Refining & marketing: Eyeing new horizons

Refining & marketing:

Eyeing new horizons
Anshu Mittal, Bala Vijayan Venkateshwaran, and Deepak Vasantlal Shah

A
MONG THE VARIOUS players in the O&G in the business. In fact, the market capitalization
value chain, petroleum refineries have been share of pure-play refiners has nearly doubled
the biggest beneficiary of the lower-for- to 12 percent in the overall industry’s market
longer oil price environment—which has widened capitalization over the past five years, breaking the
their crack spreads and renewed investors’ interest

Although many industry pundits have provided piecemeal perspectives across the phases of the
downturn and recovery, a consolidated analysis of the past five years and a complete perspective
covering the entire O&G value chain could help stakeholders—from executive to investor—make
informed decisions for the uncertain future.

With this in mind, Deloitte analyzed 843 listed O&G companies worldwide with a revenue of more
than US$50 million across the four O&G segments (upstream, oilfield services, midstream, and
refining & marketing) in an effort to gain both a deeper and broader understanding of the industry.
The ensuing research yielded a six-part series, Decoding the O&G downturn, which sets out to provide
a big-picture reflection of the downturn and share our perspectives for consideration on the future.

In part five of the series, we explore the downstream segment—assessing its fortunes during the
oil price downturn, identifying possible reasons behind its strong performance, analyzing changes
in the segment, and reflecting on the trends that will likely decipher the segment’s oeuvre in the
years ahead.

1
Decoding the O&G downturn

longstanding perception of it being a “disadvan- pure-play refiners and marketers grew three-fold to
taged” O&G business. about 6 percent because of oversupply in the crude
As always, a big change in a segment’s outlook oil market, higher price differentials between crude
typically has many facets, both implicit and ex- grades, and higher-than-expected growth in petro-
plicit, which have the potential to take industry leum products demand (figure 1).
watchers and even seasoned analysts by surprise. The market, however, did not reward the seg-
Did all pure-play refiners perform equally or was it ment’s changed outlook in line with the gains it
a mixed bag? What fueled the interest of investors reported. Was it because of a flat dividend yield of
in a region—margins or growth prospects? How do 3 percent with less than US$7.5 billion in buybacks
the segment’s stakeholders view the future? Having in 2018? No matter what the reason—uncertain
answers to these questions can be important to have prospects of growth in the long term, doubts about
an informed view about the future. the sustainability of high margins if crude oil prices
recover, concerns about impending International
Maritime Organization (IMO) 2020 regulations,2
The dark horse comes or the looming large-scale capacity additions world-
through ... wide—investors have held their optimism about the
sector in check.
For the downstream segment, less has meant Both margins and value creation are generally
more. The fall in oil prices starting in 2014, a vola- guided by actions and strategies of companies in
tile 2015, and a 10-year low of US$26/bbl in 2016, the recent past, especially investment in upgrading
followed by continued volatility in prices, have sig- the bottom of the barrel (refinery complexity). But
nificantly benefitted the segment.1 The downstream has increasing complexity proved a panacea for
segment, which was considered noncore by many cyclical maladies? Was the addition of upgrading
integrated players before 2011, became their savior complexity a successful business strategy over the
in this downturn. In fact, operating margins of past five years?

FIGURE 1

Downstream fortunes move upward in cadence with market trends

Revenue Market cap Operating margin (right axis)

200 Market capitalization accelerated at a 7

slower pace than margins as the market’s
evaluation has been conservative 6
Indexed, base year = 2013

Operating margin (%)

5
150
4

3
100
2

50 0
2013 2014 2015 2016 2017 2018/LTM

Note: This analysis covers listed companies in the downstream segment; it does not include IOCs and privately held
refiners.
Sources: S&P Capital IQ; Deloitte analysis.
Deloitte Insights | deloitte.com/insights

2
 Refining & marketing: Eyeing new horizons

The industry, however, continues to put more

Complexity and profitability: dollars into complex refinery configurations, re-
Dissonance or resonance? flected in the 40 percent growth in the asset base
US light tight oil production growth and sus- of major complex refiners during 2013–2018. These
tained price differentials between Brent and WTI investments probably reflect that companies aren’t
and between light and heavy crudes, despite the end expecting a sustained discount in US light crudes
of the US oil export ban, have principally benefitted (current Brent–WTI spread of about US$10/bbl),
simple refiners. Over the past five years, in fact, op- don’t want to skew their product slate toward
erating margins of simple refiners (with a Nelson gasoline (which is already under both demand and
complexity factor of less than 9)3 reached close to 7 pricing pressure), and would like to hold on to their
percent in 2018, higher than what a complex refiner feedstock and process flexibility (especially large
made in that year. Complex refiners have also re- refiners) (figure 2).5
cently come under pressure with cuts in supplies of These shifts and divergences have strong
heavy oil worldwide, leading to heavy crude trading regional-level implications, including where new
at par or at a premium to light crude.4 investment is going and where the most value

FIGURE 2

Globally, complex and noncomplex refiners have seen their operational results
and investment priorities diverge (2013–2018)
Noncomplex refiners outperformed their counterparts as crude slates turned turtle
Complex refiners (above 9 in NCI) Noncomplex refiners (NCI 9 and below)

8
6.91%
Operating margin (%)

6
5.74%

4
2.93%

2
1.93%

0
2013 2014 2015 2016 2017 2018

Refiners with complex configurations have expanded as they consider it essential for the
emergent energy transition
% increase in refining assets (2013–2018)

Noncomplex refiners

Complex refiners

0% 10% 20% 30% 40%

Notes:
1. This analysis covers the top 50 listed companies in the segment owning refining assets, excluding IOCs, privately held
refiners, and marketing companies.
2. NCI stands for Nelson Complexity Index.
Sources: S&P Capital IQ; Deloitte analysis.
Deloitte Insights | deloitte.com/insights

3
Decoding the O&G downturn

creation is happening. How might the competition

distillate margins remained above the past five-year
play out across regions in these new realities, es-
average).6 The result: The market capitalization of
pecially when Middle East producers are acquiring
Asian pure-play refiners grew by nearly 60 percent
refining assets in Asia to secure demand for their
since 2013, as against only 5 percent for US pure-
crude oil?
play refiners (figure 3).7
An option for export-oriented US refiners could
be to look east to sell their rising gasoline produc-
High margins in the west vs. tion, but they will likely face intense competition
growth in the east from new capacity in Asia/Middle East as well as
incumbent European capacity. Asia is projected
On account of the light tight oil boom in the to be the major contributor to global growth of
United States, margins of US refiners have traded coking units between 2018 and 2022, at around 38
US$6–10/bbl higher than Singapore refining percent of global planned and announced refinery
margins. However, investors seem to have favored coking unit capacity additions by 2022.8 Upcoming
long-term growth in Asia over transitory high capacity additions in Asia might also disrupt the
margins in the United States (which have come plans of Middle East refiners and push them to
under increased pressure lately, and have been look for other export markets such as Europe, es-
mixed at a product level as US gasoline refining pecially for middle distillates. Although short-term
margins fell to five-year lows in late 2018 while US demand pull for diesel due to the IMO 2020 ruling

FIGURE 3

APAC has grown to constitute the majority of global segment market capitalization
Asia Pacific United States and Canada Middle East Africa
Europe Latin America and Caribbean

Total 367 334 367 393 541 492

market
cap (US$B)
21 17 12 15 23 18
100
18 23 28
21 44 47
90 21
23 18 21
24 21
80

70 157 144
131
Total market cap (%)

124 137
136
60

50

40

30
202 296 263
165 152 174
20

10

0
2013 2014 2015 2016 2017 2018

Note: This analysis covers listed companies in the downstream segment; it does not include IOCs and privately held
refiners.
Sources: S&P Capital IQ; Deloitte analysis.
Deloitte Insights | deloitte.com/insights

4
 Refining & marketing: Eyeing new horizons

may provide some relief, more intense competitive should focus on the composition of demand. With
pressure may ensue on less competitive refining petrochemicals expected to represent about one-
assets in Europe and some parts of Asia.9 third of world oil demand growth between now
The impact of these changing market dynamics and 2030, and nearly half by 2050, many refiners
is not expected to be limited to fuels, competition with forward-integration possibilities are looking
between regions, and collaboration among tradi- to adjust their strategic plans.11 According to the
tional refining companies. Sophisticated large-scale International Energy Agency, petrochemicals
plants incorporating crude oil-to-chemicals (COTC) could add nearly 7 million bpd of oil demand by
technologies may change the basis of competition 2050, reaching a total of some 20 million bpd.12
in petrochemicals because of their yield advan- Apart from their regular usage in everyday prod-
tage. As against the global average of producing ucts, petrochemical products are increasingly used
8–10 percent naphtha from a barrel of oil from to manufacture many parts of the modern energy
traditional refineries, these new plants can produce system, including solar panels, wind turbines, bat-
40–45 percent petrochemical feedstocks. In short, teries, thermal insulation, and electric vehicles, says
the strategic focus of refiners may shift from advan- the agency.13
taged feedstock to market access, capital efficiency, Pure-play refiners (public and state-owned) are
and technology utilization.10 increasingly exploring value in investing in associ-
ated midstream and petrochemical infrastructure,
where there is a natural advantage or necessity.
Rejigging the menu Such companies have shown a stronger growth in
margins than pure-play refiners, as evidenced by
While demand growth for crude oil sustains their ~26 percent CAGR margin growth during
in the short-medium term, downstream players 2013–2018. But the recognition by the market of

FIGURE 4

Diversified refining players with petchem and midstream assets have shown
the highest value expansion (2013–2018)
Petchems: Key differentiator in margin growth Market favors refiners with midstream stakes
EBIT margin CAGR (2013–2018) Market cap CAGR (2013–2018)

Others Others
12.84% 0.40%

Pure-play R&M Pure-play R&M

15.29% 4.37%

Pure-play R&M with midstream Pure-play R&M with midstream

19.58% 9.16%

Pure-play R&M with midstream & petrochemicals Pure-play R&M with midstream & petrochemicals
25.53% 18.04%

Note: This analysis covers listed companies in the downstream segment; it does not include IOCs and privately held
refiners. Other companies include all those that do not have any refining assets, yet are active in other R&M areas.
Sources: S&P Capital IQ; Deloitte analysis.
Deloitte Insights | deloitte.com/insights

5
Decoding the O&G downturn

their strong performance has been muted as the processes, and incorporating molecular mod-
market waits to see if the returns can be sustained. eling into the overall refinery optimization) to
The ROI may need to be analyzed for longer to as- have more agility and adaptability in their oper-
certain its trajectory. This has been priced in by the ating model and stay ahead of changing demand
markets (~10 percent CAGR in market capitaliza- patterns. Put simply, develop a complete
tion, see figure 4). capability from crude oil to end-uses through
On the other hand, surprisingly, pure-play molecular characterization and modeling of
refiners with only associated midstream business, es-
refining streams.15
pecially in the United States, seem to have garnered
more attention from investors—these companies
• Refiners should stay ahead of regulations es-
registered close to 18 percent CAGR growth in
pecially on the emissions front through their
their market capitalization. Pipeline constraints
proactive investments in sulfur-free, high-
due to midstream bottlenecks (which has resulted
performance, clean-burning transportation fuels
in significant transportation costs) and notable
by upgrading the bottom of the barrel. Refiners
divergence in crude grades and spreads across
should bring in plant-level goals and risk control
local markets in the United States have benefitted
mechanisms that can enable the team to under-
(or reduced costs for) refiners with midstream
stand its cumulative responsibility in achieving
exposure.
these goals.
Although trends vary by region, pure-play
refiners with elements of midstream and petro-
• Refiners should look at innovative ways of
chemical exposure seemed to have garnered more
enhancing netbacks on invested capital via stra-
margins and delivered more shareholder returns
tegic, technological, and tactical alliances
as they have benefitted on all three fronts—advan-
that spread risk, maximize returns, sustain or
taged crude, midstream bottlenecks, and strong
grow their market share, and enable a win-win
petrochemical products demand.14
for all stakeholders (e.g., the 50:50 joint venture
between Saudi Aramco and Total plans to invest
around US$1 billion over the next six years in the
Lessons from the downturn Saudi retail fuel market).16 New refining assets
that are aiming to produce both refined products
The refining and marketing segment has
performed robustly over the past five years of a and petrochemicals should invest in the latest
low-price environment. But challenges are already technical processes as well achieve economies of
appearing on the horizon. These include ongoing scale in terms of size and complexity.17
price volatility in crude oil, slower growth in overall In conclusion, while the last five years may
petroleum products demand in the long term, have been the “best of times” for the downstream
changing demand and crack-spreads at the product
industry, there is no guarantee that the next five
level, environmental and regulatory concerns such
years will see similar good fortune. Refiners will
as those emanating from the IMO 2020 regulations,
need to be agile and invest in both technologies
rising risk of overcapacity, and carbon footprint. Al-
though the challenges for each company will likely and human resources in such a way that they can
be unique, the segment could benefit from the fol- preserve optionality in product lines and pricing.
lowing considerations: Considering downstream is an integral part of the
bigger O&G ecosystem, having a perspective across
• As against having a product mindset, refiners
could benefit from adopting a molecular man- the O&G value chain could be critical. Explore the
agement strategy (i.e., having a molecular-level entire Decoding the O&G downturn series to gain a
understanding about refining streams and 360-degree view on the industry.

6
 Refining & marketing: Eyeing new horizons

Endnotes

1. S&P Capital IQ database, accessed January 2019.

2. Lee Hong Liang, What you need to know: The 2020 IMO fuel sulphur regulation, Seatrade Maritime News, accessed
February 21, 2019.

3. Preem, “Nelson Complexity Index,” accessed February 18, 2019.

4. Liam Denning, “Gasoline pulls oil prices into reverse,” Bloomberg, November 9, 2018.

5. Serene Cheong, “Keep it simple, stupid: Complex oil refiner margins squeezed,” Bloomberg, December 14, 2018.

6. US Energy Information Administration, “This week in petroleum,” February 13, 2019.

7. Liam Denning, “Shale? Here’s the other wave washing into the oil market,” Bloomberg Businessweek, March 6,
2018.

8. TradeArabia, “Asia to see major growth in refinery coking unit capacity,” October 16, 2018.

9. Ibid.

10. Denning, “Shale? Here’s the other wave washing into the oil market;” R. J. Chang, “How will crude oil-to-chemicals
reshape the global petrochemical industry,” Gulf Petrochemicals & Chemicals Association, August 1, 2018.

11. Carla Sertin, “Saudi Aramco CEO: Company’s strategy will include more downstream acquisitions,” OilandGas
Middle East, November 27, 2018.

12. International Energy Agency, “Petrochemicals set to be the largest driver of world oil demand, latest IEA analysis
finds,” October 5, 2018.

13. Hellenic Shipping News, “Middle East petrochemical push signals oil’s future,” February 11, 2019.

14. Ibid; Sertin, “Saudi Aramco CEO: Company’s strategy will include more downstream acquisitions.”

15. Yongwen Wu, Molecular management for refining operations, University of Manchester, 2010.

16. Saudi Aramco, “Saudi Aramco and Total invest in high-quality retail fuel network in Saudi Arabia,” February 14,
2019.

17. Chen Aizhu, Rania El Gamal, and Meng Meng, “Saudi Aramco to sign China refinery deals as crown prince visits,”
Reuters, February 21, 2019.

About the authors

Anshu Mittal is an associate vice president in Deloitte Services LP’s Research & Insights team. He is
based in Hyderabad, India.

Bala Vijayan Venkateshwaran is an oil & gas manager on Deloitte Services LP’s Research & Insights
team. He is based in Hyderabad, India.

Deepak Shah is an oil & gas assistant manager on Deloitte Services LP’s Research & Insights team. He
is based in Mumbai, India.