Forbes.com

Global refining faces turbulent times

Success in global refining depends on how companies address three critical questions.

By Andy Steinhubl and José de Sá

First published on abril 30, 2012
min read


As the center of gravity in the global refining industry shifts away from American consumers to rapidly growing emerging markets, oil and gas companies face major implications. Sales in the US, once a key driver for global crude oil prices, have weakened in the sluggish economy and may not recover to previous levels, given the rising number of hybrids and electric vehicles. In developing markets, unpredictable demand has resulted in price volatility. Meanwhile, high oil prices and environmental costs put pressure on margins, sometimes leading to asset restructurings, sales or even bankruptcies. And despite excess supply and low margins, national oil companies (NOCs) continue to build out their refining capacity. In this turbulent environment, companies will survive only if they take matters into their own hands, rethinking their strategy in response to the industry's new dynamics. The key to staying ahead rests on answering three critical questions. How to benefit from the growing activity in emerging economies? The developing world—Asia in particular—will increasingly determine global fuels demand. OPEC estimates that between 2015 and 2020, demand for liquid fuels in the Asia-Pacific region will grow at 2% annually, while in North America and Europe, demand may decline slightly. Supply is shifting, too. NOCs continue to add refining capacity because it raises their margins over exporting crude. Many have formed partnerships with international oil companies (IOCs) to benefit from their operational expertise, and their access to global markets. For IOCs, these joint ventures give them access to the NOCs' domestic markets, with favorable tax terms and beneficial financing. NOCs also have advantages in building storage and pipeline infrastructure, especially in their own countries. But three key principles help these alliances succeed. First, there needs to be clear agreement on strategy. Partners may have different goals. For example, NOCs may want to protect national markets while IOCs aim to create shareholder value. Second, success will require effective decision-making. Management of the new entity must agree on critical decisions up front and clearly define roles and decision rights. If there's ambiguity, the success of the partnership may be threatened. Finally, joint ventures work best when they are supported by well-defined processes and metrics. The best joint ventures embed these in the organization's design to enable efficient operations. What is the right asset portfolio? Given the slowing growth in demand, we expect many refineries to cut back on the production of traditional liquid fuels, even while they may be ramping up production of alternative products and trimming their portfolios. Winning companies will consider a host of options. For example, cleaner diesel has long been popular in Europe. It's now becoming the preferred fuel in China and the rest of Asia. To meet the demand, IOCs around the world are upgrading refineries to produce low-sulfur diesel. Lubricants and petrochemicals also are becoming more attractive. That's why Total started building a lubricant-blending plant in Tianjin, China, last November, and ExxonMobil will expand a petrochemical plant in Singapore this year. And biofuels aren't going away, so smart IOCs are making strategic investments. Compared with alternative technologies, biofuels are an attractive investment, since they perpetuate the internal-combustion engine and in several cases share the same logistics and distribution infrastructure as gasoline and diesel. Industry leaders also are pruning their portfolios. Shell is selling assets in the UK, Africa, Scandinavia, Greece and New Zealand, and ConocoPhillips said it would sell about $10 billion of downstream assets over two years. The sales have generated a wave of consolidation across the refining industry as incumbents and newcomers try to gain an edge through more efficient operations. How to achieve world-class operational excellence? Margins are critical in a commodities business like refining. Companies that lower costs can benefit with significantly higher returns on capital employed—sometimes by as much as three times. Even companies with better-than-average cost positions have opportunities to improve. In our experience, they boost the output of finished products, usually through higher utilization and throughput. They increase yield, which reduces crude and overall feedstock costs. And they lower fixed costs by improving labor productivity and reducing maintenance costs. The shifting of demand growth to emerging economies and the rise of the NOCs pose challenges for refiners—but also new opportunities. By forming partnerships with well-positioned NOCs, by deciding how to benefit from emerging markets, by rebalancing their asset portfolio to address changing dynamics, and by raising their game in operational efficiency, companies can find new life—ahead of the competition—in a rapidly evolving industry. Andy Steinhubl is a Bain & Company partner in Houston and a member of the North American Oil and Gas practice. José de Sá is a partner in the firm's Rio de Janeiro office and a member of the Oil and Gas practice.

As the center of gravity in the global refining industry shifts away from American consumers to rapidly growing emerging markets, oil and gas companies face major implications. Sales in the US, once a key driver for global crude oil prices, have weakened in the sluggish economy and may not recover to previous levels, given the rising number of hybrids and electric vehicles. In developing markets, unpredictable demand has resulted in price volatility. Meanwhile, high oil prices and environmental costs put pressure on margins, sometimes leading to asset restructurings, sales or even bankruptcies. And despite excess supply and low margins, national oil companies (NOCs) continue to build out their refining capacity. In this turbulent environment, companies will survive only if they take matters into their own hands, rethinking their strategy in response to the industry's new dynamics.

The key to staying ahead rests on answering three critical questions.

How to benefit from the growing activity in emerging economies? The developing world—Asia in particular—will increasingly determine global fuels demand. OPEC estimates that between 2015 and 2020, demand for liquid fuels in the Asia-Pacific region will grow at 2% annually, while in North America and Europe, demand may decline slightly.

Supply is shifting, too. NOCs continue to add refining capacity because it raises their margins over exporting crude. Many have formed partnerships with international oil companies (IOCs) to benefit from their operational expertise, and their access to global markets. For IOCs, these joint ventures give them access to the NOCs' domestic markets, with favorable tax terms and beneficial financing. NOCs also have advantages in building storage and pipeline infrastructure, especially in their own countries.

But three key principles help these alliances succeed. First, there needs to be clear agreement on strategy. Partners may have different goals. For example, NOCs may want to protect national markets while IOCs aim to create shareholder value. Second, success will require effective decision-making. Management of the new entity must agree on critical decisions up front and clearly define roles and decision rights. If there's ambiguity, the success of the partnership may be threatened. Finally, joint ventures work best when they are supported by well-defined processes and metrics. The best joint ventures embed these in the organization's design to enable efficient operations.

What is the right asset portfolio? Given the slowing growth in demand, we expect many refineries to cut back on the production of traditional liquid fuels, even while they may be ramping up production of alternative products and trimming their portfolios. Winning companies will consider a host of options.

For example, cleaner diesel has long been popular in Europe. It's now becoming the preferred fuel in China and the rest of Asia. To meet the demand, IOCs around the world are upgrading refineries to produce low-sulfur diesel. Lubricants and petrochemicals also are becoming more attractive. That's why Total started building a lubricant-blending plant in Tianjin, China, last November, and ExxonMobil will expand a petrochemical plant in Singapore this year. And biofuels aren't going away, so smart IOCs are making strategic investments. Compared with alternative technologies, biofuels are an attractive investment, since they perpetuate the internal-combustion engine and in several cases share the same logistics and distribution infrastructure as gasoline and diesel.

Industry leaders also are pruning their portfolios. Shell is selling assets in the UK, Africa, Scandinavia, Greece and New Zealand, and ConocoPhillips said it would sell about $10 billion of downstream assets over two years. The sales have generated a wave of consolidation across the refining industry as incumbents and newcomers try to gain an edge through more efficient operations.

How to achieve world-class operational excellence? Margins are critical in a commodities business like refining. Companies that lower costs can benefit with significantly higher returns on capital employed—sometimes by as much as three times.

Even companies with better-than-average cost positions have opportunities to improve. In our experience, they boost the output of finished products, usually through higher utilization and throughput. They increase yield, which reduces crude and overall feedstock costs. And they lower fixed costs by improving labor productivity and reducing maintenance costs.

The shifting of demand growth to emerging economies and the rise of the NOCs pose challenges for refiners—but also new opportunities. By forming partnerships with well-positioned NOCs, by deciding how to benefit from emerging markets, by rebalancing their asset portfolio to address changing dynamics, and by raising their game in operational efficiency, companies can find new life—ahead of the competition—in a rapidly evolving industry.

Andy Steinhubl is a Bain & Company partner in Houston and a member of the North American Oil and Gas practice. José de Sá is a partner in the firm's Rio de Janeiro office and a member of the Oil and Gas practice.