been processing heavy crude from domestic fields, as well as Mexico and Venezuela, for many years, deep conversion projects in Europe are recent.
They have been mostly geared to taking Russian medium-heavy Urals, which would have been unlikely to make the kind of profits possible from processing heavier Mexican and Venezuelan grades.
â€œLow demand and new refining capacity coming onstream in 2009 are likely to keep refining margins below those seen in recent years, unless serious disruptions occur on the supply side,â€ said one refiner in its second quarter earnings report.