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Security In Doubt As Australia’s Aging Oil Refineries Shut Down

The looming closure of three Australian refineries will affect the security of liquid fuel supplies in Australia. This is particularly so if the government and the oil industry don’t devise a joint strategy with which to answer potential supply disruptions.

Last week, Caltex Australia has written down the value of its two oil refineries (Kurnell in NSW and Lytton in Queensland) by A$1.5 billion. Caltex announced that the results of an operational big oil refinery in the world review due in six months could result in refinery closures.

The closure may mark another milestone in the decline of Australia’s refining sector. Shell confirmed in July 2011 that it’ll shut down refining operations at Clyde and convert the Clyde Refinery and Gore Bay Terminal right into a fuel import facility by mid-2013. ExxonMobil’s Port Stanvac refinery near Adelaide was mothballed in 2003. In 2009, the decision was made to close down the refinery.

If an ongoing Caltex review results in closure of the 2 refineries, the nation might be reduced to only four, half the number in 2003.

Caltex’s position also raises questions over the viability of the nation’s four other refineries. Analysts often tout ExxonMobil’s Altona refinery in Melbourne as a candidate for divestment.

There is consensus among industry analysts that this can be very unlikely there shall be any new major additions to Australia’s refining capacity. In actual fact, BP’s chief economist Christof Ruhl described the way forward for the big oil refinery in the world local refining industry as “dire”.

Why are Australian refineries closing down
All the recent refinery closures have been attributed to the rise of huge refineries in the Asian region, where a surge of latest capacity has depressed profit margins in the industry. The closures were not carbon tax related.

Australia’s refineries have experienced declining gross margins for several years, mainly attributable to competition from foreign refineries, an oversupply of refining capacity in Asia, and the high cost of transporting crude oil to Australia.

Crude oil is transported in large tankers (VLCCs) – up to 200,000 tonnes. Petroleum products are transported in much smaller ships – up to 45,000 tonnes. The freight (per barrel) is cheaper for crude oil via VLCCs. However, that is eroded by the higher cost of refining in Australia which results from smaller scale, higher capital costs, and higher wages and energy costs. Thus, the important thing problem for Australian refiners is that the landed cost of crude oil in Australia plus refining costs and a profit margin is higher than the landed cost of petroleum products.

Refineries need a production capacity of no less than 200,000 barrels per day (bpd) in order to reach the minimum efficient scale. Australian refineries are small in capacity (see table) compared with new refineries in Asia. For example, the world’s largest refinery (Jamnagar in India with the production capacity of 1,240,000 bpd, owned by Reliance Industries) could supply more than Australia’s entire yearly fuel demand.

In addition to being comparatively small, Australia’s oil refineries are old, with the last refinery built in 1965. Consequently, they require large investment for upgrade in step with evolving environmental standards.

Australia will not be unique amongst developed countries in this regard. New oil refineries have not been built within the US since 1976, with more than 30 refineries being closed within the last decade. The story is similar in the UK, with the closure of ten refineries for the reason that late 1970s. The majority of closures have happened in OECD countries and this trend is likely to continue.

The prospects for Australian refineries rely on competitive conditions set by global refinery circumstances. The Australian refining industry operates in an internationally competitive market, with large refinery capacity existing in Asia able to exporting substantial volumes of fuel to Australia. On this context, importing refined fuel from Asian mega-refineries, akin to Reliance Industry’s Jamnagar, ExxonMobil’s Singapore refinery or Shell’s Singapore refinery is more cost-effective for oil companies.

How do refinery closures affect Australia’s energy security
The entire demand for petroleum products in Australia is 941,000 bpd. Consumption of refined petroleum products is projected to grow 1.2 per cent a year over the long term.

Future reductions in refining capacity in Australia (from current 761,500 bpd to 433,000 bpd if only four refineries remain operational) and growth in demand imply that imports will play an increasingly greater role in meeting domestic demand.

According to an Australian Strategic Policy Institute report, the truth that domestic oil production and refining capacity falls short of local demand means that Australia is, a minimum of to some extent, vulnerable to the disruption of supplies of crude and refined petroleum products during times of crisis.

In keeping with the former managing director of Caltex Australia, Des King, “Retaining a substantial oil refining capability is important to Australia’s energy security.” The closure of domestic refineries will not improve Australia’s energy security in liquid fuels.

Future reductions in Australian refining capacity, coupled with higher levels of demand for liquid fuels, will result in the elimination of spare refining capacity. Domestic refineries will have limited scope to increase production or divert export cargoes into the domestic market within the event of a breakdown. Replacing domestic production losses with imported product may take time to deliver because of the longer supply chains associated with imported petroleum products.

Domestic refineries provide a much greater degree of flexibility in the product supply chain in the event of an unexpected supply disruption. For instance, as the most important source of imported refined petroleum products to Australia, the lack of refining capacity in Singapore could possibly be the source of serious product shortages in Australia.

The closure of domestic refineries will make Australia more dependent on overseas refiners who may be less aware of the needs of their Australian customers than could be the case with a domestic refiner. It may even reduce the diversification of supply options available for Australia.

What has been the government’s reaction to closures
The Australian Government recognised in its 2008 National Energy Security Assessment, that liquid fuel security will decline significantly if the longer term viability of Australian refineries is challenged and more Australian refineries close.

Yet, as with broader energy policy, the Federal Government has adopted a laissez faire approach to refining. It doesn’t consider refinery closures as a threat to security of fuel supply.

Based on the government’s Draft Energy White Paper, a growing reliance on liquid fuel imports will not be considered to impair long‐term liquid fuel security as a consequence of our ability to import an adequate and reliable supply of liquid fuels through well‐established and diverse international supply chains.

In an announcement following Shell’s decision to shut down the Clyde refinery, the Federal Minister for Resources, Martin Ferguson, said the way forward for the refinery was a commercial matter for Shell and he didn’t have concerns about security of supply.

Yet, analysts suggest that a major disruption to Australia’s oil refining industry would have major consequences not only for the industry but also on society and the economy as an entire. Accordingly, the government and the industry are usually not adequately prepared to respond to or recover from major disaster or disruption. A considerable reduction in Australia’s refining capacity will cause a major shift in Australia’s liquid fuels supply chain and may have significant security implications if supply disruptions arise.