New York, 9 January 2012

The financial crisis at Swiss independent refiner Petroplus may herald more than the closure of a few refineries but also the death of the independent refinery model in Europe. Petroplus was the biggest attempt to transfer the independent model from the United States to Europe and was led by Tom O'Malley, who built up and sold at a huge profit two independent U.S. refining companies.

As in America, the idea was to buy up refineries at a fraction of their replacement cost and run them better than previous owners. But while successful last decade in the United States, where refining capacity had fallen into a deficit, the model has proven toxic in Europe, where overcapacity is chronic.

With worldwide net new crude oil distillation capacity additions expected to exceed global oil demand growth by more than 1 million barrels per day this year, 2012 was always going to be tough for the weakest members of the refining herd.

But it might have been reasonable to expect the impending decimation of the U.S. East Coast refining sector -- where up to three Philadelphia-area refineries face closure -- to allow Europe's zombie plants to stagger into another year. After all, it has long been the accepted wisdom of the industry that European refineries will remain open due to strict labor laws, environmental regulations, and political pressure.

Europe's credit crunch might be changing that. Staring down tighter capital restrictions and a possible eurozone recession, Petroplus' bankers dealt the wounded company another, possibly fatal, blow this week, when they froze the its remaining credit lines.

CULLING THE HERD

Already Petroplus' three least efficient refineries are shutting down and it is hard to see them getting restarted any time soon. Nostalgists might want to see European governments pick up these refineries but bond vigilantes would almost certainly hammer any government that moved into a money losing business to save a few hundred jobs.

No major oil company wants more refineries, particularly those they have previously identified as the dogs of their portfolio and sold off to independents. And smaller firms will likely struggle to get the funding needed to pick up all but the most efficient refineries and cash-rich companies are hardly likely to chose a notoriously unprofitable business for a big equity investment.

For now, the temporary Petroplus closures will boost margins for the rest of the sector by reducing competition for crude oil and cutting refined product output. But the grim fact is that at a bare minimum the shutdown of the three Petroplus refineries and at least two of the Philadelphia-area plants will be needed just to keep the Atlantic basin refining sector healthy this year.

This past June, the International Energy Agency predicted hard times for refineries worldwide in 2012, citing an anticipated 2.4 million bpd net increase in global crude oil distillation capacity, compared with only 1.3 million bpd in oil demand growth.

The latest closures cut this imbalance down to about 300,000 bpd. It seems certain that at least six refineries with a combined 800,000 bpd in total distillation capacity will close in addition to other shutdowns already factored into the IEA's June estimate.

This figure includes two in the Philadelphia area (Sunoco's 178,000 bpd Marcus Hook plant and ConocoPhillips' 185,000 bpd Trainer refinery); LyondellBasel's 105,000 bpd Berre, France refinery; and the three Petroplus refineries, which have a combined capacity of 337,000 bpd. Should Sunoco's 330,000 bpd Philadelphia refinery also close, then refinery capacity growth would be brought into line with demand growth.

But come 2013, will these closures be enough to sustain the balance? It is not clear. After all, demand in North America and Europe is widely believed to have already peaked while Asian countries seem bent on ensuring they have buffers of spare refining capacity. The real problem is not just that there is excessive distillation capacity but rather that existing refineries, particularly in Europe, are in the wrong place and make the wrong products.

Too many older refineries turn out the wrong proportion of refined products: too much fuel oil and gasoline and too little diesel. A lot of crude oil is being wasted meeting galloping demand for distillate fuels like diesel because incremental diesel production means refineries end up making a lot more unwanted fuel oil and gasoline as by-products.

For a while, this was masked by shuffling marginal refineries between companies with the help of bank loans and private equity funds. But until bankers are more willing to make risky loans that looks increasingly like yesterday's solution.

Ends --

By Robert Campbell, Reuters market analyst. The views expressed are his own.