Essar Energy (LSE: ESSR.L - news) believes Stanlow refinery can survive the gloom that threatens the UK industry - but warns more refinery closures will leave Britain ever more dependent on imported fuels.
When Stanlow refinery was bought by Essar Energy more than a year ago, many of the plant’s staff had never even heard of their new employers.
The sprawling industrial site to the south of the Mersey estuary had been owned since the 1920s by the global oil giant Royal Dutch Shell (LSE: RDSB.L - news) . Essar, by contrast, was a new entrant to the London Stock Exchange (LSE: LSE.L - news) with a handful of power plants and a refinery in India.
But that difference, Stanlow’s staff claim, could prove to be the key to its survival amid an industry downturn that is likely to see other UK refineries fail.
“Shell was maintaining the site but it wasn’t really investing in developing the business,” explains John Mason, Stanlow’s site manager.
“In the Shell world, the threshold for project approval on margin generation was very high because the alternative was always to invest upstream [in exploration and production] and make even more money. In an Essar world, as a standalone business, the dynamic changes completely.”
Without high-return oil drilling prospects in its portfolio, it made sense for Essar to invest $30m (£18m) in a 3km pipeline to bring natural gas to Stanlow’s boilers, replacing less efficient fuel oil and saving money in the long term.
Dozens of further changes are planned out on A3 sheets in the office of Volker Schultz, Essar Oil UK’s chief executive. The aim is gradually to fine-tune the refinery to increase the margin on each of the 75m barrels of crude oil that Stanlow processes every year making it more competitive against its European peers.
Stanlow enjoys some innate advantages it is large scale, the fuel-hungry cities of Manchester and Liverpool are on its doorstep and it has the biggest “residue cat cracker” in Europe. This piece of kit enables it to process the “gunkiest” parts of crude oil, producing a higher proportion of more lucrative diesel than some of its competitors.
Those advantages have allowed Stanlow to build in a bigger gross margin than its competitors running at $2-a-barrel over the European average when Essar took over. With the changes planned, Schultz believes at least $5 above average is achievable.
That should be enough effectively to insulate Stanlow from the worst troughs of the refining market such as those seen at the start of this year, when Coryton in Essex was forced to close with the loss of 850 jobs.
Refiners have enjoyed a brief respite from doom in recent months as supply disruptions elsewhere in the world have boosted margins. But Schultz says low margins will return and that will put more refiners under pressure.
The core of the problem is that petrol production from European refineries is outstripping demand at the pumps. It isn’t just a short-term feature of the recession but a structural change reflecting more efficient cars, the popularity of diesel and the mandated addition of biofuels to petrol, which alone has caused a near-5pc disjunct between supply and demand.
The UK, like other European countries, finds itself importing diesel but with petrol left to export. Finding buyers for that surplus, says Schultz, is the issue.
Other regions also have a surplus: in the US, where refiners enjoy cheaper energy costs; in Russia, where the tax regime can be more favourable; and in the Middle East and India. “These are world-scale, shiny, beautiful refineries, with better economies of scale,” he says. “Of course they will be better off to export.”
UK refiners, which cannot sell their surplus petrol, are left with little option but to reduce volumes and that puts margins under pressure. “I think you’ll find refiners closing on the back of it,” Schultz warns.
He won’t be drawn on names, but smaller or more petrol-focused refiners could be next. Milford Haven in Wales is seen by some as particularly vulnerable.
For refiners on the edge, every few cents of margin are critical and that’s why Schultz says incoming green measures such as the UK’s unilateral carbon price floor will be damaging: “Anything that only hits the UK, we don’t like. If margins come down again, a couple of those items together can tip a refiner.”
He is “absolutely confident” Stanlow will survive and for Essar, the closure of other UK refineries could help to reduce petrol over-capacity. But Schultz warns closures will be a double-edged sword: “Refineries will struggle because of gasoline but, at the same time, there is a shortage of diesel and jet fuel. We currently import about 30pc of diesel. If you shut a refinery that will go up. I don’t know, as UK plc, if I would like to rely on [imports for] 50-70pc of a critical, strategically important fuel .”
Schultz may have the plans to save Stanlow but this diesel-petrol imbalance is one problem he admits he does not know how to solve. “All we can do, whatever happens, is to be competitive and ride out the storm.”