Oil Refiners Warm to K-Shaped Recovery

As the world emerges from the economic slowdown triggered by the COVID-19 pandemic, many economic observers have lamented that the recovery is likely to be K-shaped: some sectors of the economy will recover and begin to expand quickly, while others will see a prolonged downturn and may, indeed, never fully recover. The causes of this phenomenon are as varied as the industries impacted. Several leading oil refiners are predicting a K-shaped recovery unique to their industry: one in which lower carbon fuels expand, while traditional, more carbon-intense fuels continue to face challenges, and signs abound that the industry is moving quickly to adapt to this expectation.

Although the market dynamic for renewables and fossil fuels has seemingly been nearing a tipping point for years, the travel restrictions imposed during the onset of the COVID-19 crisis resulted in plummeting demand for gasoline, diesel and jet fuel, as the transportation and aviation industries were essentially shelved overnight. This sharp decline in demand wreaked havoc on global oil and gas supply chains. During April 2020, spot prices for oil in many regions dipped below zero dollars, and some predicted that storage capacity for oil and refined products could fill up and lead to more broad shutdowns of oil production and refining operations. While the worst of these predictions did not fully play out, refiners returned historically bad financial results. An Oct. 21, 2020, article in S&P Global stated, "In the second quarter [of 2020], analysts had expected the revenue of the seven largest refiners to fall by $46.89 billion year over year. Instead, the group reported a total revenue decline of $62.03 billion."

At the same time as traditional oil refining experienced these unprecedented challenges, tailwinds continued to push lower carbon fuels forward. Even before the COVID-19 pandemic struck, 2020 started off with an unmistakable message from the investor community that capital allocation needed to increasingly favor lower carbon options. In his closely watched annual letter to chief executives, Larry Fink, CEO of BlackRock, the world's largest asset manager with nearly $7 trillion in assets under management, focused on a "fundamental reshaping of finance" being driven by an urgent need to combat climate change. "Climate change has become a defining factor in companies' long-term prospects," said Fink, indicating that the question of "how climate risk will impact both our physical world and the global system that finances economic growth" are "driving a profound reassessment of risk and asset values" that will result, "and sooner than most anticipate… [in] a significant reallocation of capital."

Industry's Decarbonization Plan

This message came as no surprise to the industry, which had been reassessing the rate at which it expected the decarbonization of the energy economy to proceed. In February 2020, BP announced its goal to be net-zero carbon by 2050 or sooner. The company then provided a roadmap with additional details on its plans in its August annual report to investors. In that report, which is viewed by many as a barometer for the broad outlook of the industry, BP projected that demand for oil – which it had previously expected would continue holding steady – would instead fall over the next 30 years and ultimately be replaced by renewable energy. BP CEO Bernard Looney did not mince words when describing the future of the company during an August conference call:

"We're moving earlier than we thought on our strategy. We're moving faster, we're moving further and we're moving more decisively. The world is in a different place because of COVID-19 and so are we. And the more we understand about the consequences for the global economy and the inevitable uncertainty that it brings, the more convinced we are that the ambition and the direction that we laid out … is taking us in the right direction for BP. … Within a decade, BP intends to be a very different kind of energy company."

This "right direction" will lead BP to cut its oil and gas output by 40 percent and invest more than $5 billion annually in low-carbon alternatives by 2030. BP is certainly not alone in this – nearly every significant multinational oil company has laid out similar plans.

Consumers are shifting their focus too. In September, China, the largest consumer of carbon in the world whose carbon emissions are still on an upward trajectory, shocked many around the world by pledging to be carbon neutral by 2060. This pledge requires an enormous reallocation of investment by China from carbon-intense energy to lower-carbon alternatives.

Trend Continues Toward Renewable Fuels

This confluence of events has resulted in nearly immediate operational effects in the industry. Among others, one particular market response has stood out: oil refineries in both the U.S. and abroad are rapidly being converted for the production of renewable fuels. In doing so, refiners are taking advantage of the most readily available opportunity to lower the carbon intensity of their fuels. In June, HollyFrontier announced plans to convert its Cheyenne, Wyoming, oil refinery into a renewable diesel plant. In August, Phillips 66 announced that it will reconfigure its San Francisco refinery into one of the world's largest biofuels plant, which, if approved, will begin production in early 2024. In October, Marathon Petroleum Corp. shuttered plans to restart its Martinez, California, oil refinery in favor of repurposing it into a renewable diesel production plant.

The trend has played out in other parts of the world as well. In Europe, another supermajor, Total, along with Neste and Gunvor Petroleum Antwerpen, are considering permanent shutdowns for certain refineries in France, Finland and Belgium. In Sweden, energy and biofuels producer Preem AB has already begun converting a petroleum refinery into Scandinavia's largest producer of renewable fuels. BP announced in November it plans to shut down one of the largest oil refineries in Australia. Although it currently intends to convert the refinery into an import terminal, BP is reportedly exploring other options as well, such as including storage for sustainable aviation fuel and renewable diesel.

Oil and gas companies are often discussed as being the best situated players to consolidate the energy industry. The recent conversions to biofuels certainly underscore that notion, but they also preview a different future for the industry, as many are now exploring longer term opportunities in emerging technologies. Hydrogen is widely viewed as perhaps the most promising long-term transportation fuel because of its ability to power fuel cell electric vehicles over long distances with fast refueling systems that are similar to and complement existing refueling networks. And, when paired with excess renewable energy and developments in production technologies, hydrogen could become a cost-competitive option that produces zero carbon emissions over its entire lifecycle. This promise led BP and Ørsted, the world's largest offshore wind developer, to announce in November a joint venture that will pair Ørsted's wind energy with electrolyzers to produce green hydrogen that BP will use to offset current hydrogen sources that are more carbon intense.

These trends were well underway even before it became clear that President-Elect Joe Biden intends to steer a more green energy-friendly White House for at least the next four years. Indeed, while the COVID-19 pandemic has made 2020 an extremely challenging year in many ways, industry observers may look back on this year in energy – and the impact that COVID-19 had on it – as a pivotal time where several factors converged to accelerate the pace of decarbonizing energy around the world, and for transportation fuels in particular.