U.K. Deal Marks Latest Shift For European Refining Sector

AUGUST 2, 2011

By ALEXIS FLYNN

Essar Energy Monday completed a deal to buy the U.K’s second-biggest refinery at Stanlow, in Northwest England, from Royal Dutch Shell PLC, marking another step in a changing of the guard for the European refining sector as the fully integrated oil majors sell out to a new coterie of owners.

Essar Energy, a subsidiary of the giant Mumbai-based Essar conglomerate owned by Shashi and Ravi Ruia, paid Shell $350 million for what Essar Energy’s Chief Executive Naresh Nayyar says is a valuable, strategically positioned asset that gives the company an outlet to export surplus products made by its giant refinery at Vadinar in the Indian state of Gujurat.

The entry of one of India’s biggest independent energy companies into the U.K. comes at a time when many industry observers have concluded that the business of refining—essentially buying crude oil and boiling it until it separates into more valuable, easy-to-sell fuel products—is unlikely to improve in Europe for the foreseeable future. Margins are expected to remain under pressure as new capacity outpaces refined product demand, at least until 2015, said consultants KBC. In addition, owners face having to increase investment to comply with new emissions rules, with the first mandated reductions in CO2 emissions under the European Union Emissions Trading Scheme due to come into force from 2013.

In the face of these challenges, owners such as France’s Total SA, Shell and BP PLC have decided to reduce their European refining portfolios and instead invest in emerging markets and higher-margin areas. Their willingness to divest refining assets and a shortage of willing buyers has pushed prices down, attracting interest from a diverse range of buyers, including new emerging-market refinery owners like Essar looking to gain a foothold into the European market, sovereign wealth funds, traders, private-equity and fuel-marketing companies.

These putative new owners are diverse, with different buyers interested in those assets that best suit their type of business. PetroChina Co. bought into refineries in Grangemouth, Scotland and Lavera, France, via a joint venture with Swiss chemical manufacturer Ineos. Abu Dhabi sovereign wealth fund International Petroleum Investment Company, or IPIC, bought a controlling stake in Spain’s CEPSA from Total for around €4 billion ($5.76 billion) in a deal that also included marketing and some production assets.

Commodity traders Trafigura and Vitol, which in 2009 bought some refining assets from Petroplus in Antwerp, are also on the hunt for smaller refining assets that can be used as storage facilities, according to a report by KBC.

Mr. Nayyar said Essar plans to invest $100 million a year in Stanlow over the next four years, money which will be used not only for necessary upgrades to meet environmental standards but also to increase throughput and allow it to process heavier crudes, thus helping to improve profit margins. Essar says burgeoning U.K demand for diesel, which has risen 38% since 1998 according to industry body UKPIA, will soon justify the decision.

This willingness to invest amid difficult market conditions is also explained in large part by the fact Essar is operating from a position of relative strength. With its Vadinar refinery already about to ramp up throughput to 400,000 barrels a day of higher margin products, Stanlow provides “optionality” for Essar, Mr. Nayyar says, explaining that Essar intends to use the refinery’s storage capability and market access to good export effect.

Stephen Brooks, a fuel analyst at consultancy Wood Mackenzie, says this a trend that is likely to continue. “As the oil demand profile changes, not only in Europe but elsewhere, particularly as some of these new large-scale refineries come onstream in the Middle East and Asia [refinery owners] are looking for markets to sell their products and as fuel specifications change, so I think the demand for oil storage will increase.” However, he cautions that Essar’s acquisition of Stanlow shouldn’t necessarily portend a wave of similar deals. Several of Europe’s larger refineries are still for sale.

Last week Total’s Chief Financial Officer Patrick de la Chevardière described the challenge of attracting buyers prepared to meet the firm’s valuation for its Lindsey refinery, Britain’s third-largest, in the present climate. “It is extremely difficult to sell a refinery today,” said Mr. de la Chevardière.

“You have to look at each facility on its merits,” says Mr. Brooks, explaining that what made Stanlow an attractive buy for Essar wouldn’t necessarily translate to other refineries. “Obviously, you can’t ignore the market environment, which has been adverse for refiners in general, that’s an underlying feature affecting the value of these assets.”

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