While the European refining sector had been declining for years, the high margin environment and economic robustness of the 2004-2008 "golden age" gave the sector a new lease on life. A wave of M&A deals allowed international oil companies ("IOC") and independent refiners to offload some of their assets. This allowed them to reshape their downstream portfolios while addressing the strategic needs of national oil companies ("NOC"). It also presented an opportunity to emerging players interested in acquiring European outlets for crude production and access to trade flows in the North West Europe and Mediterranean regions. However, this exuberant surge of M&A deals gave way to tears once the price environment declined and Europe was flooded with Russian, US and Middle East oil products.
Opportune LLP ("Opportune"), a leading international energy consulting firm, has explored the complex dynamics of the European market and the long-term outlook for the refining industry in Europe. In the second of a 3-article series, Opportune provides insight into M&A in the European context, addressing what might be for sale, the market of buyers, and potential opportunities.
Since 2008, a large number of European refineries have been considered for sale but there have been few suitable buyers with adequate financial backing to show interest. The obvious problem has been that these assets are unattractive to buyers.
The M&A market in Europe is currently distressed. Only when buyers' demands are fully addressed in terms of valuations, contingent liabilities, workforce, and investment requirements will deals occur. Periods of improved margins will likely result in temporal openings of the bid/ask spread, with deals being postponed and executed in a depressed market environment. Given the many assets that are available, buyers with a clear vision of the type of refinery that will add value to their business model will be able to find exactly what they need.
Opportune has identified two sources of opportunities and new types of buyers with different strategic targets:
Oil traders are now the main buyer of refining assets. They are taking advantage of opportunities to maximize both flexibility and arbitrage, looking to profit from demand and supply disconnects in time (contango), location (geographical price differentials) and quality;
Distressed asset investors and, to a lesser extent, private equity firms are looking to profit from the same disconnects as traders but potentially with a wider strategic focus.
Evolution of the buyers' universe The buyer's landscape has changed significantly in the last decade.
The golden age of refining in 2004 - 2008, characterized by its improved margins and capacity shortage, provided the opportunity for IOCs and independent refiners to offload assets and reshape their downstream portfolios. This was thanks to the emergence of new investors interested in entering and/or consolidating their positions in European downstream. Beginning around 2009, refining profitability deteriorated, but the market was not without buyers. There were still strategic buyers keen to acquire a European outlet for crude production and access to trading flows in the North West Europe and the Mediterranean regions.
National Oil Companies
Oil producing countries have been an important source of potential buyers of refineries. Many NOCs have tried to become vertically integrated and gain access to or consolidate their downstream position in Europe:
Lukoil was keen to establish a presence along the Mediterranean coast and North West Europe, acquiring the Priolo refinery (Italy) from ERG and a 45% stake in the Vlissingen refinery (Netherlands) from The Dow Chemical Company;
KazMunaiGas acquired The Rompetrol Group and its Petromidia refinery in Romania to gain access to European market;
Rosneft acquired PDVSA's 50% interest in the Ruhr-Oel JV with BP and a 21% interest in Saras to gain access to key outlets for Russian crude (respectively the Germany and Mediterranean regions);
GazpromNeft acquired 51% in NIS to support the geopolitical strategy of the Russian government and become a key player in the Balkan market;
Petrochina acquired an interest in Ineos' Lavera (France) and Grangemouth (UK) refineries to improve logistics and gain market intelligence on crude and product flows;
MOL acquired IES and its Mantua refinery (Italy) as a defensive move against OMV's attempt to take them over;
IPIC consolidated its position in CEPSA (Spain) by acquiring the remaining 48.3% interest from Total.
Independent refiners had different motivations, driven by the investment strategies of private equity firms and potential arbitrage plays with other markets:
Petroplus aspired to become the leading independent refiner in Europe and went into a major buying spree. Initially, leading private equity firms such as Carlyle and Riverstone sponsored the purchases, but exited once made public at the end of 2006. In 2007 alone, Petroplus acquired 4 refineries, including Petit Couronne and Reichstett (France) from Shell, Ingolstadt (Germany) from ExxonMobil, and Coryton (UK) from BP;
Essar Energy acquired the Stanlow refinery (UK) from Shell to gain access to infrastructure (storage, pipelines) and to ship products from their refinery in Vadinar (India);
Valero acquired Chevron's Pembroke (UK) refinery to add flexibility to their portfolio and establish a trading flow in the Atlantic;
Keele Oy acquired the Gothenburg refinery (Sweden) from Shell.
In 2012, the euphoria around the refining sector definitely ended with the insolvency proceedings of Petroplus and the distressed sale or closure of its refining plants in Switzerland, France, Germany,
and the UK. Since then, NOCs achieved their strategic objectives and they are now short of funds as their governments (in a low oil price environment) have other domestic political priorities. Independent refiners remain primarily focused on defending their profitability, challenged by a difficult refining scenario, rather than on M&A.
Furthermore, most of the acquisitions executed in the 2004-2011 period ended in tears as buyers, unable to navigate a volatile market environment, realized they had overpaid for unprofitable assets. In addition to the Petroplus bankruptcy mentioned above:
MOL converted the Mantua refinery into storage; Essar Energy shut down a distillation unit of the Stanlow refinery because it was
unprofitable and recently sold 98% of its downstream business to a consortium led by Rosneft (49%) and including Trafigura and United Capital Partners; KazMunaiGas suffered significant losses, entered into litigations with the Romanian government, and finally sold 51% of KazMunaiGas International (formerly The Rompetrol Group) to CEFC China Energy Company as part of a larger package of deals (worth US$ 4 billion) between China and Kazakhstan in the oil and gas, telecommunications and nuclear power sectors; Lukoil is considering a sale or spin-off of the refining assets they previously acquired.
All this resulted in a distressed M&A market characterized by an abundance of refining capacity either for sale or under strategic review, and new buyers entering the sector with different strategic targets.
What is for sale?
The IOCs have been attempting to reshuffle their downstream portfolios for more than 20 years. In 2015, the IOCs announced, once again, their intentions to reduce refining capacity. However, results for 2Q 2016 signaled the renewed problem for European majors, a reliance on refining profits to weather the oil price collapse. Refining margins for the second quarter of 2016 were the lowest since 2010. So far, the majors have reacted to unsatisfactory results by cutting capital investments, announcing divestment plans, and increased borrowing to continue to pay dividends; their top financial priority.
Independent players are also considering their options. In the last decade, these players have achieved exits or partial exits at good valuations when the sale process has been able to address the strategic needs of potential buyers such as Lukoil (ERG-Priolo and The Dow Chemical-Vlissingen), Rosneft (Ruhr Oel, Saras and Essar Oil), GazpromNeft (NIS), KazMunaiGas (Rompetrol), and IPIC (CEPSA).
In general, refiners are concentrating on core assets at the expense of less well-placed assets. Refiners are taking steps to improve the resilience and flexibility of their best refineries and integrate them more tightly with trading operations. This effort aims to decrease inefficiencies, maximize margins, and better position these higher tier performers. As a result, other refineries remain potential candidates for sale. Among the refineries reviewing strategic options and considering a potential sale, we include:
Phillips 66's Whitegate refinery (71 kbpd) in Ireland (in the process of being acquired by Irving Oil);
Shell's Fredericia refinery (70 kbpd) in Denmark (in the process of being acquired by Dansk Olieselskab);
Koch's Rotterdam refinery (85 kbpd) in the Netherlands that recently kicked-off a sale process;
Total's Lindsey refinery (223 kbpd) in the UK; Tamoil's Holborn refinery (78 kbpd) in Germany; Lukoil's European refining assets including Petrotel Ploiesti (Romania), Neftokhim Burgas
(Bulgaria), Priolo (Italy) and Vlissingen (Netherlands); ENI's Livorno (106 kbpd) and Taranto (120 kbpd) refineries in Italy; API's Falconara refinery (83 kbpd) in Italy; ExxonMobil / TotalErg's Trecate refinery (127 kbpd) in Italy; IPLOM's Busalla refinery (40 kbpd) in Italy.
In addition, the IOCs are willing to sell other sites not identified, but are less open to the formal sale processes because they are aware of the limited set of buyers and the potential gap between buyers' and sellers' price expectations.
The majority of the above-mentioned sale candidates are small and have configuration issues; hence they will not immediately appeal to potential buyers. A successful sale largely depends on the refinery configuration, price expectations of the sellers, environmental liabilities, and workforce requirements.
Who will buy?
The buyers' universe is very limited and almost entirely geared towards a trading investment proposition where access to oil, oil product flows, and logistical infrastructure is more important than the refining business itself.
Since 2012, oil traders emerged as the main buyers of refining assets with the aim of adding operational flexibility to their portfolios and taking advantage of arbitrage opportunities:
Gunvor acquired in 2012 the Ingolstadt (Germany) and Antwerp (Belgium) refineries out of Petroplus insolvency, and in 2016 the Kuwait's KPC Rotterdam refinery (Netherlands);
Vitol established Varo Energy with Atlas Invest/Carlyle, which acquired the Cressier refinery (Switzerland) from Petroplus and a 45% interest in the Bayernoil refinery (Germany) from OMV;
Puma Energy / Trafigura acquired the Milford Haven refinery (UK) from Murphy Oil to turn it into a storage site.
Private equity firms have played a limited role in the European downstream sector with the exception of:
Carlyle/Riverstone, which sponsored the initial Petroplus management buy in and the company IPO in 2006;
4D Global Energy, which acquired and sold a minority interest in the IES' Mantua refinery (Italy) and has in its portfolio since 2006 a 20% interest in the IPLOM's Busalla refinery (Italy).
Currently, Carlyle is the only private equity firm with an active investment strategy in European downstream through its portfolio companies Varo Energy and HES International. This approach leverages the track record of the investment team that led the original buy-in of Petroplus. Carlyle's strategy favors refining assets that could be integrated into a broader midstream portfolio and that take advantage of trading flows.
In addition, some distressed investors are circling the sector looking into refineries as cyclical industrial investments that could be bought at attractive valuations. This investment strategy usually aims at improving the profits through integration with sophisticated trading operations, exploiting the full potential of the logistical assets. Among those, Klesch has been probably the most successful, acquiring the Heide refinery (Germany) from Shell and establishing a commodity trading business.
Family-owned investment firms have an advantage over traditional private equity firms because they can keep the assets for longer without the urgency to sell in a 5-year timeframe. They do not have internal rate of return ("IRR") thresholds adding pressure during periods of adverse refining profitability and a stagnant M&A market.
What are buyers looking for?
Potential buyers are looking at the individual capabilities of each asset. In general, seven key factors are making a refinery profitable and appealing to them:
Size to gain economies of scale in fixed costs and energy consumption; Complexity to convert a broad variety of crude grades into a high-value product mix;
Flexibility of supply to minimize the cost of feedstocks, promptly react to market changes by re-optimizing crude runs, and take advantage of market distortions and opportunities;
Marketing flexibility to produce fuels in high demand and access alternative marketing options to take advantage of oil demand in different geographies;
Integration with the supply chain to blend non-standard crudes and oil products and to exploit respective synergies among grades and product specification niches in new and/or regional markets;
Logistics and infrastructure to create an efficient trading hub around the refinery with an attractive cost structure, storage capabilities, and access to port, rail, barges, and pipelines;
Captive market for refined products to access inland markets that could guarantee higher margins due to limited transportation infrastructure and shortages of specialty products.
Refineries can be attractive if they possess these features and can leverage their natural long exposure to product crack spreads to exploit trading opportunities and marketing inefficiencies.
However, deal closures are also highly dependent on:
Valuations that are representative of the market situation. In Europe, only distressed sales have real chances of success. Historical transaction multiples are not a good reference considering persistent refining overcapacity and expected volatility of margins around a low base. Net asset values are converging towards the market value of the inventory equivalent to a significant discount to replacement costs;
Limited capex required to upgrade the refinery, improve operational flexibility, and comply with environmental regulations and product specifications;
Good assets in terms of configuration and location that previously underperformed compared to other refineries, due to mismanagement or lack of focus from prior owners;
Potential uplift in profits to be achieved through operational changes (reduction in energy consumption, system optimizations, etc.);
Favourable agreements with trade unions to allow reductions in workforce; Sustainable environmental situation allowing for continued long-term operation of the
In this context, identifying attractive acquisition targets and successfully executing transactions is challenging, reflected in the limited number of assets changing hands and M&A processes extending over the years.
A buyers' market for years to come
The market is flooded with refining capacity for sale, although a few companies are now announcing strategic reviews and formal sale processes, aware of the limited appetite from investors. Opportune expects a buyers' market where a limited number of select players will be able to cherry pick the best refining assets for their midstream and trading portfolios, and establish exclusive and confidential negotiations with sellers. Deals will be executed only when buyers' demands will be fully addressed in terms of valuations, contingent liabilities, workforce, and investment requirements. Periods of improved margins will likely result in temporal openings of the bid/ask spread with deals being postponed and executed in a depressed market environment. Sellers will disregard opportunistic buyers with limited financial capabilities for reputational issues and risks related to potential post-acquisition bankruptcy, mismanagement of trade union relationships, and environmental liabilities. This will result in few global traders, private equity firms, and distressed investors being the only players in the refining M&A chessboard.