Big trouble for big oil (page 1 of 2)

Sultan Hussein, the CEO of Emirates National Oil Company, is worried. His company could soon be facing bankruptcy, which he blames on the regulated market - the government sets the price at which he can sell gas to retail consumers without capping the price that he has to pay for crude oil.

Hussein says that because of rising crude prices, which have jumped from $10 a barrel in 1998 to nearly $30 a barrel this year, his company is losing heavily at the pump, where the prices have failed to keep pace. His company is losing nearly $35,000 every month, he says, because of this difference in prices.

ENOC's Hussein is not the only oil executive worried about the impact of rising crude prices. His counterparts at oil majors ExxonMobil, Shell and BP are all suffering due to a combination of the sharp rise in crude prices and a slowdown in the global economy, which has reduced the demand for petroleum products around the world.

The trouble for almost every integrated oil company - those firms that deal in every aspect of oil, from exploration and production to refining and distribution - comes from their refining activities. Refining is a chemical process by which crude petroleum that is produced from the oil well is converted into the gas and diesel you fill your tank with.

Since this involves value addition and is the aspect of the oil business that is closest to the final consumer - after retail distribution - margins are usually better and risks far lower than in exploration or production. This is the reason why almost all major oil companies have been present in the refining business for several decades. For a long time now, the trend in the oil industry has been for companies to be integrated players.

But that's changing. Increasingly, companies are looking critically at their refining operations, and some have even shut down their refineries. Royal Dutch/Shell, the world's second largest oil company, is closing down 17 percent of its refineries in Europe.

The company is also axing its refining activities in North America, where it will shut down 12 percent of its refineries, and is poised to make cuts in Asia as well. According to Paul Skinner, "The margins in the business have collapsed. For instance, in Asia the refining margin is down from $2.35 per barrel in 1997 to $0.23 this year."

Skinner's pessimism about the sector is shared by Frank Sprow, vice president for safety, health & environment at ExxonMobil. "Refineries are clearly under pressure. The question is: Will oil companies get out of the business?"
Overcapacity is the biggest problem facing the refining industry.

The global oil refining capacity now stands at 82 million barrels per day, while demand for refined oil products is only about 75 million barrels a day, leaving a gap of 8 million barrels. This overcapacity has resulted in a slump in profits for refineries.

According to an industry study, refineries do not make money unless they are operating at 90 percent of installed capacity. The average capacity utilization for 2001 stood at 85 percent. And a refinery needs to refine 100,000 barrels per day in order to break even. The average daily output per refinery in 2001 was less than 90,000 barrels.

Enticed by booming economies in the late 1980s and early 1990s, especially in Asia and Latin America, the construction of refineries all around the world was carried out at a frenetic pace. By 1998, the world's total refining capacity stood at a record 83 million barrels per day.