Refineries: The New Global Power Broker in Oil
During the 28 hours it took me to fly back from Uganda, I had plenty of time to think about what I learned from the trip.
Uganda has found oil, and lots of it. But it lacks the ability to turn crude into needed oil products, like gasoline, diesel, jet fuel, and low sulfur heating oil. Unless it can develop a local way to process the oil coming out of the ground, it must rely upon exporting that production as raw material – at a far lower price than the refined product would command. That, in turn, places the nation’s economy outside of its own control – and at the mercy of what happens in the international market.
The battle shaping up in capital city Kampala looks much like the decisions facing a number of other developing markets.
The “petroleum curse” is all about how oil holds producing nations captive. But the real problem comes from not being able to use at home the oil being produced at home. That ultimately translates into the nation having to forego domestic diversification and expansion of its local employment and revenue bases.
Yet the problem is hardly limited to producing countries. And here is where the investor needs to take stock of the changing landscape in the hunt for oil profits…
To be sure, refining capacity is quickly taking over as the barometer of actual oil market control…
Oil Product Is Cheaper to Import Than Crude
The key to profits now lies less with the extractor of crude oil than with the processor of that crude oil into refined product.
Consider the following. Much has been said about the U.S. failing over the last 30 years to build a new refinery anywhere in the country. Environmental regulations and NIMBY (“Not in My Back Yard”) opposition are often given as the causes. Yet these are not the real reasons. It turns out that, by the time a new refinery in the States could move into production – six years or more if the project were to start today – it will become cheaper to import the oil products from plants abroad.
For several years, we have been doing just that.
The importing of oil products into the U.S. has actually been increasing faster than the import of crude oil. In other words, as we continue to fix attention on the rise of raw material likely to be coming into the country – especially with the uncertainty surrounding offshore drilling following the Gulf blowout – we fail to notice our increasing reliance on foreign refineries for more and more of the gasoline, diesel, and jet fuel consumed at home.
And that is the real reason new refineries here are not going to happen. It’s just not an effective way to drive down a company’s bottom line (or drive up its profits). National security considerations aside, therefore, the refinery market will become increasingly driven by plants built close to production locations, especially in developing countries.
That’s why I have recommended to both the parliament and the ministry in Uganda that they oversize any refineries likely to be built in the country.
Domestic demand alone probably cannot justify a plant producing more than 150,000 barrels a day. But the larger regional market, and genuine prospects to export value-added (and higher-priced) oil products, could easily justify several much bigger refineries. And when the local market begins to expand from a careful oil policy, the supply required to meet increasing demand will have a local (and expandable) refinery capacity ready to handle it.
Profiting from the “Refinery Rush”
As a result, it is little wonder that, while there are no American companies vying for the oil production licenses, Swiss company Foster Wheeler (NasdaqGS:FWLT) is currently conducting a feasibility study to build a refinery in Uganda. It is further along in plant constructions in countries such as Turkey, Morocco, and Kuwait.
Moving forward, this is the wrinkle in the global energy market that may well provide a substantial return on investments.
Watch the companies building refineries in developing countries to service demand, both domestic and export. The overall capital needed to build the facilities there is lower, as are operating costs, while there’s a significant discount in access to a guaranteed raw material flow to the expense of building the plant elsewhere and importing the crude.
In addition to Foster Wheeler, there are several high-profile engineering and construction companies currently emphasizing the building of refineries in developing production countries to straddle both the domestic and export markets. The list includes Texas-based Fluor Corp. (NYSE:FLR) and California-based Jacobs Engineering Group Inc. (NYSE:JEC), along with the ever-present KBR Inc. (NYSE:KBR) and AMEC (LSE:AMEC.UK).
This is an exploding market. While aggregate refinery capacity in developed countries shows only an anemic improvement over the past several years, those figures are rising significantly in other parts of the world. That means, as demand rises in the more established markets – and that is already beginning, as the global recession recedes – more of that demand will be met by imported oil products.
Don’t be surprised if somebody puts together an exchange-traded fund (ETF) to highlight the engineering and construction companies at the leading edge of providing refinery capacity in developing nations to meet the rising needs in other parts of the world.
Rest assured – that trend is only going to increase.