A New Golden Era for Oil Refining
Civil war in Sudan, American inventory builds, China's pivotal reopening, long journeys for European oil tankers and the Middle East's expansion into East Africa.
12 min read
“Ambitious” is a word not only used to describe my low-fat diet, but also Aliko Dangote, the Nigerian business mogul worth over $13 billion USD, making him the wealthiest African – for ten consecutive years. That is if we leave out Elon Musk, who was born in South Africa and later became a U.S. citizen in 2002. Dangote started his entrepreneurial journey in an upper middle-class family selling cartons of sweets as a kid, later graduating from university in Egypt when his uncle agreed to lend him money to start a business importing Thai rice and Brazilian sugar. He bought these at wholesale prices from international suppliers, then sold them in small quantities in his local area with lucrative markups. He eventually vertically integrated, building a plant to produce what he had been importing. It was around this time that he was also awarded a state-owned cement company, with which he constructed a cement manufacturing plant with his own money plus a loan from an affiliate of The World Bank. Now, for the first time in his career, he is taking a large position in oil by building the continent’s largest oil refinery, humbly named: Dangote. With this he also hopes that the financial returns are sizeable enough to help him buy Arsenal, the English football club, an acquisition he has been yearning for for years.
The Dangote mega refinery’s construction has not been smooth sailing. It has faced years of delays with debt restructuring, inefficiencies with contractors, issues accessing foreign exchange, potential tweaks in the refinery’s design to adapt to recently changing refining economics and a strong-arming by the state to sell a stake to NNPC, Nigeria’s national oil company. A realistic start date with all the information we currently have is Q1, 2024 despite the publicly advertised H2, 2023.
In theory the refinery will be able to supply 100% of Nigeria’s domestic (oil) fuel demand, but with the country suffering from acute foreign currency shortages it may be forced to export a significant proportion of refined products in return for USD. The wider economic implications of this project are vast with 57,000+ people being employed by the refinery and its affiliates, with dozens of companies and additional infrastructure being set up around Dangote in the Lekki Free Trade Zone highlighted below in anticipation of the refinery’s grand (eventual) opening.
Zooming out, the world is building refineries at a startlingly rapid pace. Oil refining capacity is growing at a speed not seen for nearly two generations, with the 2023 - 2024 increase likely to be the largest two-year increase in net refining capacity globally in 45 years, according to RBC Capital Markets.
Large new refinery projects and their capacities include:
Dangote (Lagos, Nigeria): 650,00 b/d
Al-Zour (Kuwait): 615,000 b/d – commenced operations in November, yet to reach full capacity.
Jazan (Saudi Arabia): 400,000 b/d – has been gradually coming online since 2021.
Jieyang (Guangdong, China): 400,000 b/d – now operational.
Beaumont (Texas, USA): 250,000 b/d – the largest single addition in the U.S. in 10+ years. This expansion project is part of the refinery owned by ExxonMobil and is now in full operation as of end of March.
Duqm (Oman): 230,000 b/d – this will be the third refinery in Oman, which is well positioned on the Arabian Sea to take crude coming from the Arab Gulf and the rest of Asia.
Karbala (Iraq): 140,000 b/d – more on this below.
Sentuo (Ghana): 120,000 b/d – this will be Ghana’s largest refining complex. Construction began in June, 2021 with no solid deadline for completion.
During the Covid pandemic refining was a primary chokepoint with high costs and razor thin (or negative) margins which caused several refineries to shut down, those left standing that relied on natural gas as an input later had margins further hit by expensive gas resulting from the Russia-Ukraine conflict. Now, this new ramp up in refining capacity stems from many drivers, including a fluke: the simultaneous appearance of projects which were delayed over the pandemic. A general consensus that oil will still be needed for decades to come, especially when considering petrochemicals, despite ESG pressures and favourable refining economics in the past year have also refreshed investor sentiments. The increase in global refining capacity will put downward pressures on oil products, especially gasoline and diesel over the next few years.
The Oil Story in Data
Oil prices initially continued to climb in early April on the back of cooling U.S. inflation data, a weaker dollar and generally stronger than expected Chinese trade data. Announcements from the U.S. around buying oil to replenish their SPRs (strategic petroleum reserves) in the second half of the year also contributed to bullish sentiment. This trend then reversed in the past week (April 14th to present), driven in part by uncertainty around future interest rate hikes; shaken economic indicators, especially in manufacturing; and tightness in the availability of dirty tankers (more on this below) causing supply-side concerns.
Global crude production (March): 76.76 million b/d
Global refinery crude runs (March): 79.2 million b/d
Global refining throughput (est. daily average for 2023): 82 million b/d
Global oil demand (March): 100,596,000 b/d (+1.33% vs. March ‘22)
Global oil inventories: 7.27 billion barrels
Largest proven crude reserves by country (infographic)
Events to Watch
1. A potential third civil war begins in Sudan
On April 15th fighting broke out between the president-backed Sudanese Armed Forces and the paramilitary Rapid Support Forces (RSF) loyal to the country’s Vice-President. Foreign embassies (e.g. France and the U.S.) in Khartoum have evacuated staff and some airlines have stopped all flights to and from the country. At least 180 people have been killed and 1,800 wounded, mostly in the capital. Whether this fully escalates into a third country-wide civil war since its independence in 1956 is yet to be determined.
Sudan and South Sudan split into two independent countries in 2011 after decades of conflict between the Christian south and Arab Muslim north. Combined, they hold 5 billion barrels of proven oil reserves with current production sitting at around 224,000 b/d. South Sudan produces the majority (70%) and Sudan the minority (30%). The main three crude blends are Dar, Nile and Fula. Liquid fuel consumption in Sudan and South Sudan is estimated at 152,000 b/d, with motor gasoline and diesel accounting for most of this according to the EIA.
Sudan has three oil refineries, only two of which are active: Khartoum Aljaili (100,000 b/d) and El-Obeid (10,000 b/d) both of which are operated by Sudapet, Sudan’s state-owned oil company. Sudan has two main export pipelines that travel north to the Mars al-Bashair terminal, just south of Port Sudan on the Red Sea. Most of Sudan’s storage capacity for both crude and refined products are located at this terminal, operated by GNPOC – with a storage capacity of 2.5 million barrels and an export-import facility with handling capacities of 1.2 million b/d. While the two countries have 3 trillion cubic feet of proven gas reserves, they do not yet produce natural gas for commercial or domestic consumption.
The largest foreign companies operating in the oil sector, as measured by value of equity stakes, include CNPC from China, Petronas from Malaysia, ONGC from India and Ansan Wikfs from Yemen, who hold significant equity in local entities GNPOC, Petro Energy and Star Oil. If a civil war escalates there may be disruptions to crude production and refined product yields in the country, resulting in potential disruptions to exports out of the Red Sea.
2. China’s economy fully reopens three years later
China abandoned zero-Covid restrictions in December following popular opposition to the rolling lockdowns that paralysed the country for the better part of three years. As expected, demand increased with Chinese commodities markets rallying further following a release of macro and trade data, including GDP expanding by 4.5% YoY in Q1. Private sector investment and confidence remains shaken given the past three years of domestic policy, which also means there is more room for growth.
Chinese oil demand is a key growth factor to watch this year as it rises above 15.9 million b/d, which is near the top of its 2017 - 2021 range. Domestic and international flights increased in February (21% and 37% MoM respectively) with other transportation sectors such as rail and road expected to gradually continue recovering. This gargantuan appetite for oil is attracting a large share of exports out of the Middle East and Russia.
When China has a short circuit, the rest of the world gets a shock. This applies as much to oil as it does to supply chains for fabrics, artificial vegetation, batteries, metals and other commodities - both on the supply and demand sides. Resultantly, Chinese electric vehicle sales have slowed down, hitting battery demand and therefore lithium prices, a key battery metal. If China does experience a strong economic recovery this year then demand and therefore prices for lithium may buck the dip and continue upwards. If so, and if you are a bull for the long-term electrification of transport, you may consider shares in American miner and refiner Albemarle and their Chilean rival SQM, who have recently been trading at their cheapest forward earning valuations in almost two decades – although please don’t take this as investment advice.
3. U.S. oil inventories to be restocked this year
On April 12th the Biden administration announced plans to refill the Strategic Petroleum Reserve after draining record volumes from it in 2022, which was originally approved in an attempt to lower high prices last summer which was adversely affecting American consumers. Timing of these refills has not been fixed, although the likelihood is inversely related to the crude oil price and so the intent to refill could support a crude oil price floor. Looking at last month, U.S. commercial crude stocks declined to 470 million barrels at the end of March following build-ups in early Q1.
The Biden administration campaigned for office with the promise to wean the U.S. economy off oil, and while they are investing significant resources into the energy transition, the tone simultaneously encourages increased oil production as drillers are being urged to pump more oil in response to high prices and energy security concerns. Anecdotally, more drilling permits have been approved than the Trump administration in its first two years. Looking ahead a variety of U.S. scenarios could play out, one of these being a continuation of restrained capital spending as producers prioritize short-term shareholder returns amidst macro headwinds, dampening production growth – while robust economic activity domestically drives industrial productivity, GDP growth and consumer demand up; both of which would put upwards pressure on prices.
As a side note, the costs of American power projects (including renewables) have risen slightly since 2021, after a decade of declines, as measured by Lazard’s Levelised Cost of Energy Analysis released earlier this month. This is largely attributed to rising input (inflation of equipment and labor costs) and financing costs.
4. Iraq’s Kerbala refinery opens (140,000 b/d)
Located roughly 100km outside Baghdad and owned by the Iraqi Ministry of Oil, the refinery was inaugurated on April 1st after a series of delays. I’ll admit that when I saw the news on this day I thought it was a twisted April Fool’s joke. It is however yet to start commercial production according to the Prime Minister’s office. Full production of 140,000 b/d is expected by the end of July, when fully operational it will be able to produce 9 million litres of fuel/day which is 60% of Iraq’s currently imported 15 million litres/day.
The refinery can produce light products that meet European specifications, including gasoline with up to 95 octane. The refined products Kerbala is capable of producing are: LPG, jet fuel/kerosene, motor gasoline, diesel, heavy diesel, fuel oil, bitumen and solid sulphur. It has storage units and a 200 MW power station, 60 MW of which is intended for the national grid.
5. Kenya to source 100% of its oil products from Aramco, ADNOC and ENOC this year
Kenya, East Africa’s largest economy and a consumer of roughly 120,000 b/d, has signed government-backed deals with Saudi Aramco, ADNOC and ENOC to import all its fuel from the Arab Gulf. These imports will carry six month credit periods in a bid to strengthen the Kenyan Shilling currently being battered by the U.S. dollar. The deal, signed on March 7th, will be in effect for the remainder of the year, expiring in December with the option to extend or revert to their Open Tender System (OTS). This includes gasoline, diesel and jet fuel but excludes LPG.
The intention is to help stabilise the Shilling macro-economically and solve the issue of fuel marketers having constrained access to dollars to purchase fuels and build stocks, which has consequently led to shortages in retail stations across the nation. On the other side of the deal this is a long-awaited opportunity for NOCs in the Arab Gulf to further penetrate nearby downstream markets and grow their political influence in the wider region. The deal does not change how fuel prices will be calculated, the major change will be the landed cost of fuels which is the largest cost component, usually paid in dollars but now to be paid in Kenyan Shillings. Freight rates will become uniform across diesel, jet and super grades, as opposed to previously when rates differed by individual cargoes. Outstanding contracts on the legacy Open Tender System will be honoured.
Does this mean the end of the Kenyan Open Tender System? The short answer is no, with EPRA, the national regulator, claiming that the country will revert to the OTS if and when conditions allow, although these conditions have not been strictly defined.
The deal has been signed, although is facing some legal challenges by market participants. If all goes ahead then the operational side now needs executing. Kenya Pipeline and private depots are working to increase pipeline capacities and boost flow rates to minimise demurrage costs. This is a fairly unique move by a free market state and calls into question what happens to neighbouring countries who partially rely on Kenyan fuel imports including Tanzania, Uganda, Rwanda and Ethiopia.
6. Freight rates skyrocket with a 150 million-barrel increase in oil in-transit resulting from Russian sanctions
Political fallout from the Russia-Ukraine war has enacted the Europeans to place sanctions on everything from Russian oil to Russian caviar as discussed in the previous update. This is shifting Russian exports from predominantly short-haul (to Europe) to long-haul (to Asia). Compounding this issue, Europe is filling the gap of short-haul Russian oil with longer-haul Middle Eastern, African and North American oil – meaning the average travel distance for oil cargoes has increased significantly.
The impact is an increase of 100 million barrels in transit, roughly 7% of the global crude tanker carrying capacity, and so freight rates have doubled as a result. Likewise for refined products, which have increased by 50 million barrels with freight rates also roughly doubling.
This results in wider interregional price differentials for crude and oil products and inflates the bullish risk associated with an increased quantity of oil unavailable for commercial drawdown/use as a larger proportion is on the water instead of in storage for faster consumption.
It is also worth noting the sharp increase in the “dark fleet”, i.e. tankers carrying Russian, Iranian and Venezuelan oil that often turn off their AIS signals to avoid being tracked and therefore scrutinised by Western sanctions. Estimates put the number of these tankers at 700 - 750 in Q1 alone, a roughly 300% increase vs. Q1, 2022. As a side note Pakistan, a nation of 232 million people, placed its first order for discounted Russian crude on April 20th with the first cargo arriving in May.
Thanks for reading. We will continue to track market events closely and pair it with insightful data to keep you informed.