Grangemouth closure has echoes of Rough gas storage

Eighteen months ago I wrote a blog entitled: Cakism in energy policy begins to bite which gained a lot of attention, in which I pointed out that policy-makers tend to want to have their cake and eat it when it comes to energy policy. I cited the example of US President Joe Biden, who once told a young woman: “I want you to look at my eyes. I guarantee you. I guarantee you. We’re going to end fossil fuel.” but later, when gasoline prices rose on the back of refinery capacity reductions, threatened to use emergency powers if oil companies didn’t increase supply in response to high prices, telling them:

“You need to work with my Administration to bring forward concrete, near-term solutions that address the crisis and respect the critical equities of energy workers and fence-line communities….in advance of that, I request that you provide the Secretary with an explanation of any reduction in your refining capacity since 2020…”
– Joe Biden, President of the United States of America

I still don’t know what “critical equities of energy workers and fence-line communities” are, but the meaning was clear – and not at all consistent with “ending” fossil fuels.

Now we have another refinery crisis, this time in Scotland with the potential closure of refinery activities at Grangemouth, which is set to be converted to a fuel import terminal in 2025, and a governing party, this time the Scottish National Party (“SNP”) which similarly wants to move away from fossil fuels, saying it is proud to have “the most ambitious legal framework for emissions reduction in the world”. It intends to reach net zero by 2045.

So, one would expect the SNP to be delighted to see the closure of Grangemouth, after all just a few months ago, the SNP opposed the provision of a drilling licence for the Rosebank oilfield in the North Sea, with First Minister Humza Yousaf describing the award as the “wrong decision”. In a recent speech he said Scotland was “collectively guilty of catastrophic negligence” by remaining a major oil producer. But the closure will cost many jobs and threatens both the country’s energy security and the viability of the Acorn carbon capture project, since in ending its refinery operations, Grangemouth will emit much less carbon dioxide on site.

Grangemouth just transition plan delayed to the point of being pointless

The SNP is widely seen as being paralysed by its coalition with the Green Party, which opposes both fossil fuel use and carbon capture. It has dithered in bringing forward its draft energy strategy and just transition plan, which is now delayed until next summer. Grangemouth is to have its own dedicated plan, being “ideally placed to produce future products in a net zero economy”.

The Scottish Government’s energy strategy states that there is significant potential for carbon-intensive industrial clusters, such as Grangemouth and Mossmorran, to unlock deeper de-carbonisation across Scotland.

“In particular, Grangemouth’s wealth of investment, infrastructure, skills, knowledge and productivity has strong potential for supporting a net zero economy… Given the critical role of Grangemouth, both for our economy and our climate change targets, it is our ambition to see the site remain not only a key manufacturing base for the future, but also one that is significantly decarbonised, supporting further carbon reduction across Scotland,”
– Scottish Government Draft Energy Strategy and Just Transition Plan

The just transition plan for Grangemouth is expected to be finalised by the end of the year, and will include “baseline mapping” of the state of the cluster as it stands today, as well as a “future vision” for 2045. A draft plan is then set to be published for a consultation in the spring of 2024. However, the Scottish Government has been criticised for not delivering the just transition plan for Grangemouth sooner. In fact, far from being “just” the energy transition in Scotland appears reactive and chaotic, and even the SNPs own expert advisors have apparently compared the potential job losses at Grangemouth to the loss of industry jobs under Margaret Thatcher, which given the extent to which Mrs Thatcher was abhorred by the SNP, is some criticism.

The delays in developing the just transition plan for Grangemouth risks making it moot. If the company moves away from refining to pure fuel import, its emissions will fall dramatically.

Grangemouth set to end refinery operations and become an import terminal

Built in 1924, Grangemouth is one of just six refineries in the UK and the only one in Scotland that processes crude oil, often produced in the North Sea, turning it into fuels such as gasoline and diesel. It has a refining capacity of 150,000 barrels per day and employs around 2,000 people and up to 7,000 contractors. Grangemouth is owned and operated by Petroineos, a joint venture between Ineos and PetroChina, and accounts for about 4% of Scottish GDP.

The plant produces a range of refined products:

• Ethylene – intermediate (building block) used in the manufacture of the plastic: polyethylene (on site) and other chemicals in the petrochemical industry (eg emulsion paint, car fuel tanks, resins, adhesives)
• Propylene – intermediate (building block) used to manufacture, for example, the plastic: polypropylene (on site)
• Polyethylene – typical applications include plastic bottles (milk, shampoo), wrappers, food film etc
• Polypropylene – carpets, carpet backing, DVD cases, cabling, water pipes etc
• Ethanol – used in the pharmaceutical industry in the manufacturing process as a solvent
• LPG – for example camping gas
• Gasoline (petrol) – fuelling vehicles
• Jet fuel – aviation
• Home heating oil
• Diesel – fuelling vehicles

After the mid-1970s, the development of North Sea oil enabled Grangemouth to take crude through the Forties Pipeline giving access to the very oils used in setting Brent crude prices, giving the plant an advantage over other refineries. In addition to receiving piped crude through the Forties Pipeline, Grangemouth imports other crudes, notably from West Africa, via its deepwater terminal.

Originally Brent crude prices were set by the Brent field, but in 1984 as production from the field peaked, the output of other fields was added, initially from the nearby Ninian field in 1990. Forties and Oseberg were added in 2002, followed by Ekofisk in 2007 and more recently Troll in January 2018, together known as “BFOET”. The Forties stream alone is a blend of crudes flowing from 70 different fields, including the sour Buzzard stream. Being lower in quality, Forties is in theory the cheapest grade to deliver. Since the cheapest BFOET cargo traded in the 4 pm – 4:30 pm London trading window sets the price of dated Brent, Forties typically sets Brent spot prices. (Dated Brent is the basis for pricing spot brent cargoes – the term “Dated Brent” refers to physical cargoes of crude oil in the North Sea that have been assigned specific delivery dates.)

Despite its locational benefits, the refining business has not performed particularly well. Petroineos Trading Limited which owns both Grangemouth and the Lavera refinery in France lost over US$ 0.5 billion between 2011 and 2021 (the most recent available financial statements), driven by particularly bad years in 2014 and 2020. The accounts do not separate out the two businesses, but it appears that the Lavera accounts for about 60% of the financial performance and Grangemouth about 40%.

During the pandemic, Grangemouth, like many other European refineries, mothballed some fuel-processing units, due to lack of profitability. In November 2020, Petroineos announced the mothballing of the oldest of the three crude oil distillation units, and its fluid catalytic cracking unit, both of which had been shut down since the start of the pandemic. This was accompanied by the loss of up to 200 jobs and reduced the plant’s capacity to its current level of 150,000 bbl /day, from 210,000 bbl /day. At the time, Petroineos blamed this restructuring on the reduction in demand for road and jet fuels – a direct result of the pandemic – along with a gradual long-term increase in the electrification of road vehicles, and a decreased reliance on fossil fuels.

In November 2021, Petroineos shut the hydrocracking unit at Grangemouth. A hydrocracker converts vacuum gasoil (“VGO”) primarily into regular gasoil, which is typically de-sulphurised to produce diesel, although the unit also produces kerosine, naphtha and fuel oil. European hydrocracker units had become increasingly expensive to run as natural gas prices increased from September 2021 onwards having a knock-on effect on hydrogen costs – hydrogen is injected during the hydrocracking process. This closure came just a month after TotalEnergies closed the hydrocracker at its 310,000 bbl /day Antwerp refinery, and a host of other European refinery capacity reductions.

“At the start of the year we did our [regular] analysis on closure risk, and didn’t see a high risk of closure in the near term,” he says. “But in April, the hydrocracker unit which produces a lot of diesel went offline and hasn’t come back. That hits the profitability of the refinery very hard. Global refining profit margins are expected to weaken next year so they might well have doubts about how much money they need to spend and how effective that would be. So all those things have come together for them to say, actually, let’s just stop processing crude and convert it into an import terminal,”
– Alan Gelder, vice-president and lead analyst for refined products at Wood Mackenzie

The Grangemouth hydrocracker was subsequently re-opened, only to go offline again in April 2023, and has not operated since. The Telegraph reported that the cost of repairing the unit has contributed to the plant’s anticipated closure in 2025, when it is set to convert into a fuel import terminal. Analysts say that the costs make keeping the refinery in business are unrealistic – particularly with the profitable hydrocracker out of action.

Refinery economics are likely to be increasingly volatile

European refineries are older than more modern plant elsewhere, and are struggling to compete, despite recovering refinery margins. According to Rystad Energy, the sector has experienced a “significant strategic shift” over the past few years. Demand collapsed during the pandemic, but the Ukraine-Russia war “catapulted refining from famine to feast in term of margins”. More recently, concerns over global economic conditions and oil demand have seen margins contract again.

Between December 2018 to December 2025, the refining industry is forecast to add 12 million bbl /day of production capacity due to new projects which were sanctioned some years ago were subject to delays, including the Al Zour refinery in Kuwait and the Dangote refinery in Nigeria. Over the same period, refinery closures are expected to remove 10 million bbl /day of capacity. Depending on the region it takes between five and ten years to open a new refinery, and there are questions about the long-term future of the sector against de-carbonisation ambitions. In addition, due to the cyclical nature of the industry, refineries typically require 10-20 years of cash flows to justify the large upfront investment.

The main purpose of refineries has been the production of road and aviation fuels but climate poicies mean demand for these products is set to fall. For example, by 2040 road transport fuel demand in the US is forecast to decline by 50% versus 2022 levels, and to 25% by 2050. This undermines the rationale investments in new capacity or plant upgrades, and is driving the closure of older, and less efficient sites.

Rystad Energy sees three possible scenarios for the future of the sector:

• Steep decline: refinery closures in anticipation of de-carbonisation, particularly in the US and Europe;
• Resilience: the US benefits from strategic advantages in terms of technological complexity, location, crude supply, and fuel costs, and could remain resilient with government-aided de-carbonisation initiatives and moves to bio-refining and petrochemical integration. Europe is unlikely to provide that support will struggle to compete with refineries in the Middle East and Asia. An integration with petrochemicals, bio feeds, carbon capture and storage and green hydrogen technologies being the only feasible path;
• Volatility: the most likely scenario with policy shifts and volatility in a carbon credit-driven financial operating environment. The recent recommendation by the US Environmental Protection Agency to delay a scheme to give electric vehicle manufacturers tradable credits under a federal biofuels program is “symbolic” of the expected policy landscape.

Rystad Energy expects refineries east of Suez to gradually gain control of the global market for refined products making the west increasingly dependent on flows from the east. In this case, it says western countries may need to consider building significant strategic stocks of products. With declining global crude oil demand the Middle Eastern refineries are expected to accelerate crude to chemicals, with OPEC potentially moving to controlling the flow of refined products as well as crude.

In terms of prices and margins, Rystad Energy believes there will be more price spikes and higher volatility in the aviation and petrochemical sectors as declining refiner capacity creates shortages in sectors with resilient demand such as jet fuel, liquefied petroleum gas, bitumen, and petrochemical feedstocks. With refinery closures happening faster than the transition to EVs, there could also be shortages in road transport fuels.

It also thinks refineries will face an “upside-down operational shift” – demand for heavier sour crudes will be drastically cut while light sweet paraffinic crudes of shale quality would become particularly sought after.

This analysis throws up some interesting food for thought. Refineries in Europe face some major headwinds – their age and relatively unfavourable cost base, and the desire of governments in the region to drive de-carbonisation. However, there are recent signs that the push to replace conventional cars with EVs is slowing, and with concerns over access to minerals required not just for making electric cars but also delivering renewable generation, charging infrastructure and wider grid infrastructure, there is a growing realisation that it will be difficult for these targets to be met as they are pursued by many countries simultaneously. Concerns over the costs of the energy transition is also growing. Against this backdrop, it is not unreasonable to conclude that the pace of the transition may slow, supporting fuel demand beyond the next decade.

“Grangemouth is quite small and quite old by global standards. This is a problem for all the refineries across the UK and Europe and we are likely to see more closures in coming years. The UK now just has five refineries left, so this is going to make the UK very vulnerable to future global shortages,”
– Greg Newman, chief executive of Onyx Capital Group

Another factor is the risk associated with reliance on refineries in the Middle East and Asia, and in particular, China. China is already cornering the market in many minerals essential to the energy transition – allowing it to also dominate conventional fuel markets would be to create a major geo-political risk. Rather than European countries trying to build strategic product inventories as suggested by Rystad Energy, it might make more economic sense to retain European refinery capacity. This also has environmental benefits in that emissions from shipping refined products would be reduced.

It appears that Europe is going to need to invest one way or another, so it would be sensible to make investments that provide the most energy security, even if that comes at an apparent near-term premium. And in this there is some serious thinking for the UK and Scottish Governments to do in relation to Grangemouth.

Parallels with Rough – let’s not make the same mistake twice

Back in 2016, Centrica determined that it was no longer feasible to continue operating the Rough gas storage facility in the North Sea. After 10 years as a working gas field and then 31 years as a storage facility, its wells were old and beginning to fail. Centrica deemed that the only truly safe option would be to re-drill the wells, at an estimated cost of around £1 billion. The trouble was that with a global supply glut, the value of its storage operation was too small to justify such an investment, particularly with net zero ambitions likely to limit the life of the facility.

So, Centrica decided that unless the Government stumped up the cash, it would close the UK’s largest gas storage facility. The Government demurred, and Rough duly closed, with Centrica producing all of the cushion gas and a good portion of the tail reserves in the original gas field.

Then came the post covid gas bull run and the Russian invasion of Ukraine. Suddenly there was no global gas glut and gas prices became much more expensive and volatile – the ideal conditions for a storge operator. There were many complaints about the short-sightedness of the decision not to keep Rough open (although none that I saw supported by a cost-benefit analysis demonstrating that the £1 billion would have been well spent), and Centrica decided to re-open the facility, initially with 25% of the working volume available, rising to 50% this winter. However, with no cushion gas and less tail gas, the reservoir pressure is greatly reduced, and with no compressors on the production wells, deliverability rates are a fraction of what they used to be (although this lower pressure makes the well integrity concerns smaller).

The salient point, however, is that an important piece of energy infrastructure was allowed to close because remedial investment was considered uneconomic, a decision which many have subsequently regretted. While I continue to criticise those who insist Rough should have stayed open without demonstrating that the £1 billion cost was justified, the saga should be considered now when evaluating the situation at Grangemouth. Like Rough, analysts are suggesting the fundamental economics are tricky, even without the technical challenges, but as with Rough, it is easy to imagine a scenario where a few years down the line, this situation changes.

I’m not suggesting that Petroineos needs to cough up the money for a new hydrocracker, but that the UK and Scottish Governments should think long and hard about whether this is a strategic asset which is important to the country’s energy security. Realistically, the energy transition will take a significant amount of time, during which, hydrocarbons will continue to be required – and it is important to remember that refineries do not only produce fossil fuels, they produce petrochemicals which are used in a wide range of other industries.

When Russia invaded Ukraine, the global gas market underwent a seismic shift, with Europe scrambling to replace Russian gas and other energy products (with mixed success). This resulted in sustained higher prices, requiring the UK and other European countries to subsidise end users, both domestic and industrial, to minimise hardship and maintain competitiveness. The previous logic about the ability to meet UK gas demand on a just-in-time basis was called into question, with many believing that the country would be more resilient if Rough had remained open.

There are clear parallels with the Grangemouth situation – in order to remain competitive, the plant likely needs significant investment, but without it, the UK will have a higher reliance on imports, and in particular, imports from countries whose friendliness is not certain. If China were to invade Taiwan the resulting sanctions could impact the markets for refined fuels in much the same way that the Russian invasion of Ukraine impacted gas markets. It is no longer sensible to discount such concerns – the Russia-Ukraine situation has shown the importance of properly managing geopolitical risks and not placing undue reliance on imports.

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As Joe Biden discovered, when refinery capacity closes, petrol price rise. This may be less politically sensitive in the UK than in the US, but it is still undesirable. Moves to embrace electric cars are stalling, with EV mandates being delayed, and other problems such as access charging infrastructure and insurance hurting demand for electric vehicles. Demand for petrol and diesel is likely to continue for at least another decade even for light vehicles, and longer for heavy trucks. Transition timescales are likely to slip, so it would be wise to ensure the infrastructure necessary to maintain energy security is not compromised in the meantime.

The closure of Rough storage is something many came to regret. The UK and Scottish Governments should take a long, hard look at Grangemouth and avoid making the same mistake again.