Europe's refining sector braces for major downsizing as margins stall

With the end soon in sight for Europe's "golden era of refining", its downstream oil sector could soon be braced for an historic wave of capacity closures as energy transition headwinds begin to bite.

Germany, the heartland of European refining, has been at the forefront of announced capacity closures, with Shell planning to end crude processing at its Wesseling site by 2025 and BP planning to cut its Gelsenkirchen capacity by a third. Meanwhile Italy's Livorno has suspended crude processing, while the UK's Grangemouth could face closure.

Early announcements of downsizing are likely to usher in a broader wave of transformation as refiners turn their attention from the record refining margins to shifting demand patterns and long-term, existential questions around the future of the sector.

Based on expected overcapacity of refined products, the International Energy Agency forecast that some 1-1.5 million b/d capacity could be at risk of closure in Europe by 2030, dwarfing a previous average 220,000 b/d closures annually.

As a result, refiners are expected to increasingly consider run cuts, conversions or upgrades to clean fuels hubs in order to adapt, fundamentally transforming the industry in years to come.

Fading margins

The shock of the Russia-Ukraine war in 2022 put planned refinery closures on hold as margins shot up and refiners rushed to maximize production.

Two years on, margins have trended back toward historical norms, bringing longer-term energy transition pressures back into the foreground.

According to S&P Global Commodity Insights, Northwest Europe's ultra-low sulfur diesel margins peaked at $42/b in 2022, and have since receded to $29.71/b in 2023.

Longer-term, margins look set to become even more challenged. Western Europe's gasoil demand peaked in 2017, while both gasoil and gasoline demand are set to progressively erode after a brief uplift in 2025, propelled by electric vehicle uptake.

A rising burden of emissions charges will also push up operating costs for refiners, denting their ability to compete with new large-scale projects in the Atlantic Basin, such as Nigeria's Dangote refinery or Olmeca in Mexico.

Strategic shift

Faced with a dwindling margin outlook, many refiners have simply opted to close their European refineries and refocus on other regions.

According to Commodity Insights forecasts, Northwest Europe's ULSD cracks could drop from $25.45/b in 2024 to $16.27/b by 2026. The 36% decline contrasts with an expected 16% reduction in ULSD cracks on the US Gulf Coast over the same period, while Singapore' 500 ppm diesel cracks are expected to drop 22%.

In a race to adapt, oil majors have shut capacity in Europe, or sold assets to trading houses and other players typically focused on shorter investment timelines. ExxonMobil has slashed its capacity in Western Europe by around a third since 2000, while Shell has pledged to "right-size" its European business to just two refineries, focusing instead on North America and China.

According to forecasts by Commodity Insights, refinery utilization rates will drop from around 84% in 2024 to 81% in 2027 as refiners adjust to a weaker margin environment, accelerating closures through 2029-2030.

Close to 1 million b/d could be shuttered over 2029-2030, according to Commodity Insights forecasts, more than double the 473,000 b/d after the financial crisis (2007-2009) and well above the 656,000 b/d closed due to Covid-19 pressures (2019-2021).

Conversion plans

Others eyeing long-term opportunities in Europe have opted for biofuels projects or integrated petrochemicals facilities, both benefitting from longer-term demand certainty.

Livorno became the latest of several Italian refineries designated for conversion into a biofuel plant, while in France, La Mede and Grandpuits have also been converted into biorefineries.

A recent slump in biofuels margins appears to have blunted investment appetite, as companies have failed to realize returns on big renewables bets, though stakeholders have insisted that paused projects will be picked up as the commercial landscape improves.

Investment in the nascent biofuels sector will therefore rely on careful policymaking as governments seek to foster demand shifts and propel production investment. Otherwise, the continent could face a more dramatic pivot toward import dependency for new energy sectors.

"I think Europe will move toward clean fuels -- it has to, really," said Andy Brogan, energy sector partner at EY Parthenon. "Petchems will struggle because of feedstock costs. From an investment perspective, biofuels should make sense," he said.

According to analysis by Commodity Insights, 17% of completed or announced refinery closures for 2020-2027 have involved planned transformations into biofuel facilities, 23% were scheduled for permanent closure and 29% transformed into storage.