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Business Analysis & Features

Squeezing out the last few drops out of the UK's oil industry

Petrol sale slumps have left oil refineries on the brink of closure, reports Mark Leftly

For the best part of a mile, the trees that flank a long road leading up to the Stanlow oil refinery in Ellesmere Port have been shorn of nearly half their branches. In the spring, this will ensure that there is just enough room for a 20m wide, 400 ton head of a catalytic cracker to be slowly driven to the refinery.

The cat cracker, as Stanlow's 1,100 workers refer to it, refines the thickest, toughest-to-process residue of crude oil and is the biggest of its type in Europe. The new head, brought over from Belgium, is the key part of a $45m (£28.2m) investment to upgrade the cracker, the type of funding that was almost unimaginable under Stanlow's previous ownership.

India's Essar Energy bought Stanlow from supermajor Shell for a token $350m last year, a bold move as oil refining is a desperately struggling industry. It certainly hasn't helped Essar's share price, which was around 520p at the time of the deal but stands at under 140p today.

The remaining oil majors want out of the refineries business as petrol sales have slumped through the financial crisis. They would rather hunt for black gold in the Arctic, Latin American or East African frontiers than try to make just a couple of bucks out of the five-day process to refine a barrel of oil.

Moreover, this year's collapse into administration of Coryton, which supplied 20 per cent of London and South-east England's fuel, was a stark warning of the refining industry's bleak prospects. Increasingly, it is up to independents to try to squeeze cost savings by sharpening the refining process.

There are seven refineries left in the UK, some of which are either up for sale or welcome to offers. Even post-Coryton, the market is too crowded for them all to make a decent profit: eventually some will have t close and motorists will have to pay higher fuel prices.

"I don't think seven can survive, particularly with demand declining," says Volker Schultz, who is the chief executive of Essar Energy's UK oil business. "There is tough competition. Only the best can survive. More closures will follow."

There are about 90 refineries in Europe, which Mr Schultz thinks could fall to 70-75 over the coming years. "I'm bearish. In the medium term I see much lower margins than historically as there are too many refineries in Europe. The aim is to live off returns during the spikes in price and in the base times break even."

One of those spikes took place this year, with gross margins at Stanlow more than doubling to $7.53 a barrel in early summer. Stanlow produces around 220,000 barrels a day, so this is the time to cash in.

Later in summer, Hurricane Isaac brought the US refining industry, which is far more developed than Europe's, to a standstill and there was an explosion at Venezuela's 745,000 barrels-a-day operation. Margins should remain reasonable for a while as Europe takes up the slack.

But, when those refineries are back at full capacity, profit in Europe will fall. The smaller refineries, like the 100,000 barrels-a-day Milford Haven operation in Pembrokeshire, will struggle to keep going.

The Coryton closure was not a one-off, but a $45m investment in a cat cracker is certainly a rare event. This is an industry on the edge.