Closing down UK oil refineries

On June 29th the first 180 permanent workers at the Coryton oil refinery lost their jobs as redundancy notices served earlier by the plant’s administrators, Price Waterhouse Cooper (PwC), expired.  This follows efforts by PwC to find a buyer for this producer of strategically important oil products, namely gasoline (petrol) diesel oil, kerosene (for jet engines) and fuel oil (for boilers).  Nominal capacity is almost ten million tonnes per annum (t.p.a.), although figures suggest Coryton has been producing at about half this rate recently which amounts to about 8% of UK aggregate demand for those products.

While this loss of productive capacity can presently be made good by the remaining UK refineries, closure of capacity on this scale for producing any vital product – and fuel certainly is vital – raises the question as to how far short-term free market pricing, environmental constraints, and taxation levels should compromise our capacity to produce for ourselves the necessities of personal and national life such as energy, food and defence.  Put another way, how much should a country pay over and above short-term market prices to retain long-term productive capacity in vital areas of national life.  These concerns apply in different degrees to all West European countries and in respect of defence to our own resource rich sister countries Australia and Canada.

Financial Realities of Oil Refining

A number of refineries in Western Europe have been closed in recent years.  Stanlow in Cheshire with a rated capacity of twelve million tonnes a year was almost closed by Shell in 2008, but was purchased by the Indian company, Essar, in 2009 for a quoted £820 million.  This gives a capital cost “burden” of around £68 per t.p.a. at full output capacity, double this when running at half capacity.  The figures for Coryton were very similar: a purchase price in 2007 of £715 million at its rated capacity gave a capital cost burden of £71.5 per t.p.a. or £143 per t.p.a. when running at half capacity.  One t.p.a. translates to about 1200 litres per year.  So when running at five million t.p.a. (half-capacity), and paying a return on investment equal to the lowest interest rate available for this class of business – say 6% – each litre of oil pays about 0.7 pence in capital charges.  Labour charges are also very small – about 0.55 pence per litre.  When maintenance (0.6 pence) and depreciation (1.2 pence) are added, the total refinery costs are 3.0 pence per litre.  A reasonable return on investment of say 10% would still keep this figure under 3.5 pence per litre.  Clearly then refinery costs have barely been a significant factor in pump petrol prices for some years.

So how do we arrive at this typical pump price of 135 pence per litre today (6th July 2012)?

Brent crude prices (the marker for oil trading in Western Europe) have risen from about $60 per barrel in mid-2007 when Coryton was bought by Petroplus to $90 per barrel today with highs of 130 and a low of 40 and an average over 2011 of about $110 per barrel.  This translates to about 36 pence per litre with $1.55 to £1.

So the total refinery processing cost is equivalent to about a 2½ per cent change in the $:£ exchange rate.  This shows, if no other, how dangerously exposed Britain’s mass production industries are to financial factors completely beyond their control.

The UK government adds to the uncertainty by frequent changes, usually rises, to its fuel duty charge, currently 58 pence per litre.  This is paid to the Government on delivery from the refinery, together with VAT at 20% on the total cost at that point.  In addition there is Petroleum Revenue Tax levied on the oil companies (1.2 pence per litre) which is an additional input cost for the refinery operator.  This means that the average cost of retail gasoline and diesel leaving the refinery is about 118 pence per litre of which only 3.5 pence or 3% is under the control of the refiner.

This is the fundamental reason why practically all the large oil and chemical companies in Western Europe have either sold or are in the process of selling their refineries.  Needless to say the situation is very different in other Anglosphere countries.  Canada, the USA and Australia have federal and state taxes combined amounting to less than half the UK rates of duty, so their refineries are staying open.

Strategic Questions

Duty is levied on the refined oil products, so even if the refiner got his crude oil for nothing, it would do no more than halve the present UK gasoline price.  As it is, the figures above suggest that every one of the UK’s remaining seven refineries could be shut down on the same grounds.  This would mean in turn that the UK would have to import all its refined fuels at whatever the price in North-West Europe happened to be.  The import fuel bill for this would be in the range of £5-10 billions per annum and would have to be paid for by shipping to overseas customers more than the crude oil we currently use in our refineries.

This brings into sharp relief a more general question: How much should the UK or any Western country pay above the short-term world market price to retain industrial capacity (for example in machine tools, aerospace, electronics, defence equipment) in their countries?  And if some capacity is retained by paying above market prices or by reducing tax, what criteria should be used to decide which and how much?

We shall return to these questions in the near future.

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