Oil refiners: Seeking protection from ‘carbon leakage’

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Europe’s fuel refining sector may be succeeding in its attempt to receive free emissions credits under the next phase of the EU’s CO2 trading scheme, EURACTIV learned in an interview with Isabelle Muller, secretary general of Europia, the oil refining industry association.

Isabelle Muller is secretary general of Europia, the European Petroleum Industry Association, which represents the oil refining and marketing industry in Europe.

To read a shortened version of this interview, please click here.

As a representative of the refining sector, how would you assess the volatility of oil prices this year?

It is a concern for us to stabilise the investments and our activity. This extreme volatility is a real problem because oil is our raw material. The prices of oil products usually follow but with a different time lag. 

However, due to the high prices, it has been very clear in the USA as well as in Europe this summer that consumption of oil products has actually decreased. And this is very new because for the last thirty years, we have been unable to identify a price-elasticity in the consumption of fuels. And this is a new element to be taken into account.

Are you implying that you would favour a higher price for oil to encourage fuel savings?

What we hear in the Brussels arena is that if you want to do something on consumption or emissions, price signals have to be given. 

When I started working in this industry, prices were very high because of the oil shocks in the late 70s and early 80s. Consequently, a lot of work was done on renewable energies such as solar and wind power. Then the price went down and all this work was dropped until it was resumed five years ago. So it can be interpreted as twenty lost years. This is why I am saying that if society really wants something to happen on the energy side, then the prices of oil have to reflect this wish.

The oil industry is at the centre of the debate on energy at the moment. Do you sense a shift in the way the industry is behaving?

I think that the main change that we have seen in our industries started in 2006 with the ETS [Emissions Trading Scheme for CO2]. The industry publicly supported this scheme as the best tool to reduce CO2 emissions and still supports it as the most practical and cost-effective way to tackle the issue of greenhouse gas emissions. So this was the real shift of the industry to take into account societal changes. 

In response to rising oil prices, there is a proposal, backed by EU finance ministers, to publish information about the availability of oil stocks on a weekly basis. What is the industry’s position on this?

The disclosure of oil stocks on a regular basis has been an on-going issue in Europe. Yet, the fact that information on oil stocks is published on a weekly basis in the USA does not provide any certainty for the markets. In fact, the opposite tends to happen because the weekly reports on stocks are quite often inaccurate. This causes economic actors to make decisions on the basis of false information. So the simple assumption that having information on the stocks of oil will stabilise the markets has not been proven. This has not been demonstrated by the US experience.

Unless the data is reliable…

Of course data reliability is important, but even accurate weekly data may not be the best way to increase transparency.

But the decision has been made and EU finance ministers backed it, so what are your recommendations for such a system to be put in place?

From what we understand, the EU finance ministers’ decision in July was a decision on principle, subject to evaluation. The Commission is committed to working on a feasibility study of the proposal by the finance ministers.

Since we are sceptical of the idea of weekly reporting, we think that such a system should only be put in place if the study shows very clear benefits and low costs, compared to other ways of improving transparency.

So your understanding is that this is going to be delayed?

It is my personal perception that things are being worked through and also that there is less pressure because the prices have gone down by themselves. So things are being worked in such a way that things would be more practical and feasible.

Why are you saying it is impossible to compile this data?

It is not so much impossible, but would be very burdensome for member states and industry alike and what’s more important, it would not benefit stocks volatility; quite the opposite, due to potential data inaccuracy. There are better ways of improving stocks transparency like making better use of the existing data. 

Has the Commission recognised that there are problems?

Yes, if my understanding is correct, they have recognised two issues; firstly, the difficulty of getting reliable data on a weekly basis and secondly, the impact that producing reports on stocks has on price stability.  

Are you favourable to a minimum price for oil? Is that an element you would like to see featured in the upcoming revision of the energy taxation directive?

We definitely do not have a position on this because taxation is mainly a matter for member states. 

On the energy taxation directive, our main point is that the taxation regime favours diesel over gasoline. Today, the balance of products is very unfavourable to diesel which means that we have to import around 20-30 million tonnes into Europe and this will increase in the future. 

And at the same time, we export approximately the same amount of gasoline that is being produced in Europe. So we emit CO2 into the air to produce gasoline through refining and then we export the products outside. We cannot reduce the production of gasoline because if we did so, we would also reduce the production of diesel. 

So now, you think that there is a case for bringing an end to this imbalance?

For a long time, there has been a case for bringing an end to it and now the fact is that it is getting too late. If we exclude taxation, the price for gasoline and diesel is the same. 

Politicians have to solve the problem but if you increase taxation, you adjust the prices of diesel higher than that of gasoline. From a social standpoint this is very difficult to address. So this is where we see the difficulty and this is where we see that there would be a case to look at the taxation directive in close detail.

Do you think a revision of diesel taxation could be part of the revision of the directive?  

I know that some wanted to have this expressed, but this is a challenging issue.  

With oil prices increasing, the Commission suggested earlier this year to raise emergency oil stocks. What is Europia’s position on this?

Over the last 50 years, whatever the crisis, the level of emergency stocks and security stocks has been such that there was never was a break in EU supply. So we did not see a case for increasing the amount of security stocks from the current 90 days. We also did not see a case to review or rewrite the directive. If there were some difficulties that were pointed out, it was not mostly in the directive itself but in the implementation of the directive. If there is a problem of implementation, there is no case for changing the directive, but to reinforce compliance with the legislation.

Are you thinking of any newer member states who were granted transitional periods?

No, but it is a fact that compliance throughout the EU is not even.

How is the refining sector affected by the increasingly tense relations with major oil supplier countries such as Russia?

First, I have to state that our association is in charge of oil refining within Europe and not oil production.

Where refiners are affected is by the supply of oil for our European refineries. As you know, oil companies are mostly unintegrated. Some companies have kept their assets in oil production and in oil refining, but both businesses work totally separately. It is not because the company X or Y produces oil that it is the same oil that will be refined in the refineries owned by X or Y: the oil is produced, placed on the market and bought again on the market. So the main issue for us is to get sufficient oil and our view is that there will be oil, only the price will be determined by the market.

OPEC has consistently been putting forward the argument that there is sufficient oil and that price fluctuations are caused by speculation on the market. Do you agree with this analysis?  

Indeed, the link between the prices and speculation is one issue. OPEC has also previously made the point that because there was not enough refining capacity, the prices were going up. However, we do not share this view. We believe that there is enough distillation capacity in Europe, so OPEC’s argument has not been statistically proven. 

So there are no plans at all to increase refining capacity in Europe at the moment?

I did not say that. There are two major issues: firstly, to have enough oil coming in and secondly, how far do you go to transform this oil into oil products. And coming back to the issue of diesel, we do not have enough cracking capacity to make enough diesel out of the crude oil coming in. So in distillation capacity, we have enough in Europe. But what may be missing is how to transform the bottom of the barrel into more diesel. And this is where investment is needed – or would be needed if it is [to be] made sufficiently attractive to invest in Europe and not in other countries around the world.

Why are those investments not taking place?

Many of them have taken place and are taking place, but we still have a deficit. Investors have already chosen to invest approximately six billion euro in European oil refining, which is huge. The second point is that today a lot of investments are being considered, but there are big elements that could hinder decisions to invest in Europe, one namely being the uncertainty of the costs that will have to be absorbed by production in Europe.  

And not the least of them is the price of carbon. Today, when investing in refineries, we do not know if 40 years from now, we will have to pay 40 euros a tonne of CO2 emissions. And of course, unfortunately, all of our investments will lead to higher CO2 emissions.

How can this mismatch be addressed?

Our concern is that it is only in Europe that we have to pay for CO2 emissions and not elsewhere. It is a competitive disadvantage for Europe. As soon as we have global carbon prices, then there will be no disadvantage and the decisions to invest in Europe or elsewhere will be even. 

Also, this situation creates legal and regulatory uncertainty on investments and although taking some risks is a business reality, we cannot take all the risks in the situation where there are no global prices for CO2. The potential competitive disadvantage in Europe has to be considered when deciding on regulation. This is the area on which we are advocating a great deal because we believe that there is a benefit to maintain industrial operations inside Europe. In our view this is a security of supply issue.

On the issue of industry relocation due to CO2 emissions constraints – the issue of carbon leakage – how are these discussions evolving from your point of view?

I think discussions have evolved in the right direction. One year ago, when the ETS directive review was issued, refineries were assimilated with the power sector. And as you know, in the revised ETS, the power sector will be under full auctioning from the very beginning, in view of the fact that you cannot transport electricity. If you need electricity, you buy it from the supplier nextdoor, it is not a commodity that can be transported overseas, and so there is no international competition for electricity.

The situation is fundamentally different for our sector because crude oil and derived products are moved around the world. This means that if you create a price opportunity in Europe because you have higher costs, then this will attract products from all over the world because the costs of transport are approximately the same as the CO2 costs. So if you increase the CO2 costs, you have the choice to travel from further away. This demonstrates that we are working in a very open market in which we are totally exposed to worldwide competition, which is different from the power sector.

The discussions have gone in the right direction because these simple facts have been recognised and now we are no longer identified as eligible for full auctioning, but we are now considered as the manufacturing sector, energy intensive sector and possibly subject to carbon leakage. This was a move from the Commission that was much appreciated.

As all energy intensive sectors, which are subject to carbon leakage, we are working on getting the right criteria in order to make the CO2 price affordable. Otherwise, there is a risk of creating a competitive disadvantage for European operations and therefore the system should be balanced by some possible free allocations. 

There is a possibility stated in the directive – subject to some criteria demonstrating carbon leakage and high energy consumption – that there would be a possibility for free allocations. Given that our industry is exposed to global competition and subject to carbon leakage we aim to demonstrate that we should be eligible for as many free allocations as possible.

This does not mean that we do not do anything on CO2 emissions because today, we already have a cap that has been fixed by the ETS and our emissions have to be reduced over time. So in any case, at least 20% of our emissions will be paid for on the market. When we say free allocations, we mean allocations under the cap. But what is over the cap, we have to pay for, whatever happens. And one additional consideration that needs to be taken into account is that because we will be producing more diesel to meet the rising demand, we will emit more in the refineries. 

Essentially, we are making the products that the market wants but in order to do so, we have to increase our emissions. We also need to comply with environmental specifications of other products: moving from high-sulphur to low-sulphur products for marine fuels, for example. All this, according to some projections, could lead to an increase of up to 50% of our CO2 emissions compared to what we have today. 

So it is very simple: we have a 100% CO2 emissions today. From that, we have to go up to 150 while decreasing emissions 20% from the initial 100. We consider that’s already a considerable contribution.

Do you feel that your position is well understood by EU countries and the European Parliament, which are currently discussing the climate change and energy package of legislation?

Our understanding is that at the highest level in the Council, some countries have understood the issue. Even at the highest level of the Commission, President Barroso has also understood the issue. And we have repeated confirmation from legislators that the intent is in no way to kill the industry and that the objective is definitely to balance competitiveness, climate change and security of supply. We believe that we are one of the industries at the heart of these three issues. The will to take into account this dimension has been demonstrated, the question is how to achieve this. And we are not yet sure of the outcome.

Some options have been mentioned such as free emission permits under the ETS or a so-called ‘border tax adjustment’. What is your preferred option?

In the directive today, there are some potential solutions, which are the ‘carbon leakage’ criteria and free allocations under the ETS. 

Then there is another one which has not been included in the directive which has been promoted under the wrong name of border tax adjustment. Now, however, the concept has changed: It has been renamed the ‘carbon inclusion mechanism’. And this is extremely important in the debate among businesses. When you talk about a border adjustment tax, the answer from business is: “No, we are businesses operating worldwide, we don’t want protectionist measures”.

But the idea is slowly progressing that if it came to the point that the price of carbon creates a competitive disadvantage for Europe, then the possibility of having a mechanism – which would not be a protection measure but which would impose a carbon price on all producers inside and outside the EU – would be an element of free trade. 

In practice, in a product, part of the price would be allocated to CO2, regardless of whether it is produced in Europe or not. And this is an element of free trade – to have the same competitive conditions. 

But foreign countries and businesses are probably going to argue that this is a border adjustment tax under a different name and that the effects are very similar, no?

Yes, some may probably argue in this way, however the effects are definitely not similar. In the US, for example, there have been discussions about trading schemes for CO2 that explicitly include such a ‘carbon inclusion mechanism’. Such systems have been specifically proposed to the Senate and the issue will come back right after the elections. 

This means that, if we do not put this in the legislation today, we run the risk that, two years from now, the US will have such a system in place and we may essentially have to pay for the CO2 twice. 

My view is that we should be cautious, look into the future, and at least include in our text the possibility of working on such a system. We all know it will be complicated, but I think it could still be one way of balancing the prices of CO2.

…And when the time comes, EU heads of state could then decide on which solution to apply?

Exactly.  

Do you think that EU lawmakers and member states are warming up to this solution of a carbon inclusion mechanism?

I would say that this option is no longer directly rejected.

You mean, among EU member states or in the European institutions?

I mean in the wider business community, because they were the first to reject it. And my feeling is that they are now listening when it is better explained how the system could look. 

Returning to the issue of carbon prices, you said that at some point, continuing with refining activities in Europe would become too expensive. Have you identified the CO2 price at which this tipping point will happen? 

As an industry, no, it would have to be an individual question for each refinery. There will not be an average answer for our industry. Some refineries are very efficient and offer good margins whereas others are less. This really has to be seen case-by-case.  

Would a price of 30 euro per tonne, for example, be too high?

30 euro per tonne of CO2 would approximately consume half of a refineries’ margin. Over the last 25 years, there have been very low or even profits made in refining. The margin was almost zero. Only recently there have been positive margins for our industry. 

So it is up to each refinery to assess what is the acceptable price depending on its costs, its positions and VAT. 30 euro per tonne is already a considerable cost. We have approximately 150 million tonnes of CO2 emissions. So this makes 4.5 billion euro. 

Talking about billions of euro, there has been public outrage this year about the enormous benefits that oil companies made since prices have started to soar. This has led some politicians to suggest imposing a tax on the profits of oil companies, which was nick-named the ‘Robin Hood tax’. If oil companies are making such high profits, why are they not able to afford rising CO2 costs?

Even though some oil companies operate in production, refining, trading and marketing, more and more of these operations are now separated. This means that oil companies involved in production are rated on production and the results are being accounted for only on production.

Refining is downstream, it is a different business, and it has to be profitable by itself. Companies cannot simply transfer money from one part of the business to the other. 

If you are a big producing company and all your profits are being absorbed because you are at the same time a big refiner, then your share price will go down because investors would rather put money in companies that are not involved in refining. So it is a false economic assumption that you can take money from one part of the business where money is being made and transfer it to another part. At the end of the day, this would threaten the whole company.

But a lot of the oil companies are indeed integrated, aren’t they?

Not all of them, only the very big ones. And you may see that some of the big ones are moving out of downstream in Europe.

The European Commission has had a constant policy of trying to split up entire sectors by breaking up the infrastructure from service provision. Although it hasn’t completely happened, this is the direction it has taken in the telecoms and electricity sectors, for example. Could there be a case to do the same in the oil and refining industry as well?

It is the case already. We have a very open market in crude oil. In parallel, there is the logistics side with the whole system of pipelines. Then there is the downstream market, the product market for end products, which is also a very open market. It is already practically separated. The companies were historically integrated because they wanted to have more certainty that they would have access to the final consumer.

Now there is a big demand for oil particularly in the developing markets such as China or India and it is less critical to secure a market for final products. Therefore some companies have started disinvesting in downstream, and are no longer present in marketing and refining. So when speaking about the oil sector, one has to realise that there is a whole chain and the parts of that chain are affected differently.

Still there are big brands, such as Shell and ExxonMobil, which are involved in the whole chain…

Yes, but this is changing. Some big worldwide companies have moved out from marketing. Some other companies have sold their refineries in Europe to new business actors. These are the signals that it can happen.

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