The Who’s single, “Won’t Get Fooled Again,” released in 1971, cautioned against political revolutions, which (especially in the developing world) often don’t deliver on all their promises. Though we do our best, the same can sometimes be said regarding petroleum supply and demand forecasts, on which refiners typically based their capital spending decisions. Refiners generally add processing capacity based on the expectation of what global product demand will likely be in about five years, as this coincides with the typical timeline to approve, design, fund, and construct new projects. Once projects are launched, however, they are generally completed even if expected demand increases do not materialize. This process works reasonably well during periods of consistent demand increases but not during economic disruptions like the Great Recession, when previous forecasts for robust demand and economic growth that failed to materialize “spurred us [refiners] on” to build an excess of new refinery projects. The resultant supply/demand imbalance has had a significant impact on global utilization rates and, as a result, refining margins. However, this current imbalance is likely to bode well for refiners for the next several years, or at least until refiners once again decide to “Take a bow for the new revolution” and once again ramp up the rate of new capacity expansions beyond those of product demand growth.
For over ten years, Turner, Mason & Company (TM&C) has been monitoring global refining construction. The data for each project is gathered from publicly available sources, including press reports and corporate announcements (from owners and vendors), corporate financial filings, and other reporting entities. Where appropriate and allowable, information obtained by TM&C from nonpublic sources and our own professional judgment and knowledge are used to supplement the public announcements. Data on the refinery owner, location, unit capacities, completion date, and construction costs are tabulated for each project evaluation.
In our latest refining assessment, we gathered data on 215 global projects which would add nearly 23 million BPD of incremental refining capacity if all the projects were completed. These include new refineries and expansions to existing facilities. Not all announced projects are built, however. While virtually all projects are announced with the best of intentions, many suffer from significant deficiencies. Some are announced for political reasons and there is little follow-through while others have nonexistent or vague sources of capital. Projects may be canceled or delayed due to expansions at competing refineries or shifts in demand patterns while many are simply delayed until the business environment or funding capabilities improve.
For these reasons, TM&C assesses a Probability Index for each announced project based on a scale from one to five with Probability 1 representing a very low likelihood of completion (0 to 20%) and Probability 5 representing a project which is already under construction or highly likely to be completed (80% to 100%). Numerous criteria are used in this evaluation (in addition to actual project progress) such as the economic rationale for the project, the financial standing of the project, ownership and the owner’s ability to fund or finance the project, regional crude and product balances and the past performance of the participants. Figure 1 displays the percentages of projects which fell into each probability category in our construction current outlook.
We believe that only the projects with a Probability of 3 or higher will be constructed. Of the 215 announced projects, about half have a Probability of 3 or greater and these will add approximately 7.4 million BPD of crude processing capacity, or about 32% of the announced total.
In addition to providing an insight in future refining growth, the construction outlook also provides a history of project completions. This allows a comparison of future refining growth with recent history to establish construction trends. An example of this is seen in Figure 2 which details the yearly global capacity additions since 2010 along with our current refining projections through 2021. The erratic swings in construction are very evident along with the plunge in new capacity additions from 2013 through 2017.
The yearly changes in new refinery construction projects are often logical but generally lag changes in demand due to the approximate five-year horizon to approve, fund, design, and construct new facilities. The increases in 2010 through 2012 were the result of the solid demand growth which preceded the Great Recession beginning in 2008. The new projects in 2010 through 2012 were already underway through much of the economic downturn and were completed in spite of the declines in global demand in 2008 and 2009. The demand declines did create a massive contraction in expansion approvals, however, which have resulted in the sharp downturn in new capacity additions in 2014 through 2017. As usual, the refining industry has overreacted, and the effects are likely to have a significant impact on global margins.
It is obvious that global refining construction was overheated in 2012 through 2014 with an annual average of nearly 2.4 million BPD of new capacity additions. Global petroleum demand only increased by slightly less than 1.1 million BPD over the same period. Refinery closures were less than the difference of 1.3 million BPD with the result that global refinery utilization rates declined during the period. Since 2014, however, global utilization rates have steadily increased as new construction has sharply declined. Utilization rates in 2016 were the highest since the first year of the Great Recession in 2008. Because of the continued decline expected for 2017, global utilization rates are expected to go even higher.
This situation clearly bodes well for global refiners, but the good news is not just limited to 2017. While we expect an upturn in new capacity additions in 2018, the addition rate of 2018 through 2021 will not likely change utilization rates from their 2017 levels. The 2018 through 2021 average is approximately 1.5 million BPD and well below the overheated 2012-2014 level of 2.4 million BPD. The actual increase in refining capacity will be the net of the new construction increases and future refining shutdowns, but new capacity additions at 1.5 million BPD are only modestly above the projected product demand increases of around 1.0 million BPD. Recent refinery closure rates have been in excess of 0.5 million BPD so it is likely the current high utilization rates will hold for several years. This topic is more extensively discussed in our recently published 2017 Worldwide Refinery Construction Outlook.
The TM&C Worldwide Refinery Construction Outlook is published semiannually along with our Crude and Refined Products Outlook. In addition to monitoring refinery construction, TM&C monitors changes and projected changes in pricing and supply and demand across the globe for crude oil and petroleum products. Our projections take into account changing rules and regulations, technological advancements, production and transportation costs, demographics, changes in consumer behavior, and other factors impacting supply and demand. More information on these publications and our other work involving oil industry developments and dynamics can be obtained by contacting us, visiting our website at turnermason.com or calling Shanda Thomas at 214-754-0898.