Oil refining in the energy transition: key questions answered

Competitiveness is key for assets to be successful in the energy transition, and the most resilient refineries will have strong margins and a low carbon intensity.

Using Wood Mackenzie data, we have plotted individual refineries’ emissions intensity versus their net cash margin in a 2x2  matrix. This includes both petrochemical-integrated assets and refining-only assets. Fill in the form to download an extract of this report, and read on for an introduction.

• For assets with high emissions intensity and low margins, the prospects for positive returns aren’t great. Eventually these asset owners will likely be looking at divestment, closure, or conversion as the energy transition continues, particularly in regions with robust carbon pricing regimes.
• Assets with high margins and low carbon intensity are the most competitive, the most future-proofed assets for the transition. Chemicals integration is very helpful, with high margins and low Scope 3 emissions. Gasoline-focused refineries have also had higher margins than diesel-focused ones in recent years, but this could change as the passenger vehicle fleet electrifies.
• Assets with low carbon intensity and low margins will look to invest in higher-value, lower volume products that can improve returns. This could include liquid renewable fuels, whose margins are several times higher than conventional fossil products in Europe due to regulations like the Fit for 55 policies and the Renewable Energy Directive.
• Assets with high carbon intensity and high margins will look to invest in reducing emissions. Download the report for detail on refiners' strategic options to reduce carbon emissions.

What is the outlook for oil demand, supply, and prices? 

The global economy performed relatively well in 2023, defying the general gloomy sentiment. As inflation eases and the interest rate cycle nears its peak, we expect similar GDP growth of 2-3% for the rest of the decade.

In this macroeconomic context, we see oil demand growth continuing to slow, primarily due to the electrification of the passenger vehicle fleet, and our modelling has global liquids demand peaking in the early 2030s. In Europe, the post-Covid recovery in oil product demand eases by the mid-2020s, after which demand enters terminal decline.

We don’t see global demand falling off a cliff, because not everything can be electrified. Hard to abate sectors, like long-haul trucking, tend to be middle distillate consumers. The expansion of petrochemical capacity in emerging markets is the main source of future oil demand growth in our forecast – but this is more than offset by the accelerating demand decline in the passenger vehicle fleet.

Global refinery crude throughput peaks in the late 2020s in our outlook, then plateaus until the mid-2030s. We see a gradual increase in naphtha yields, and a decrease in gasoline yields, as demand for petrochemical feedstocks ramps up, particularly in Asia.

Overall, supply gains combined with weaker demand growth puts downward pressure on crude oil prices after 2025.

When does the theme of refining capacity rationalisation return?

The pace of refinery closures and conversions has slowed down during the 2020s, and based on firm and announced projects, around 3 mb/d of refining capacity will be added globally by 2026. But net capacity additions turn negative by the late 2020s.

Looking ahead beyond 2030, in Europe, falling demand and the negative impact on margins will force more refinery closures in the 2030s, and Europe is forecast to lose as much as 5 mb/d of capacity by 2050. North America follows a similar trend. Asia Pacific and the Middle East are the only regions expected to see net capacity gains in the 2030s, with large chemicals integrated sites coming online, but Asia also starts shedding capacity by the 2040s.

With demand falling in the 2030s and 2040s, refining capacity will shrink as refiners aim to keep utilisation rates at profitable levels. So, we see capacity rationalization returning in the 2030s, and refiners need to plan to adapt.

What is the margin outlook for the European refining sector?

The key leading indicator of that adaptation process will be the financial performance of refineries. Benchmark refining margins climbed to record highs in 2022 as the market tightened due to a perfect storm of sanctions on Russian oil products, the post-Covid recovery, and recent refinery closures. Margins have since come back down but are expected to remain relatively attractive through the 2020’s in a tight global products market. Complex hydrocracker margins remain advantaged, driven by middle distillate strength. FCC or gasoline-focused refinery margins are weaker due to the more rapid replacement of gasoline-powered passenger vehicles.

In the longer term, margins become challenged as demand declines, creating oversupply and the need for capacity rationalisation. European refiners have the greatest need to adapt, with a more rapidly declining market and greater margin deterioration compared to their peers in the US and developing Asia.

In fact, by the early 2030s half the refineries in Europe will be generating negative net cash margins, based on analysis from Wood Mackenzie’s Refinery Evaluation Model using variables like feedstock costs, gross product worth, operating costs, and carbon costs. 2021 was not a great year for most assets, while in 2022 every refiner in Europe had positive margins. Margins are expected to come down in the mid- and late-2020s. The least competitive assets will need to invest to produce lower carbon, higher value products, or else consider asset closure or conversion.

Margins will remain positive for the most advantaged and resilient refining assets, and we will increasingly see a linkage between an asset’s margins and its cost of carbon.

Fill in the form at the top of the page to download an extract of our refining in the energy transition market outlook for a deeper dive into the data.