In the midst of fighting the worst drop in demand in decades, oil refineries across the world face the risk of needing to close their doors, while the shock waves of the crash spread throughout the oil industry.

Demand for refined products and fuels remains relatively low and inventories have been growing, at the same time that oil refinery activity has become more expensive after cuts in production by the Organization of Petroleum Exporting Countries (OPEC). This scenario has reduced the profit margins of the refineries, which convert oil into products such as diesel, jet fuel and gasoline.

Europe is considered to be the region most at risk, because the facilities tend to be older and governments have embarked on initiatives to gradually decrease the use of fossil fuels in means of transport.

UBS analysts estimate that it would be necessary to reduce the world's refining capacity by about 3 million barrels per day (equivalent to twice the consumption in the UK or 3% of the total in the world) by the end of 2021 for the sector recover profitability. Small refineries in the United States and some in the Asia-Pacific region could also be forced out of the market, analysts added.

New refineries are often more complex and efficient, allowing them to process more types of oil at a lower cost. On the other hand, refineries built in the 1950s and 1960s, when the adoption of mass vehicles took off, appear to be more vulnerable, especially as there is a great new refining capacity emerging in developing countries, from Nigeria to Kuwait.

"We had too much refining capacity before the covid," said Robert Campbell, global head of oil products at the consulting firm Energy Aspects. "Now, undoubtedly, we have [capacity] too much."

Loss 

Demand for fuels began to recover from the depths of April and May, at the height of the containment measures, when world consumption fell by more than 20%. Few, however, are betting on a return to pre-pandemic levels before the end of 2021. Some refineries are already making a loss when total operating costs are taken into account.

Analysts say the outlook for the sector is reminiscent of the post-global financial crisis of 2008, when profit margins only recovered after the definitive closure of some refineries.

Plan B 

Predicting which refineries could close their doors is difficult, as some governments often bail them out, concerned about national security and job cuts. Still, it is possible to see from the sector numbers that refineries such as Essar's, in Stanlow, in northwest England, and Eni's, in Milazzo, Sicily, may have difficulties, as well as the Grangemouth refinery, the only one in engine fuel in Scotland. Commodity trader Gunvor is already studying how to shut down its refinery in Antwerp.

Essar said the Stanlow refinery is a "profitable and sustainable" business. Eni is not "making any specific assessments" of the refinery in Milazzo, which it jointly controls with Kuwait Petroleum Italia. Petroineos, owner of the facilities in Grangemouth, did not return requests for comment.

Even before the coronavirus, the refining industry was under pressure, in the face of new refineries in Asia and the long-term trend to move away from petroleum-based fuels. Recently, the HollyFrontier refinery, in the USA, converted its facilities in Wyoming to biodiesel. Eni and Total can do the same with refineries in Europe, according to UBS.

"There will be a shake-up in the refining industry," said John Auers, executive vice president at the consulting firm Turner, Mason & Company.

In recent weeks, profit margins have collapsed as the price of oil has risen more than the price of finished fuels. Richard Joswick, head of analytics on the refining industry at S&P Global, said that refineries, in a normal year, have net earnings of around $ 10 a barrel. Now, half of that has been earned. Some earn even less. Par Pacific, an American refinery, announced a profit margin of just $ 0.24 per barrel in the first quarter from its activities in Hawaii, 93% less compared to the same months in 2019.

USA 

Despite the weakening of margins, the refining sector in the USA has been relatively resistant, partly because it had already stopped processing activities when demand fell earlier in the year. About 35% of the country's refining capacity was idle in April, according to the US Energy Information Agency (EIA).

In the past few weeks, American refineries have started to process more oil, but states that are big consumers of gasoline, like Texas, are again imposing quarantines against covid-19 and consumption may stagnate. Gasoline inventories in the US are close to their highest seasonal levels in history, despite the start of the local summer, when driving further and demand peaks.

End of the road? 

A British refining executive said there are about 10 refineries in the world considered "at risk" in the coming years. In addition, with countries like the United Kingdom scheduling a ban on selling new gasoline or diesel cars in the 2030s, fuel manufacturers may be nearing the end of the road. In this context, investing in capital goods to increase the long-term profit margin of refineries seems to be a risky bet.

Alan Gelder, head of refining analysis at the consulting firm Wood Mackenzie, compared the industry's thinking to the story of the duo being chased by a bear.

"If you keep running and the rival next to you falls, you will be saved," said Gelder. "But now, they are running downhill towards the water and it is not clear if any of them can swim."