The recent performance of BP underscores the persistent complexities and obstacles confronting the European refining sector. BP Stock Experiences Notable Decline Following $2 Billion Impairment Notification.

Businesses experiencing a secular decline may occasionally experience a temporary resurgence of activity. However, these periods of renewed growth are often fleeting and unsustainable in the long term.

The European refining Industry is currently facing significant challenges. While sanctions imposed on Russian products initially led to increased margins and a temporary reprieve, the situation has since normalized, resulting in a continuation of the sector’s unfavorable circumstances.

The most recent company to experience financial difficulties is BP. On Tuesday, its stock value decreased by more than 4% after the company issued a warning regarding a potential loss of $500 million to $700 million due to lower refining margins. Additionally, an impairment of up to $2 billion was indicated, which is partly connected to the Gelsenkirchen refinery in Germany, where capacity is being reduced.

BP is not the first oil major to reduce its refining capacity, and it is unlikely to be the last. Refineries are typically situated near demand centers because it is more economical to transport crude oil than refined products such as diesel or jet fuel. However, demand in Europe has declined from 12.1 million barrels per day in 2003 to 9.6 million barrels per day in 2022, according to Alastair Syme of Citigroup, with the rate of decline accelerating in recent years due to sluggish industrial activity. 

Europe has been reducing its refining capacity at an average annual rate of 220,000 barrels per day since 2010, according to the International Energy Agency. This decline is due to several factors, including the increasing cost of refining in Europe, the availability of cheaper refineries in Asia and Africa, and the growing demand for refined products in those regions. As a result, refining margins in Europe are under pressure, and plants in northwest Europe are expected to make an average of only $3.91 per barrel in the third quarter of this year, which is less than half of what they were making in the first quarter. 

The energy transition will further reduce prospects. According to the IEA, global demand for refined products will increase by 1.2 million barrels per day (b/d) between now and 2030. However, refining capacity is expected to increase by 3.3 million b/d. This will put approximately 1.5 million b/d of European capacity at risk of closure.

The European energy industry believed they had discovered a solution to the overcapacity issue by converting a significant portion of their production capabilities to biofuel production. However, this strategy has also proven to be fraught with challenges. Shell’s recent $1 billion writedown of its biofuel facility in Rotterdam underscores the risks associated with relying on demand driven by government policies, particularly in light of the recent trend of reneging on green commitments.

Refining has become a relatively minor component of the European majors’ operations, accounting for an average of 8-10 percent of normalized cash flow, according to Citi’s analysis. Despite this, the sector is currently experiencing financial difficulties. Further writedowns are anticipated.