Future of European Refining Industry

8/10/2019 Future of European Refining Industry

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KPMG GLOBAL ENERGY INSTITUTE

The Future of theEuropean Refining

Industry

June 2012

kpmg.com
http://www.kpmg.com/http://www.kpmg.com/


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Executive Summary 01

Michiel Soeting

This time its bad and it could stay that way 02

Jeremy Kay

Acting differently:What this means 06

for refinery owners

Gerard Shore

Acting differently:

What this means 16

for investors

Anthony LoboWhy KPMG? 18

2012 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent

member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.


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The Future of the European Refining Industry | 1

EXECUT

IVESUMMARY-

MICHIELSOETING

THEFU

TUREISUNC

ERTAINSO

ACTDIFFERE

NTLY

Michiel Soeting

Global and European Head of Energy

and Natural Resources

T: +44 20 7694 3052

E: [email protected]

European refiners are on a different path to the one

they have been used to for the past 50 years.

The European refining industry has gone through

numerous cycles, but this time many of the changes

are likely to prove permanent and we expect the

current trends of falling demand, rising imports,

increasing European legislation, growing

competition from emerging markets and eroding

margins to continue.

However, it is not all negative:

The worlds appetite for hydrocarbons will keepgrowing, especially in India, China and across the

wider Asia Pacific region;

Positioning refinery assets and operations properly

now - when asset purchases are cheap, and the

costs of improvements are not as expensive as

they were in the boom years - provides a good

opportunity for high quality European refineries

to compete profitably in the future; and;

Europe remains one of the largest economic

regions in the world, and will be for the

foreseeable future.

Significant recovery, though may take some time:

cost pressures will continue; over-supply and

competition will remain fierce; and the European

carbon tax will continue to tilt the playing field in

favour of overseas refiners that are subject to less

regulation. The industry has seen a number of plant

closures in recent years and more may well follow

as demonstrated recently by the announced closure

of the Coryton refinery in the UK. The survivors will

have to be leaner, more efficient and more able to

adapt to changing market needs. A strong focus now

on building and maintaining their relative competitive

advantages is vital to help ensure their survival today

and profitability in the future

THE SURVIVORS

WILL BE LEANER,

MORE EFFICIENT AND

MORE ADAPTABLETO CHANGING

CUSTOMER NEEDS... 2012 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent

mailto:[email protected]:[email protected]


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2 | The Future of the European Refining Industry

JEREMYKAY

THIS

TIMEITSBADANDITCOU

LDSTAYTHA

TWAY Jeremy Kay

Partner, KPMG in the UK

T: +44 20 7694 4540


The profitability of the European refining industry

has long been cyclical, with repeated fluctuations

in demand, price and production levels. However,

this time things are different, and many of the

challenges the industry faces today may prove to

be permanent.

For example:

Many European refineries built 30 to 40 years

ago using less sophisticated technology are

now at a disadvantage. Built to a smaller scale to

process lighter, sweeter crude oils, producing an

excess of gasoline, and with strong labour lawsand high wages; many European refineries have

experienced a structural erosion of their margins;

The size of the Middle East, Indian subcontinent

and Chinese refinery building program has

fundamentally shifted the scale and location

of the new, high quality, price setting plant.

Operators from these regions enjoy a number

of key advantages, including new equipment,

cheap labour, large reserves of capital and rapidly

growing local demand;

Many companies in Asia now consider Europe

a key market for both exports and acquisitions.

For example, Essar Energys acquisition of the

Stanlow Refinery in the UK and PetroChinas

acquisition of shares in trading and refining

joint ventures with Ineos, including Scotlands

Grangemouth refinery and the Lavra refinery

in France1.

With the transfer of some European refinery

ownership to non-European companies, their

new owners are less likely to be influenced

by local politics when considering maintainingunprofitable plant; and

European refiners are likely to continue to be

disadvantaged by the disparities in environmental

legislative requirements across the globe.

Furthermore, with continuing pressure on margins

the short to medium outlook remains bleak and not

surprisingly divestments are on the rise. But what

is interesting is less the origin of those who have

bought assets, but more the fact that European

refiners are increasingly focusing on investing

in tighter portfolios of quality survivor sites to

maintain both quality and competitive advantage.

AGING EUROPEAN REFINERIES GENERALLY HAVE

HIGHER MAINTENANCE AND OPERATING COSTS THAN

PLANTS BUILT MORE RECENTLY IN ASIA AND THE MIDDLE

EAST. THIS, COMBINED WITH CURRENT ECONOMIC

CHALLENGES, IS CAUSING THE LESS ADVANTAGED

REFINERIES TO HAVE TO FIGHT FOR THEIR SURVIVALFergus Woodward.Director, KPMG in the UK

1Europes refiners fall on hard times, Financial Times, January 30, 2012.

See also Foreign investment: Indian companies blaze trail across the country, Financial Times, September 15, 2011




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Overcapacity - the challenge of supply

versus demand

Once again European refining is suffering from

over-capacity versus demand.

Demand for fuel is heavily dependent on economic

activity, which has dropped dramatically in Europe

since the start of the global economic downturn

in 2008. Compounding this effect is the impact of

continuing improvements in fuel efficiency and the

substitution of refinery hydrocarbon fuels by bio-fuels.

At the same time there has been some modest

reduction in refining capacity. A few small

refineries have closed, and some older units -

particularly distillers - have either been put on hold

or decommissioned. But investments in plant

improvements have also continued, and the net

reduction in refining capacity has fallen well short of

the reduction in demand for fuel.

As a result, utilisation of Europes refineries has

fallen dramatically since 2008, and are likely

to remain low for many years. Furthermore,

with refining margins closely aligned with plantutilisation, the outlook for margins is likely to remain

depressed for some time to come.

REFINING CAPACITY AND UTILISATION - EUROPEAN UNION

90%16000

89%15900

88%15800

87%15700

86%15600

85%15500

84%15400

83%15300

82%15200

81%15100

15000 80%2000 2001 2002 2003 2004 2005 2008 2009 20102006 2007

Refinery capapcity Refinery utilisation

Refinery

capapcity

(Thousandbarrelsperday)

Refineryutilisation(%)

Source: BP Statistical Review of World Energy June 2011: KPMG analysis




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The Skewed Barrel

Europe has long experienced a gasoline middle

distillate imbalance, as the industry produces a

surplus of gasoline for export and has to import

diesel and heating oil. Refining margins therefore

reward diesel production over gasoline, and those

refineries with hydrocrackers (which make more

diesel) benefit from this skew, whilst refineries with

only FCC crackers (which make more gasoline) are

penalised by it.

For many years Europe has imported middle

distillates from Russia and the US, whilst exporting

gasoline to the US and Africa. These flows are likely

to continue. In addition some Middle Eastern and

Asian diesel exports may make their way into Europe.

US GASOLINE IMPORTS FROM EUROPE

Exporters of diesel to Europe have to absorb their

transport costs, and this provides an economic

cushion for good European refiners, though

marginal plants may suffer. However, the real

Achilles heel for less competitive refineries remains

the surplus of gasoline. Any refiner having to export

significant surplus gasoline from Europe to the US

is likely to face increasingly fierce price competition,

and downward pressure on profits especially

given the fact that US demand for imported

gasoline has fallen considerably since 2006. This key

weakness is likely to determine the fate of many

imbalanced refineries and thus large investments

in hydrocrackers and cokers may be their only

strategy for survival, which unfortunately may be

too expensive to justify for a long time to come.

450

400

Thousandsbarrelsperday 350

300

250

200

150

100

50

0

90%

80%

70%

60%

50%

40%

30%

20%

10%

Jan2

000

Jan2

001

Jan2

002

Jan2

003

Jan2

004

Jan2

005

Jan2

006

Jan2

007

Jan2

008

Jan2

009

Jan2

010

Jan2

011

US gasoline imports from Europe % of total US gasoline imports

0

Source: US Energy Information Administration 2011: KPMG analysis




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ACTINGDIFFERENTLY:WHATTHISMEANSFOR

REFINERYOW

NERS

GERAR

DSHORE Gerard Shore

Director, KPMG in the UK

T: +44 20 7311 3268


In the face of tough market conditions, cost

pressures and the emergence of new players from

Asia and the Middle East, European refinery owners

should act differently now if they are to be profitable

in the future. The main options available to them are:

Investin their refinery plant to increase

production, improve yields, and reduce costs

Improveoperations, procedures and

management to reduce costs and improve yields;

Divestunprofitable assets to maximise return on

investments made; or Closeunprofitable assets, and possibly convert

some, or all, of the site to other uses, such as

storage.

Invest

Technology improves, existing plant wears out,

energy costs grow, and the advantages of scale

grow ever larger. These truths have been with the

refining industry since its beginnings, and continue

to mean that over the long term all refineries will

require new investment if they are to remain

competitive and profitable.

But timing is everything. Investing too early devours

the cash flows of previous investments, and

waiting too long can tip the refinery from a survivor

site, where reinvestment will pay, into a closure

candidate, where it is impossible to justify the costs

of upgrading investments on what is fundamentally

an uncompetitive plant.

Given the emerging dominance of high quality new

refineries East of Suez, it is critical that owners of

European-based refineries understand and clearly

acknowledge which category their site fits into.

Sites without competitive advantage are becoming

increasingly poor reinvestment candidates, and

should be placed on a path to harvesting cash and

either divestment or closure.

On the other hand, where a refinery retains inherent

advantages from its location and existing plant,

then reinvesting in existing or new plant can prove

profitable. To reap the full rewards from owning these

survivor sites it is critical to invest steadily through

the life of the site, as maintaining competitive

advantage is likely to generate significant profits

and cash flows over the cycle. For these sites, it isessential to have a clear investment strategy.

The following are some investment options

to consider.

Upgrading capacity

Investment in coking, deep cracking, expanding

existing crackers and other plant upgrades are all

expensive options, not to be considered lightly. But,

the reality is that straight-run capacity is unlikely

to be cash positive again, and even traditional FCC

investment margins are being steadily eroded

over time. Therefore, as East of Suez products and

economics enter the European market, the existing

upgrading plant will increasingly become themarginal operated plant and therefore the margin-

setting capacity.

All survivor sites must maintain a clear strategy for

steady investment in upgrading capacity. And, for

those prepared to invest strategically, now is a good

time to seize the opportunities presented by weaker

investment costs during the economic down-turn

while capturing the high cash flows that should flow

from plant that commission ahead of the next margin

peak. This peak may be some way off, given the

depth of this down-turn and the economic problems

in the region, but it will come, and will remuneratecarefully considered but bold investment decisions

which are made in sufficient time.

Capability to process poorer quality crude oils

For many years, most coastal refineries in North

West Europe have been configured to run a wide

variety of crudes, taking advantage of the liquidity

in the traded crude oil markets to provide them with

cost competitive crude oil on the day. Operating

flexibility, plenty of storage capacity, and an

entrepreneurial approach have paid off handsomely.

Investments to run poorer quality crude oils are

likely to continue to pay off, as available crude oils

become ever heavier, increasingly sour and more

contaminated with heavy metals and the like.

Product Quality, Energy Cost Savings and

CO2 Emissions

Most European refineries have now made the

investments needed in desulphurisation capacity

to meet gasoline and diesel specifications imposed

by the last wave of environmental legislation. The

next major threat is on the quality of bunker fuels.

This is likely to be a significant issue for coastal

refineries, and could hasten and complement the

drive towards deeper upgrading.

2012 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member

firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.


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TO IMPROVE PERFORMANCE, REFINERS WILL CONTINUALLY

NEED TO CHALLENGE ALL ASPECTS OF THEIR BUSINESS.

INVESTMENT OPPORTUNITIES MUST BE SCRUTINISED

AND IMPROVEMENTS PURSUED RELENTLESSLY IN ALL

COMMERCIAL AND OPERATIONAL AREAS




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And with CO2 emission prices likely to rise, energy

saving investments are now firmly back on the

agenda. It is even possible that in the next decade

some refineries will consider investment options

for carbon capture and storage of CO2 as a way of

mitigating the cost of CO2 emissions.

ImproveWhether margins are good or bad, one thing

remains true - in absolute terms they are small.

The profitability of a refinery is highly leveraged

and small yield and cost improvements can make

a large impact on the bottom line.

Once the investment is made the key is continuous

improvement if this does not happen the refinery

will, inevitably, drop back. A well operated plant,

getting the best yield from the best available crude

oil, and paying continuous and steady attention to

costs is essential to get the desired return on the

investments made.

Operations and Maintenance - running the plant

reliably and safely

Poor reliability and plant availability can be

devastating to a refinerys profit and cash flows.

The pace-setters operate their plants safely,

maintain them properly and often have the lowest

operating costs in the business with a significant

difference in performance and approach versus

average performers.

So how do these pace-setters create and

maintain this circle of safe, highly reliable and lowcost operations?

The first key principle is doing everything right,

the first time. Good operators have - and follow - a

good Operating Management System. This spells

out - in a practical way - procedures to be followed,

and provides the information needed to make good

decisions from the top to the bottom of the

organisation. At the same time, it helps build an

organisation and culture of competence and

compliance, based on continuous improvement, in

which well-trained people gets things done

properly, the first time.

The second key principle is that good operators

inspect and maintain their plant properly, from the

start, and without fail throughout its operating life.

They have consistent, clear and fully funded plans

and strategies for maintenance, conducted within a

quality Maintenance Management System, which

is executed through both good times and bad.

Reliability Centred Maintenance (RCM) dominateswith high proportions of preventative and predictive

maintenance on production critical equipment,

limiting the need for reactive maintenance which

results from plant failure. This proactive approach to

maintenance has been proven repeatedly to deliver

the lowest operating costs.

Production optimization and crude acquisition

Feedstock typically accounts for 90 percent of the cost

base of the refinery. Small improvements in yield and

costs drop straight through to the bottom line, and can

make a huge difference to profit and cash flow.

Intellectually, all refiners understand the

importance of making the products and buying

the crude oil that maximises their margin on the

day. However understanding market demand,

optimising refinery production, and buying and

running the right crude at the right time at the right

price remains a crucial activity, and is sometimes

almost a dark art, understood and available only to a

few technical experts.

Commercial optimisation, as it is often called, draws

heavily on the need to bring together commercial,

trading, technical and operating skills. It is heavilydependent on the knowledge and skill of the people

involved, and can make an enormous difference to

the actual margin captured at any time.




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Given the value at stake, we would recommend

frequently revisiting this area and investing

significant time and cash in a number of areas:

Examining, improving and periodically rebuilding

the economic planning, plant optimisation and

feedstock procurement processes;

Upgrading the optimisation models used.

However, it is even more important to regularly

review whether: they are being used properly;

the data fed into them is soundly based; the

processes for making decisions from them are

robust and valid; and the human judgement that

must overlay any model-based process is based

on good experience and skill; and

Understanding the way in which the interface

between traders, commercial teams and refiners

is managed. This can be a huge source of value,

but the tension between traders and refiners

can quickly become counterproductive if left

uncontrolled and unmanaged.

A renewed focus on optimising individual process

unit performance can also provide significant

improvement opportunities. Opportunities to

increase product yields by processing alternative

product streams and optimising operating

parameters are too often overlooked in favour

of the larger improvements from major capital

investments. These smaller opportunities can

deliver significant value rapidly and often with very

modest investment.

Finally, member firms experience indicates that

unstructured and outdated monitoring, control and

optimisation processes frequently contribute to

sub-optimal unit performance. These processes

can often be improved by clearly redefining the

accountabilities of Operations and Technical

personnel and by installing robust cross-functional

governance mechanisms.

Variable energy and utility costs

Although variable cash costs account for a smaller

proportion of the total cost than feedstock, they can

cost tens of millions of Euros and must therefore bea key area of focus for refiners.

Energy and utilities are by far the most significant

items. Member firms experience is that even

in modern sites improvement opportunities

exist to reduce these costs, particularly around

key equipment such as furnaces and turbines.

The pursuit of these opportunities is also helped

substantially by the application of on-line energy

monitoring and energy management systems.

An efficient way of reducing variable costs is through a

plant-wide energy and utility assessment. This involvesmapping production unit energy consumption against

product stream throughputs, with comparisons

made against the original design performance of

the equipment, or other suitable benchmarks. The

resulting improvement opportunities are usually best

delivered using cross functional project teams of

Technical and Operations personnel.

Fixed cash costs

INDICATIVE REFINERY FIXED CASH COST

BREAKDOWN BY FUNCTIONAL AREA

HR Admin

Commercial

Technical

HSSE

Projects

Operations

Maintenance

42%

28%

9%

6%

6%

5%2% 2%

Source: Analysis based on KPMG firms engagements

Managing, and where possible reducing, fixed cash

costs is one of the most difficult areas for refiners to

deal with. Five to eight percent of the total cost baserelates to employees, contractors and various goods

and services procured. However, our experience is

that these costs are often not fully optimised.

Reasons for this are:

Management lacking the right tools and

approaches, with cost reduction programs

often focussed on short terms actions (e.g.

discretionary budget cuts across the board, or

freezing / cutting discretionary spend);

Lack of visibility of the true cost base and

headcount of the organisation at a sufficient levelof detail to enable a clear line of sight between

improvement projects and bottom line impacts;

Adopting cost optimisation activities in the

absence of robust hard economic facts and

comparator insights that dispel myths and

challenge the status quo;

Lack of external challenge to maximise potential

value without compromising on operational

integrity; and

Employment legislation and weaknesses in the

quality of Industrial relations.




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However, as with all costs in refining, if handled

properly a small improvement can often have a

significant impact on the bottom line. Albeit the

reverse is also true, and if allowed to run out of control

it can be extremely difficult to recover profitability.

The key is to have long term focus, underpinned with

clear plans, that keep the plant well maintained and

operated, as well as a steely determination to control

and challenge all fixed cash costs.

KPMG analysis indicates that over 60 percent of

functional fixed cash costs are usually people-

related (including payroll, contractors and

outsourced personnel). These fixed cash costs

can almost always be reduced by optimising work

processes, both within individual functional areas

and at points of high complexity where teams

interface with each other. Examples of areas of

potential opportunity include:

Maintenance inefficient permit to workexecution caused by:

o equipment not ready to be removed from

service

o risk assessment paperwork not completed

o scheduling/timing disagreement between

Operations and Maintenance;

Laboratory embedded inefficiencies in product

testing due to:

o laboratory staff conducting routine low

complexity testing which could have beenabsorbed by Operations personnel

o missed opportunities to conduct in-line testing

o excessive testing conducted beyond required

service levels; and

Operations overstaffing resulting from:

o Sub-optimal shift structures with excessive

cover and overtime in place

o Control rooms not consolidated resulting in low

levels of staff utilisation

o Excessive management oversight in place asdemonstrated by lower spans of control ratios

than similar organisations.

Outsourcing services is a long-established

practice in European refineries. Many refineries

run a combination of in-house and outsourced

maintenance, much engineering is now contracted

out, and outsourcing back-office functions such

as IT, accounting, and transactional HR activities

are common. However it is essential to maintain

control of the core activities of the business, such

as operations, while retaining the capability to

maximise value through effective performancemanagement of outsourced service providers.

Procurement - of both goods and services is an area

in which fixed cash cost reduction opportunities are

likely to exist. Many businesses believe they excel in

procurement - in reality however, this is only true in the

initial supplier negotiations. Often, once agreements

are in place, less importance is placed on delivering

ongoing rigorous performance management, which

results in value leakage. In this situation, a prioritised

review of contracts and suppliers is important to

ensure that performance and productivity goals are

achieved by third-party suppliers.




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EUROPEAN REFINERIES - DEAL HISTORY

Year Asset name / Bidder Total refinery Seller

location capacity - bpd

2011 Stanlow Refinery, UK Essar Energy 296,000 Royal Dutch Shell

2011 Pembroke Refinery, Valero Energy 220,000 Chevron

UK2011 Grangemouth, UK PetroChina 420,000 Ineos

Lavra, France

2010 Gothenburg Refinery, Keele Oy 87,000 Royal Dutch Shell

Sweden

2010 Ruhr Oel, Germany Rosneft >1,000,000 PDVSA

2010 Heide Refinery, Klesch & Co. 90,000 Royal Dutch Shell

Germany

2009 TRN, Netherlands Lukoil 158,000 Total

2008 ISAB Refinery, Italy Lukoil 320,000 ERG

2008 Petit Couronne and Petroplus 239,000 Royal Dutch Shell

Reichstett Refineries,France

2008 Berre L'Etang, France LyondellBasell 105,000 Royal Dutch Shell

2007 Milford Haven Murco Petroleum 108,000 Total

Refinery, UK

2007 Mantova Refinery, MOL 52,000 IES

Italy

2007 Coryton Refinery, UK Petroplus 172,000 BP

2007 Kralupy and Litvinov Eni 165,000 ConocoPhillips

Refineries, Czech

Republic

2007 Ingolstadt Refinery, Petroplus 110,000 ExxonMobil

Germany2007 Rotterdam Refinery, BP 400,000 Chevron

Netherlands

2006 Mazeikiu Nafta, PKN Orlen 260,000 Yukos-Lithuanian State

Lithuania

2006 BRC Refinery, Belgium Petroplus 115,000 European Petroleum Holdings

2006 Wilhelmshaven ConocoPhillips 275,000 Louis Dreyfus Energy Holdings

Refinery, Germany

2003 Bayernoil refinery, OMV 260,000 BP

GermanyThis table summarises a number of significant European refinery transactions from 2003-2011. Information relates to total refinery capacity quoted publically at time of

transaction which may differ to the JV partner agreement share

Source: Transaction information obtained from bidder / seller press releases and websites (multiple publically available sources)




15/23


Divest

Investment groups and oil companies from Asia,

Russia and the US are being selective and targeting

only the most advantaged European refining assets.

Even so, divestment remains a viable strategy for

refinery owners if the asset is properly prepared

and the sale closely managed - indeed well over

one million bpd of European refining capacity has

changed ownership since the start of 2010.

Preparing for the divestment

Detailed planning and execution is needed for

an efficient transaction that maximises value.

This sounds logical, but in reality the activity is

very complex, involving many stakeholders, and

thus a properly structured process is crucial. Key

considerations include:

Timing- one of the first key decisions is when

to initiate the divestment process. Value can

be easily destroyed if timing is poor and anearly strategic review of options is essential.

Considerations should include how reliably

the refinery is operating and the current safety

performance as poor performance in either will

deter potential buyers;

Packaging the asset- equally important is how to

package the asset for an efficient sale. Potential

buyers usually want to buy a standalone asset,

but there are instances where infrastructure and

resources need to be shared with the vendors

retained business. Consequently carving out an

asset as a standalone entity, together with a set offinancial statements that represent the business

being sold, can be a highly complex challenge, and,

vendors should be prepared for significant effort

before, during and after the transaction;

Valuation- in the current economic environment

where buyers are cautious and extremely price

sensitive, the valuation approach adopted can

determine whether the divestment process stalls

or proceeds at speed. Over pricing assets often

leads to difficulties later on when the buyer makes

an offer. Also having a clear data based view of

the upside potential within the business and how

this value can be accessed should be a key part of

this process;

Employees- transactions may or may not be

conducted as an entity deal in which the assets

and employee contracts are bought together.

However, whatever the structure of the potential

deal, employee contracts should be thoroughly

reviewed by the seller early in the divestment

process, as vendors will need to be prepared to

discuss terms and conditions in detail with thepotential buyers. This is particularly important for

European refineries where complex employment

legislation needs to be navigated successfully,

and specialist advice is often required; and

Communications- maintaining an engaged and

motivated workforce throughout the deal is a key

challenge. The divestment process often takes

several months (or longer) and the economic

impact of reduced productivity or resignations

of key personnel can be significant. It is therefore

important to clearly define the communications

strategy to be adopted from the outset of the

divestment, and include regular ongoing dialogue

with employees from the start to the finish of

the process.

Following the completion of the divestment the

vendor will need to switch attention to a disciplined

attack on the stranded costs remaining within their

business, for example in support functions. It is also

prudent to monitor how the new owners operations

are performing, as situations can arise where

the vendor is pulled back into operational issues

involving the assets they have divested.

DIVESTMENT REMAINS A VIABLE STRATEGY FOR REFINERY

OWNERS IF THE ASSET IS PROPERLY PREPARED AND THE

SALE CLOSELY MANAGED INDEED WELL OVER ONE MILLION

BPD OF EUROPEAN REFINING CAPACITY HAS CHANGED

OWNERSHIP SINCE THE BEGINNING OF 2010. 2012 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent



16/23


Close or convert

If a buyer cannot be found and operating the

refinery is not economically viable, owners are

faced with two options: closing the refinery (either

permanently or temporarily) or converting some or

all of the site to other uses, such as storage.

Closing a refineryClosing a refinery is a complex and costly procedure.

Environmental costs, demolition work and other

costs can be very high.

The environmental costs of cleaning up the site will

be a major expense. Substantial regulation requires

removal of the accumulated pollution resulting from

decades of past use where requirements were

often less demanding than those today.

Employment law, including pensions and severance

benefits, is another key issue to be managed, with

the costs of severing employee contracts oftenunexpectedly high.

In addition, problems may also arise from the

conflicting interests of multiple stakeholders,

including the refiner, local government, regulators

and employees, which ultimately can lead to

protracted disputes and significant legal costs.

Limiting the damage to the public image of the

refiner throughout the closure process, needs

careful management.

Converting a refinery

Alternatively, converting refineries to terminals can

mitigate many closure costs, extend the assets usefullife, reduce the plant costs and release working capital.

If well located, and if the tank farm and logistics

assets are in good condition, this can be an attractive

alternative to closing the refinery completely.

But not all refineries are suitable for conversion to

terminals. Key constraining factors include:

On-site storage capacity - whether this is

sufficient for the site to operate as an effective

import/export terminal;

Transportation links - the connectivity of the site to

major ports as well as to other forms of transport

such as pipeline, road, rail and barge; and

Access to surplus capacity - whether the site

can access third party terminal services to

supplement available in-house capacity on a

flexible basis.

CLOSING A

REFINERY IS

A COMPLEX

AND COSTLYPROCEDURE.

IN ADDITION,

PROBLEMS MAY

ALSO ARISE FROM

THE CONFLICTING

INTERESTSOF MULTIPLE

STAKEHOLDERS




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ACTINGDIFFERENTLY:WHATTHISMEA

NSFORINVE

STORS

ANTHO

NYLOBO Anthony Lobo


T: +44 20 7311 8482


With a variety of European refining opportunities

open to investors, selecting the right asset to

purchase is becoming increasingly complex. In

addition, the prevailing economic climate is causing

investors to be increasingly cautious with only the

most advantaged refineries targeted.

The recent acquisition of Chevrons Pembroke plant

byValero is a good example of this approach. The

deal not only gives the US company a presence in

Europe but also ownership of a highly specialised

refinery, with a Nelson complexity rating of 11.8.

The refinery has been well maintained andmanaged, and it has an estimated cash operating

cost 25 percent below Valeros average2 .

Companies from outside the region can also seek out

European acquisitions with the purpose of converting

the site to storage for use as a trading hub.

Depending on the market position, opportunities may

exist to make more money trading oil through the

site than processing and buying an established site

simplifies compliance for environmental regulations.

Buying with a planRegardless of the perceived value and intentions of

the deal, investors should always buy with a very

clear plan on how the target asset will be operated

in the short and long term in order to maximise the

value created. Clearly this is a highly involved and

complex process - however initial considerations for

investors should include:

How well the asset matches current and expected

European product demand, in particular for middle

distillates such as diesel;

A review of how production will be marketed,

including consideration of the impact of the

refinery location;

A detailed understanding of the cost base of

the refinery, and a structured plan for how costs

might be reduced through synergies and greater

operational efficiencies;

A review of staff and management capability

and competency to deliver the business plan -

identifying gaps and establishing mitigation plans;

A review of pension obligations and their impacton future financial performance - which can be

very substantial;

The ability to handle working capital and

credit terms associated with third party crude

purchases; and

Legislation and environmental requirements

on the refinery including potential liabilities for

cleanup or new investment required to meet

environment directives.

Approaching the acquisition using a structured

framework will not only help maximise return oninvestment, but enable the investor to respond with

agility to new commercial, operational, financial and

legislative challenges which will undoubtedly be

encountered.

2Valero Energy to Purchase Chevrons Pembroke Refinery, Marketing and Logistics A ssets in the U.K. and Ireland, press release, Valero, November 3, 2011




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Essar and Stanlow: an investor rationale

The 2011 sale of Shells Stanlow refinery in the

UK to Essar is an excellent example of how an

overseas investor developed a strong rationale for

acquiring a European refinery in todays market.

Essar is a conglomerate based in India with

operations in energy, steel, infrastructure and

other businesses3. The company paid US$350

million for Stanlow, the second largest refinery

in the UK. The refinery has a production capacity

of 296,000 bpd supplying one sixth of the UKs

gasoline, as well as diesel and aviation fuel4.

Press reports indicated that Shell viewed the

refinery as a mature asset with low returns5. The

sale was also part of Shells plan to consolidate

their global manufacturing portfolio on larger

assets, which on completion would reduce

refining exposure through a combination of asset

sales and closures6.

For Essar, however, the acquisition was justified

on a number of levels. Naresh Nayyar, chief

executive of Essar Energy, believes that the

current oversupply in the market will end assmaller refineries close7. With the acquisition,

Essar can now ship crude oil refined from its

Vadinar refinery in Gujarat to the Stanlow refinery,

using the Tranmere Oil Terminal on the River

Mersey. Finally, Stanlow can help Essar deal with

cheaper, heavier crudes, which would increase

margins for finished products8.

Commenting on the deal, Nayyar says, It is a

good price. It would cost US$5 billion to build

from scratch. It gives us access to an important

market9.

3 www.essar.com/business, accessed March 5, 20124 Foreign investment: Indian companies blaze trail across the country

Financial Times, September 15, 20115 Ibid6 Shell sells UK Stanlow refinery to Essar Oil, press release,

Shell, March 29, 20117 Op. cit. Foreign investment: Indian companies blaze trail across the

Country, Financial Times, September 15, 20118 Ibid9 Ibid

Moving forward

Despite the apparent discouraging news on many

fronts, refining is still one of the largest industries in

Europe - with a throughput of over 12 million bpd10.

The EU is also one of the largest economic regions

in the world, with a GDP approaching 12 trillion,

and will continue to have a significant appetite for

refinery products.

If the current trend continues, in five to ten years

European refining will be smaller, and joint venture

partnerships are likely to become increasingly

attractive as existing refining companies look tomitigate risks and share the high costs of investing

through future cycles. The inexorable process

of change of ownership, refinery rationalisation,

upgrading and concentration on fewer sites is

expected to continue as new high complexity

capacity comes on stream in Asia providing low cost

competition to European refineries.

However, European refinery owners can expect to

make a return on their investments if they have:

A clear understanding of whether their sites are

survivor sites or eventual closure candidates;

Appropriate and clear investment strategies for

each site through the cycle;

A determination and ability to operate their sites

as a pace setter; and

A steely focus on costs and performance.

But only the best will make an attractive return

and to do so they will have to face the difficulties of

succeeding in a highly mature industry by developing

innovative solutions to meet the changing market and

growing competition from overseas.

WITH A VARIETY OF EUROPEAN REFINING OPPORTUNITIES

OPEN TO INVESTORS, SELECTING THE RIGHT ASSET TOPURCHASE IS BECOMING INCREASINGLY COMPLEX

10 BP Statistical Review of World Energy June 2011


http://www.essar.com/businesshttp://www.essar.com/business


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WHYKPMG? This is a time of extraordinary global economic

and political turbulence which has led to many

challenges for the oil & gas industry. As a result,

owners and operators of European refineries

need forward thinking and practical advice from

professionals who understand their businesses.

KPMGs Vision and CommitmentKPMGs oil & gas practice has one clear vision -

to be the leading provider of professional services to

the oil & gas industry.

KPMGs global network of independent member

firms provide audit, tax, and advisory services11; our

methodologies form the foundation of our approach

worldwide. KPMG recognizes that every business

is different, each with its own internal and external

pressures and challenges. Our methodologies

are therefore flexible to enable our people to use

their knowledge and experience to apply them

appropriately for each client.

Crucially, the services member firms offer start

from our clients perspective. We look at industry

challenges from multiple angles, pooling our

knowledge and resources to develop holistic

services that are designed to fit our clients ever-

changing challenges and requirements.

Through our global network and our 11 oil & gas

Centres of Excellence12, we constantly strive to

provide fully integrated and tailored services of the

highest quality providing clients with the skills and

experience they need to help ensure success.

KPMG member firms provide professional

services to:

84% of the top 50 oil & gas companies listed in

Forbes 100013

80% of the 76 oil & gas companies listed in

Forbes 100014


Fortune Global 50015


Financial Times Global 50016

11 Advisory services include advice relating to performance & technology; transactions; joint ventures; restructuring; and risk & compliance12Beijing, Calgary, Houston, Johannesburg, London, Moscow, Muscat, Paris, Perth, Rio de Janeiro and Rotterdam13Forbes 1000, April 201114Forbes 1000, April 201115Fortune Global 500, July 201116Financial Times Global 500, June 2011




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BIOGR

APHIES



Jeremy Kay


Jeremy leads KPMGs European Operations

Strategy Consulting practice. For the last 15 years

he has been working with oil & gas organisations

to identify and deliver cost, cash and margin

improvements across all areas of upstream,downstream and refining operations. He has

led programmes in over 18 countries both in a

deal and non-deal environment. Clients include

global integrated majors seeking to drive value

from operations as well as both institutional and

private equity investors looking to get an improved

return on asset performance. Jeremy frequently

represents KPMG on cost optimisation and

sustainable value improvement, he has spoken at

several oil & gas conferences on the subject and

published numerous articles.

Anthony Lobo


Anthony leads KPMGs European Oil & Gas practice.

He overseas KPMGs oil & gas strategy across

Europe and specialises in the role of National Oil

Companies having published a number of thought

leadership pieces over the past five years.

In addition, Anthony leads our M&A services and

has worked for the majority of the major players in

the industry. In the downstream sector Anthony

and his team have worked on many of the recent

transactions across Europe - both refining and retail.

Anthonys transaction experience covers the US,

Europe (including Russia and the Former Soviet

Union), Africa and Asia. He has l ived and worked in

Hong Kong and Africa and is now based in the UK.

Anthony has frequently spoken on changes in the

sector across the globe including Houston, Africa,

the Middle East and Europe.

Gerard Shore


Gerard focuses on providing operational strategy

support to oil & gas clients in Europe and beyond.

He specialises in the identification and delivery

of business transformation solutions that drive

operational performance improvement and higherreturns on capital expenditure.

His experience includes leading oil & gas projects

across Europe, the US, Africa, Asia and Australia and

identifying benefits across numerous business areas

including refining, petrochemical manufacture, supply,

distribution and fuels marketing.

Gerards refining experience includes delivering

performance improvement in operations,

maintenance, engineering, capital projects and

support functions.

Fergus Woodward


With over 14 years experience in oil & gas and

related industries, Fergus is an operations strategy

expert across both the upstream and downstream

oil & gas value chain. His particular interests concern

value optimisation in refining, petrochemicals and

offshore upstream operations.

Fergus typically advises organisations on enterprise-

wide sustainable operational profit improvement

programmes - covering cash, cost and margin. His

reviews have included areas such as maintenance,

turnarounds, logistics, manpower, employee

benefits & remuneration, procurement, research

& technology and integrated operating model

structures. Clients include numerous major oil & gas

companies worldwide.

Fergus began his career in the oil and gas industry

as a Chartered Chemical Engineer. He is the author

of several papers on the subject of optimising value

from operations including a recent article for KPMG

on the petrochemicals sector.


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LINKS The KPMG Global Energy Institute (GEI): launched in2007, the GEI is a worldwide knowledge-sharing forum

on current and emerging industry issues. This vehicle

for accessing thought leadership, events, webcasts,

and podcasts about key industry topics and trends

provides a way for you to share your perspectives on

the challenges and opportunities facing the energy

industry arming you with new tools to better navigate

the changes in this dynamic arena.

www.kpmgglobalenergyinstitute.com

The KPMG Global Energy Conference: The KPMG

Global Energy Conference (GEC) is KPMGs

premier event for executives in the energy industry.

Presented by the KPMG Global Energy Institute,

the GEC attracts more than 600 professionals each

year and brings together energy financial executives

from around the world in a series of interactive

discussions with industry luminaries. The goal ofthe conference is to provide participants with new

insights, tools, and strategies to help them manage

industry-related issues and challenges.

www.kpmgglobalenergyconference.com


http://www.kpmgglobalenergyinstitute.com/http://www.kpmgglobalenergyconference.com/http://www.kpmgglobalenergyinstitute.com/http://www.kpmgglobalenergyconference.com/


23/23

Contact

Europe, Middle East and Africa

London

Jeremy Kay

PartnerKPMG in the UK

T: +44 20 7694 4540


Anthony Lobo

Partner

KPMG in the UK

T: +44 20 7311 8482


Gerard Shore

Director

KPMG in the UK

T: +44 20 7311 3268


Fergus Woodward

Director

KPMG in the UK

T: +44 20 7694 3018


Johannesburg

Alwyn van der Lith

Partner

KPMG in South Africa

T: +27 11 647 7395


Moscow

Hilda Mulock Houwer

PartnerKPMG in Russia

T: +7 495 937 4444 ext: 14099


Muscat

Michael Armstrong

Partner

KPMG in Oman

T: +968 24 709 181


ParisWilfried Lauriano Do Rego

Partner

KPMG in France

T: +33 1 55 68 68 72


Rotterdam

Ruben Rog

Partner

KPMG in the Netherlands

T: + 31 10 453 41 70


Floris van Oranje

Director

KPMG in the Netherlands

T: +31 20 656 84 06


Americas

Calgary

Wayne Chodzicki

PartnerKPMG in Canada

T: +1 403 691 8004


Houston

Regina Mayor

Partner

KPMG in the U.S.A.

T: +1 713 319 3137


Rio de JaneiroManuel Fernandes

Partner

KPMG in Brazil

T: +55 21 3515 9412


ASPAC

Beijing

Peter Fung

Partner

KPMG in China

T: +86 10 8508 7017


Perth

Brent Steedman

Partner

KPMG in Australia

T: +61 8 9263 7184


The information contained herein is of a general nature and is not intended to address the circumstances of any particular

individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such

information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act onsuch information without appropriate professional advice after a thorough examination of the particular situation.

2012 KPMG International Cooperative (KPMG International), a Swiss entity. Member firms of the KPMG network of

independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm

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Future of European Refining Industry

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