Western Australia appears to be dodging the collapse of Australia’s manufacturing sector, but it would be wise to keep an eye on one of the State’s most important businesses, the BP oil refinery at Kwinana.
Critical to the supply of petroleum products, including bitumen for roads, the Kwinana refinery is facing the same pressures as all processing facilities in a country being hit by a high exchange rate, cheap imports, rising labour costs, and rising taxes.
Those factors are claiming 1000 jobs at Bluescope Steel, have already claimed the life of Shell’s Clyde oil refinery in Sydney, and last week put two more Australian refineries “under review” when Caltex said it was looking at their future.
BP has invested heavily in upgrading Kwinana and would almost certainly deny that it has any plans for closure, or sale, but what it cannot deny is that the particular problems affecting oil refining in Australia are being magnified by two other factors.
Peculiar to BP is the need to re-shape the company after the high costs and gross embarrassment of the Macondo oil spill in the Gulf of Mexico which claimed the career of the company’s then chief executive, Tony Hayward, and has led to the sale of business units to meet environmental clean-up costs, reparations for damage, and fines.
But, over-arching Australia’s cost challenges and BP’s hunt for savings, is an emerging change of direction by the world’s major oil companies which are splitting their operations into separate “upstream” and “downstream” business units with upstream handling exploration and production, and downstream handling refining, distribution and retailing.
Marathon Oil, a modest-sized U.S. petroleum producer, was the first to split earlier this year. ConocoPhillips, one of the so-called super-majors in the same league as Chevron, ExxonMobil, Shell and BP, shocked the industry in July by announcing that it would also hive off its refining operations.
Driving the urge to break up are recent financial studies which show that the integrated oil business model, which involves owning all operational layers from exploration to retail, is not delivering the best returns for investors.
Pure exploration and production companies were found to be returning between 10% and 12% more to investors than integrated companies, with the drag on profit being the refining process.
Business theorists have been quick to point out that the two primary functions of the oil business operate in completely different sectors. Exploration and production is part of the resources world. Refining and retail is an industrial production and marketing process.
If the split of Marathon and ConocoPhillips delivers higher returns for investors then pressure will be applied to the rest of the oil industry to follow.
All this is happening on a global stage while Australia passes through its own problems of trying to save the manufacturing sector and watching as its relatively small oil refineries struggle against the much cheaper mega refineries of Asia.
Shell’s Clyde refinery, which now serves solely as a refined-product import terminal, was the first to go in this phase of refinery rationalisation. It was one of the smaller refineries in Australia, processing 80,000 barrels of oil a day. Kurnell, one of the Caltex refineries being reviewed (Lytton in Brisbane is the other), process up to 140,000 barrels a day – roughly the same as Kwinana.
The Australian refineries are midgets alongside those in Asia. In Singapore, there are two refineries capable of processing 500,000 barrels a day. Korea has two with a capacity approaching one million barrels.
The refining giants of Asia can deliver petroleum into Australia at a price far cheaper than it can be refined here.
Critical as BP’s Kwinana refinery is to WA’s economy it is facing the challenges of low-cost Asian competition, an oil sector demerger trend, BP’s need to maximise profits after the Macondo spill, and the prospect of even higher costs when Australia introduces its tax on carbon.
Oil refineries will qualify for free carbon permits, but not enough to cover all carbon emissions, and any cost increase in a fiercely competitive market is damaging.
A greater worry to oil refinery management is that the start of the carbon tax is just that, a start. The tax will grow – just as Asia’s oil refineries will also grow and become even more competitive.
