Full Potential Oil Refi ning in a Challenging Environment

Refi ners have enjoyed comparatively good times as the rest of the oil industry suffered, but they should prepare for a more competitive season ahead.

Pedro Caruso, Diego Garcia and José de Sá

Pedro Caruso is a partner with Bain & Company in Houston, Diego Garcia is

a principal with Bain in Buenos Aires and José de Sá is a Bain partner in São

Paulo. All three work with Bain’s Global Oil & Gas practice.

Copyright © 2016 Bain & Company, Inc. All rights reserved.

Full Potential Oil Refi ning in a Challenging Environment

1

While much of the upstream sector has struggled

mightily since crude oil prices began collapsing in

the summer of 2014, refiners have enjoyed a period

of relative prosperity. Falling crude prices buoyed re-

fi ners’ margins, even as upstream producers trimmed

costs and strained the capacities of their suppliers.

But the easy times for refi ners may be fading rapidly.

Margins have already tightened as crude oil prices

stabilized and refiners began to pass their savings

on to customers (see Figure 1). That’s not all—

over the next few years, refiners will have to cope

with several long-term challenges sure to separate

leaders from laggards and possibly force some poor

performers from the field.

For starters, the global supply of crude continues to

get heavier and more sour, except in the US, where

light tight oil production has increased (see Figure 2).

Unstable supplies from North Africa and the Middle

East, together with fading production from the

North Sea, are also affecting this mix.

Over the next few years, refi ners will have to cope with several long-term challenges sure to separate leaders from laggards and possibly force some poor performers from the fi eld.

Figure 1: Overcapacity and price adjustments are pushing margins down

0

0.5

1.0

1.5

Q1 2015 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16E Q4 16E

Actual and projected refining margins in different regions(indexed to Q1 2015=1)

US Midwest (West Texas Intermediate) US West Coast (Alaska North Slope) Asia (Singapore)Credit Suisse North West Europe Indicator US Gulf Coast (Light Louisiana Sweet) US Gulf Coast (West Texas Intermediate)

Source: Credit Suisse Weekly Refining Margin Pack, March 2016

Projected

2

Full Potential Oil Refi ning in a Challenging Environment

industry, making life harder for refiners that operate

in regions with high labor and energy costs, or have weak

operating and capital project-execution capabilities.

Third, refi ners can expect more stringent regulation

in fuel specifi cations, refi nery emissions and biofuels—

and in most cases, new regulations will require addi-

tional investment and operating costs. Although developed

economies are leading this agenda, developing econ-

omies are rushing to catch up with these strict guide-

lines. Mexico, for example, is adopting rules that will

require heavy-duty vehicles there to comply with

emission standards as strict as those in the European

Union, and Saudi Aramco is working to reduce car-

bon emissions and tail gas fl aring.

These changes are creating more volatility in pric-

ing, forcing refiners to adjust their feedstocks more

frequently and dramatically than in the past, and

making long-range planning more difficult than

ever. The influx of heavier and more sour oils also

puts pressure on less complex refineries that must

consider investing in conversion units if they want

to stay in the game.

Second, new refineries are coming online that could

boost capacity beyond demand for refined products

(see Figures 3 and 4). Most of these large and

complex refineries are closer to the most dynamic

centers of demand in the Asia-Pacific region. Their

preferential access to markets, crude stocks and afford-

able labor supplies will bring structural shifts in the

Figure 2: The quality of crude has declined since 2000

Oil production is getting heavier ... ... and sulfur content is growing

0

20

40

60

Crude oil production by sulfur content (mbpd)Total growth in medium and heavy crude oil production (mbpd, 2000–14)

2000

US

Restof

world

25

2014

28

2000

22

2014

24

2000

38

2014

44

−2

0

2

4

6

−2 0 2 4

US

EU

MiddleEast

CIS

LatAmAfrica

APACCanada

Total growth in light crude oil production (mbpd, 2000–14) Sweet Medium sour Sour

15 mbpd, 2014 production

Getting heavier

Getting lighter

Note: mbpd=million barrels per daySources: ENI World Oil and Gas Review 2015; Bain analysis

Full Potential Oil Refi ning in a Challenging Environment

3

Figure 3: With increases in capacity, global supply of refi ned products will exceed demand

0

80

90

100

110

120

2015 16 17 18 19 20 21 22 23 24 25

Global demand and production capacity for oil products (mbpd)

Supply scenariosDemand

Refinedproducts

Biofuel, direct use of crude oiland other non-refined products

Minimum case: oversupplyaccelerates shutdowns

Base case: balanced shutdowns

Maximum case: verylimited shutdowns

Sources: OPEC 2015 World Oil Outlook; Enerdata, December 2014; Bain analysis

Figure 4: Refi neries around the world plan to increase their capacities for desulfurization and produc-ing higher-octane grades

1.0

MiddleEast

0.5

CIS

0.4

LatinAmerica

0.3

Africa

0.3

NorthAmerica

0.2

Europe

0.2

0.0

0.5

1.0

Average NCI

Asia-Pacific

11.7 9.08.9 6.6 5.8 7.6 5.8

0.0

1.0

2.0

MiddleEast

2.0

Asia-Pacific

1.4

LatinAmerica

0.8

Africa

0.7

CIS

0.5

NorthAmerica

0.2

Europe

Conversion Desulfurization and quality

0.1

Projected desulfurization and octane addition capacity, 2015–20 (mbpd)Projected additions to conversion capacity, 2015–20 (mbpd)

Notes: NCI=Nelson Complexity Index, averages for 2014; mbpd=million barrels per day Sources: OPEC 2015 World Oil Outlook; ENI World Oil and Gas Review 2015; Bain analysis

Desulfurization Higher octane

4

Full Potential Oil Refi ning in a Challenging Environment

• Markets. Consumption of refinery products is

shifting from developed to developing markets,

especially to China and other developing coun-

tries in the Asia-Pacific region, favoring the in-

dependent refiners there as well as the NOCs in

the Middle East and CIS independents, which

have competitive access to this market.

• Operating conditions. Middle Eastern NOCs

and CIS refiners have favored access to feed-

stock, lower energy costs and efficient capital

spending, which all can give them an edge in

operating conditions. European independents

and Latin American NOCs are the most chal-

lenged. Africa, given its low labor costs and sur-

plus of crude, seems a good candidate for refin-

Evaluating players and positions

These global trends affect the entire sector, with

some segments and refiners impacted more than

others. When we look at the key competitiveness

factors for refiners—markets, operating conditions

and quality of asset portfolio—we see that some are

better positioned than others to thrive over the next

decade. Middle Eastern national oil companies

(NOCs), globally integrated oil companies, indepen-

dent refiners in the Asia-Pacific region, and refiners

in the Commonwealth of Independent States (CIS)

are well positioned, while national oil companies in

Africa and Latin America and European indepen-

dents are under greater pressure (see Figure 5).

Figure 5: Middle East and CIS national oil companies are the most advantaged, EU independents and Latin American NOCs are challenged, and African refi neries are failing to capitalize on opportunity

Africa NOC 103

CIS NOC*** 103

Latin America NOC 97

Middle East NOC 99

APAC NOC 101

APAC independent 103

EU independent 102

US independent 96

Global integrated

Average crude slate adjustedby yield plus logistics (indexed)

Capital spending to expandcapacity adjusted by cost of capital (Thousands of US dollars per barrel of oil)*

Industrial electrical energy price (indexed)**

Average yearly salary in theoil and gas industry (indexed)

100

45

28

58

34

43

23

27

22

N/A

64

32

65

21

74

98

127

71

100

73

82

101

86

46

90

96

130

100

Feedstock Capex Energy costs Labor costs

Notes: *Adjusted by cost of capital in the region to oil and gas firms; **electrical energy as a proxy for refining energy prices; ***Includes CIS independents Sources: Hays; Oil & Gas Journal; EIA; IJGlobal; WACC expert; OPEC; ENI; Bain analysis

Best performers Worst performers Market vs. upstream break-even price difference Average performers

Full Potential Oil Refi ning in a Challenging Environment

5

its surplus, and Europe, Latin America, Africa and

the Asia-Pacific region remaining net importers.

In addition, they will create interesting and chal-

lenging supply-and-demand dynamics in local mar-

kets. For example, demand for fuel could decline on

the US West Coast, given the rising popularity of

hybrid and electric vehicles. If this occurs, the re-

gion would produce more gasoline than it needs,

and refiners would have to reduce capacity or export

more refined products to Asia.

Also, gasoline exports from Europe will face increas-

ing challenges from new export-oriented players,

including the US. NOC refiners in Latin America

and Africa are likely to feel the pressure from public

opinion as they continue to be net exporters of oil

and net importers of derivatives.

ery operations, but refiners there have not

capitalized on these advantages due to a lack of

engineering and construction capabilities.

• Asset portfolio. Globally integrated companies

and independents in the US and the Asia-Pacific

region are best positioned in terms of the scale

and complexity of their portfolios. Next in line

are the NOCs in the Asia-Pacific region, the

Middle East and the CIS, which are investing to

make their portfolios more competitive. The

portfolios of African NOCs, on the other hand,

are clearly at risk.

These changes will combine to shift the flows of re-

fined products around the world (see Figure 6),

with the Middle East and the CIS becoming the ma-

jor suppliers to the world, North America increasing

Figure 6: The Middle East and CIS are likely to strengthen their positions as net exporters, while Europe, Latin America, Asia-Pacifi c countries and Africa will import more

Regional balances in 2013 and 2019Thousands of barrels per day

Notes: Positive numbers indicate net export potential, negative numbers net import requirements; 2013 net exports to do not equal imports due to feedstock trade and product classification differences Sources: US Energy Information Administration; OPEC 2015 World Oil Outlook; Enerdata; Bain analysis

Stable, riding the light tight oil boom to remain a net exporter to Latin America and Europe

Continued need for diesel imports and competitionfor gasoline exports force M&A and closures

Integrating downstream, deploying the advantagefrom local oil to supply Europe and Asia-Pacific

Investing to supply diesel to Europe and Asia-Pacific, but upgrading outdated capacity is a challenge

Attempting to reduce imports with massive capacity additions, but not enough to offset demand growth

Efforts to increase local capacity and revert import status facing major financial and technical challenges

Historic importer, trying to expand into refining butfacing financial, operational and commercial challenges

−205

145

984

DieselGasoline

OECD Americas

995

1

1

−471−526 −559−548

DieselGasoline

Latin America6

2

3

4

5

6

7

−143−332

−657−998

DieselGasoline

Africa7

7021023

358762

DieselGasoline

Middle East3

−974−1490

1280

469

DieselGasoline

Asia-Pacific5

469 528897 835

DieselGasoline

CIS4718 652

−1057−1592

DieselGasoline

Europe2

6

Full Potential Oil Refi ning in a Challenging Environment

must understand their competitive differential

in each potential market, as well as key competi-

tive threats and how to achieve a logistical edge

over them.

• Optimize access to advantaged feedstock and

product yield. Now more than ever, refiners

must sharpen their linear program models to

reflect changing availability, quality and price

deltas of different crude oils. This has been par-

ticularly valuable in recent years in the US,

where refiners that quickly tapped into light tight oil

reaped great benefi ts.

• Achieve operational excellence. Focusing on

plant reliability, energy effi ciency, frontline labor

productivity, SG&A optimization and working-

Clearly, the world will become more complex for even

the most competitive refi ners, requiring them to em-

brace an agenda of strategic and operational effi cien-

cy, with the elements differing from one player to the

next, depending on the situation of each.

Toward full potential

As the conditions for the refining industry become

more challenging, even the most favored companies

have to work hard in five critical areas to achieve and

maintain their full potential. The Bain Refining Full

Potential Playbook offers a structured plan that can

help refiners remain competitive (see Figure 7).

• Protect and expand access to markets. Whether

focused on a local market or exports, refiners

Figure 7: The Refi ning Full Potential Playbook helps refi ners tackle competitiveness in a structured way

• Local and regional market full potential (channels, footprint, mix, pricing)• Export market strategy• Commercial excellence• Specialty strategy (e.g., lube, chemicals)

• Operating model • Organization effectiveness • Talent management

• Regulatory risk-assessment and adaptation plan • Regulatory compliance strategy

• Results Delivery®

• Commercial digitalization (digital B2B sales and marketing, pricing models)

• Digital operations and maintenance (predictive maintenance, operations intelligence, digital workers, remote operations)

• Digital supply chain (supply and demand market analytics, digital processes)

• Digital organization and capabilities (agile, digital innovation)

• Feedstock sourcing strategy• Crude slate to product slate optimization• Feedstock supply chain capabilities• S&OP excellence

• Maintenance and plant reliability• Energy efficiency• Frontline labor productivity• SG&A optimization• Working-capital management

• Capital projects- management process and system• Vendor management• Project and turnaround planning

• Refinery configuration assessment and reconversion plan• Portfolio assessment and optimization• Refinery closure plans• Joint ventures and adjacencies

Source: Bain analysis

Operations

Organization

Regulatory and stakeholders

Digitalization

Markets

Market access strategyFeedstock strategy

and yield managementOperational excellence Capital projects excellence Portfolio optimization

Assets

Full Potential Oil Refi ning in a Challenging Environment

7

Clearly, the world will become more complex for even the most competitive refi ners, requiring them to embrace an agenda of strategic and operational effi ciency, with the elements differing from one player to the next, depend-ing on the situation of each.

• First and foremost, they get the organization

right, with a robust operating model and organi-

zational construct that reduces costs and raises

effectiveness. (For more, read the Bain Brief “De-

sign Principles for a Robust Operating Model.”)

• Second, they grasp the external agenda, develop-

ing an essential understanding of how to manage

regulators and stakeholders, including govern-

ment agencies, owners, communities, vendors

and customers. Failing to properly engage with

any of these stakeholder groups may result in

asymmetric regulation, operational challenges

and loss of commercial opportunities.

• Third, they prepare for the future, capturing the

promise of digitalization—from delighting cus-

tomers with transparency and novel interfaces,

to improving reliability and the supply chain

with predictive analytics, to making internal

processes more efficient. Refiners have been

pioneers in the use of data and analytics, and

digitalization can take these capabilities to the

next level.

capital management are key to achieving excel-

lence. Many refiners have focused on this task

in recent years, but a large gap remains between

the most- and least-efficient players. Leading

performers use a system (see the Bain Brief

“What ‘Good’ Looks Like: Creating an Opera-

tional Excellence Management System”) that

clearly describes what excellence looks like, how

to achieve it and how to continuously improve

on it.

• Improve ability to manage capital projects. As

with operational excellence, achieving excellence

in capital projects requires refi ners to implement

and relentlessly improve robust project- and vendor-

management systems. Understanding the driv-

ers of cost, and working systematically to reduce

them, are especially important in regions that

have not been able to perform well in this dimen-

sion, such as Latin America or Africa.

• Optimize the refinery portfolio. Refiners

should pursue full potential for each refinery

and for their entire system without compro-

mising safety, yield, reliability or environmen-

tal compliance. They must evaluate scenarios

for the future and decide which signposts to

monitor to determine the most likely scenarios.

(For more, read the Bain Brief “Beyond Fore-

casting: Find Your Future in an Uncertain En-

ergy Market.”)

Finally, leading performers tend to focus on three

capabilities that put them in the best position to

tackle a full potential agenda.

8

Full Potential Oil Refi ning in a Challenging Environment

The refi ning sector is poised for a cycle of “natural

selection” that will separate the fi ttest from the rest,

based on how well they used the profi ts from this

most recent cycle to prepare for the storm on the ho-

rizon. The agenda is quite complex, even for the most

prepared players. But if tackled in a structured man-

ner with a focus on the highest value opportunities,

the odds for success increase dramatically. Time to

think ahead wisely and execute impeccably.

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Key contacts in Bain’s Global Oil & Gas practice

Americas Riccardo Bertocco in Dallas (riccardo.bertocco@bain.com) Pedro Caruso in Houston (pedro.caruso@bain.com) Diego Garcia in Buenos Aires (diego.garcia@bain.com) Ricardo Gold in São Paulo (ricardo.gold@bain.com) Eduardo Hütt in Mexico City (eduardo.hutt@bain.com) Jorge Leis in Houston (jorge.leis@bain.com) Rodrigo Más in São Paulo (rodrigo.mas@bain.com) John McCreery in Houston (john.mccreery@bain.com) José de Sá in São Paulo (jose.sa@bain.com)

Asia-Pacifi c Sharad Apte in Bangkok (sharad.apte@bain.com) Francesco Cigala in Kuala Lumpur (francesco.cigala@bain.com) Dale Hardcastle in Singapore (dale.hardcastle@bain.com) Brian Murphy in Perth (brian.murphy@bain.com) Europe, Joachim Breidenthal in Johannesburg (joachim.breidenthal@bain.com)Middle East Christophe de Mahieu in Dubai (christophe.demahieu@bain.com)and Africa Torsten Lichtenau in London (torsten.lichtenau@bain.com) Roberto Nava in Milan (roberto.nava@bain.com) Peter Parry in London (peter.parry@bain.com) Mark Porter in London (mark.porter@bain.com) Tiziano Rivolta in Milan (tiziano.rivolta@bain.com) Natan Shklyar in Moscow (natan.shklyar@bain.com) Luis Uriza in London (luis.uriza@bain.com)