European Refineries - Good buy or Goodbye? The Dilemma Facing Potential Purchasers Jan 2012

Executive summary Since refining margins collapsed around the world in 2009, the outlook for Refiners in Europe has become increasingly difficult. Refiners have been forced to access cash, debt or parent company reserves, and margins have thus far stubbornly refused to recover as further economic turmoil has landed globally during 2010 and 2011. As of early January, at least 3 of the 8 refineries in the UK are up for sale, with 2 of the others having changed hands in the last 12 months. In Continental Europe, Harburg, Wilhelmshaven, Cremona and Reichstett have all either converted into terminals, or are in the course of doing so; Arpechim is shutting down. Total, signed an agreement with EDF to invest in a liquefied natural gas terminal project after closing Dunkirk refinery. LyondellBasell has started to mothball its Berre refinery in France to give extra time to find a buyer. The challenge, therefore, for a potential investor looking to “dip buy” in the current fire-sale, is which of the refineries on offer (at whatever price they may be accessible for), represents a solid medium to long term investment opportunity that will return cash and provide further strategic options over time. Traditional assessment of refinery attractiveness is driven by location, scale and global complexity (often represented by Nelson Index). Whilst these factors will always matter, we would argue that due to the increasingly complex and “dis-integrated” nature of Europe’s downstream supply chains, a potential buyer also needs to take into account other drivers of value and strategic sustainability, if they are not to make an expensive mistake. These include the ability for the assets to be used flexibly for trading and storage purposes, the relative strength of the asset within its natural marketing “catchment area”, and its access to the primary supply infrastructure (e.g. pipeline and rail) that will enable it to compete against existing and new market entrants. Finally, great care needs to be taken if considering acquiring an asset that has been partly or fully mothballed, as there are a number of elements (both market and asset related) that will make re-accessing historical margin levels difficult.

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Trading flexibility, using refineries as terminals Historic refinery profit and loss accounts that are prepared for sale purposes rarely take into account the additional margin benefit that might be associated with the trading that goes on in an integrated oil company “around an asset”. The value of this varies greatly, depending on the location and flexibility of the refinery in question, but can potentially be worth up to 50c/bbl, in our experience. Whether or not a potential purchaser can capture this value depends on their own capabilities and the synergies that might exist with their current business. As for the potential attraction of refineries for conversion into terminals for storage and onward distribution, this has tended to be a last resort for owners – as witnessed by Reichstett, Wilhelmshaven, Harburg, Cremona and the Cypriot Refining Company recently. The value derived from the conversion will be around the baseload of the local supply envelope and an additional trading margin from contango play, bulk breaking, blending and arbitrage cargoes. Even in a backwardated market there are seasonal contango plays that can support the asset's margin. The size, configuration and flexibility of the final set up of the asset as a storage terminal, as well as the human capability when managing that asset, will determine how much of the above mentioned sources of value will be realised. Such decisions are perhaps easier to economically justify while markets are predominantly in contango, but with current long term backwardation, any such moves by a current owner are more likely to be driven by a desire to avoid the environmental remediation costs associated with full closure. An exception might perhaps be found if the local supply envelope (for example in Switzerland) provided material levels of supply optimisation value from the conversion of a refinery to a terminal, rather than its complete closure. Other, more strategic, reasons could also exist if the potential purchaser wished to support an existing marketing position that is over-extended, they wished to allow linkages with other of their assets (either within or outside of the region), or they wanted to create additional trading optionality.

Locational, infrastructural and supply envelope competitive advantage Beyond the traditional metrics of scale and complexity for measuring the relative competitiveness of refineries, it is essential to consider structural advantages that flow from location, access to primary supply infrastructure and market position. In the UK, all of the 8 operating refineries are at coastal locations, yet the Ineos-Petrochina refinery at Grangemouth benefits from direct pipeline access to Forties crude, providing a freight advantage vs. other refineries processing North Sea crudes. Port draft restrictions and proximity to primary crude supplies also merit consideration. In terms of products, an assessment of the proximity of a refinery to large centres of hydrocarbon demand and the means of accessing such are essential. For example, Exxon-Mobil Fawley, Petroplus Coryton and Essar Stanlow refineries are well located compared to the Humber (TOTAL & COP) and particularly the South-West Wales (Valero & Murco) refineries.

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Beyond the natural refinery hinterland for truck deliveries, the capability of a refinery to access other markets through bulk movements (pipe, rail & ship) is also critical, as very few supply all product locally. Further, equity ownership and shipping rights are an essential consideration in this regard. Refineries with rail loading facilities require locomotives, tank cars and agreed ‘rail paths’ to facilitate product movements. Exxon Mobil, with its proprietary pipeline logistics network has complete control of product movements throughout their network, whereas Petroplus Coryton holds no equity, nor shipping rights, in the primary UKOP pipeline, thereby relying on wholesale sales to other companies such as BP & Shell, who hold UKOP shipping rights. A refiner’s influence and control over end-user product supply is another important consideration. Exxon Mobil’s integrated model enables direct refinery supply from Fawley to Esso’s customers in their refinery hinterland as well as customers in the hinterlands of terminals supplied by their pipeline network. In this way, they can supply customers with their own refinery product in the South-East of England rather than be supplied by product from Petroplus’ Coryton refinery and/or Trading companies, who utilise hired storage facilities on the Thames. In contrast, TOTAL Lindsey, Essar Stanlow, INEOS Grangemouth and Petroplus Coryton are dependent on third party retailers of products, with purchasing power potentially shifting to these parties following expiration of the initial supply agreements. Competitive supply advantage is also an important consideration. The location of Petroplus’ Cressier refinery in ‘landlocked’ Switzerland affords freight advantage over alternative supplies via Rhine barges and SPMR pipeline from Southern France, whereas the Petroplus Teesside refinery, mothballed in 2009, whilst having the advantage of direct pipeline access to Ekofisk crude, had to compete against adjacent sea-fed product storage capacity and the two Humber refineries in relatively close proximity. In summary, a detailed assessment of the market position of each refinery is essential to inform the robustness of a refinery’s competitive position, the threats to existing sales channels, as well as the opportunities for generating additional inland sales (and thus increasing margin) over time.

Mothballed refineries – issues and opportunities Weak refining margins continue to result in part or full immobilisation of a number of refineries in Europe as the variable margins available are not high enough to make a contribution towards fixed costs. A shutdown can range from a very short term approach where start up is expected to be imminent – this entails cooling and inerting equipment for safety reasons but leaving utility systems live to prevent blockages – through to full shutdown which should include removal of all hydrocarbons, gas freeing and inerting of equipment (using nitrogen) as well as careful shutdown of utility systems. Final decommissioning would then entail removal of the inerting atmosphere and removal of any valuable catalyst and should only be completed if the unit is not expected to restart in the medium or long term as internal corrosion will then occur. “Mothballing” suggests a Refinery can be easily switched back on once the margin environment improves. Unfortunately, plants are designed to run. Inerting of equipment using nitrogen helps prevent internal corrosion and catalyst deactivation. However external corrosion, and other types of deterioration such as damage to bearings (due to dirt and debris), catalyst deactivation, chemical attack, standing water and even problems caused to cabling by nesting birds, will occur. It only takes a couple of months of shutdown,

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especially in the cold and damp of a Northwest European climate, for the environment to start to take its toll on equipment which has lain idle. Costs to restart a plant after an extended period are reported to range from 5% - 20% of replacement value depending on how well the process of mothballing was planned and executed. A potential purchaser must also consider whether key operations and maintenance personnel who have experience of running the plant are available for a restart and ongoing operation. The loss of these skills will slow down and may even prevent any potential restart of the refinery. Equally, to the extent that previous customers are now being fed from other supply envelopes, re-accessing them on similar terms may no longer be possible. Finally, European Refiners are subject to strict environmental legislation that results in significant ground remediation costs if they decide to close a site. Hence many will choose to either mothball a refinery or convert it to a terminal as an intermediate step to reduce losses without triggering all the closure obligations. However, a buyer considering purchase of a mothballed refinery should be able to negotiate ownership of previous environmental clean-up costs by adjusting the purchase price to take these into consideration. Alternatively they might only purchase ownership of the top few inches of land on which the plant stands coupled with an arrangement to monitor and recompense for any future contamination of the underlying ground.

Conclusion The current environment represents a historically unusual opportunity to acquire a wide range of European refining assets (and potentially also associated marketing positions) at extremely low prices. The relatively bleak outlook for refining margins, however, dictates that any potential acquirer fully understands the strategic position that the refinery holds within the dynamic European market to ensure that it will be a long term winner, whatever the future may hold. Having carried out similar evaluations within the European market on a number of occasions over the last 24 months, RPS Energy is very well placed to provide support for any such work that may be required as part of an acquisition or a strategic study of the options available to a potential investor. A summary of the RPS Energy Downstream approach and consultancy offers is provided in the appendix.

For further information, or to arrange an exploratory conversation with our senior specialists, please contact, in the first instance, our Downstream Director: Simon Telling

M +44 7880 785 999

E [email protected]

W www.rpsgroup.com/downstream

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About RPS Downstream RPS Energy – a global energy consultancy

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RPS Energy is part of RPS Group, a FTSE 250 company with a turnover of $700m and 4500 employees

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One of the world’s leading suppliers of independent technical and commercial advisory services, project management and transaction support to the international energy industry

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Over 30 years international experience and a resource base

The Downstream Consultancy business of RPS Energy has provided advisory services across the value chain from Refining, Trading and Supply, to Commercial Fuels, Lubricants and Retail

of over 1000 technical staff and associates

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We carry out 500 projects in 100 countries each year for clients including Governments, NOCs, IOCs, Independents, and Financial Institutions worldwide

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RPS Energy operates from main locations in UK, Ireland, the Netherlands, USA, Canada, Brazil, United Arab Emirates, Singapore, Malaysia and Australia

Our experience and capability have supported a large number of strategic investment and business improvement projects for downstream companies worldwide

Deep sector knowledge and project delivery  The focus of our support is on optimising business performance and maximising growth potential  Our teams are made up of highly experienced, industry professionals with unparalleled depth of knowledge and a strong track record of delivering incremental value and process improvement for worldclass companies in major markets around the world

 We work closely with our clients to understand their issues and find effective ways of improving their business. We then craft solutions that ensure we also build enhanced, long-term capability

 Given the unique combination of deep sector experience and market insight we are able to offer tailored, pragmatic solutions and deliver actionable plans to help our clients achieve and sustain their business goals

RPS Downstream Consulting Offers

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Relevant Project Credentials RPS Energy has deep experience in European refining & marketing sectors and has recently undertaken a large number of consulting projects for refiners, fuel marketers, and financial investors on market assessment, strategic option evaluation, feasibility study, project review, refinery due diligence, and M&A advisory and support. Our team of sector specialists with considerable practical business experience and insight has enabled us to deliver highly qualified and uniquely differentiated consulting services. Some of our recent assignments undertaken in respect of the downstream industry both in Europe and globally are as follows:

Downstream M&A Support M&A Support for Refining and Marketing

RPS provided M&A support to a significant independent oil company undertaking a major refining and marketing transaction in Europe. Our expertise was utilised in providing on-the-ground management support and helping to shape and lead the overall acquisition programme in terms of directions, structures, roles, accountabilities, contracts and project management. Further specialised support was provided to the negotiating teams in regards to detailed knowledge of products and markets in order to secure the best position from the vendor.

Refinery M&A Commercial Support

With its intimate knowledge and extensive operational experience in the UK refining, supply and logistics market, RPS was enquired to provide knowledge and guidance with respect to the UK Downstream market to support our client with a major financial transaction, including negotiations with counterparties.

Acquisition Support and Due Diligence

Project managing the process for an NOC to acquire a major stake in a new refining and petrochemicals complex, including carrying out due diligence on the economic evaluation.

Refinery Commercial Due Diligence

Undertook due diligence work for a refiner considering acquiring a number of refining assets. Scope included:  assessing the potential margin improvement opportunities through medium and long term investments,  developing a view of what the purchases could bring to the client in integrated system value,  assessing the value and constraints implied by various marketing businesses and supply and trading agreements associated with the potential acquisitions.

Fuel Market Entry Strategy

The client is a global leader in the downstream marketing of fuel products, who wish to make asset acquisition in Europe. They have engaged RPS to:  conduct an assessment of these markets and form initial viewpoints and insights as to their suitability for an entry strategy  detail all fuels market environment and future outlook, market structure and players’ models, price & margin analysis as well as other special considerations  screen a large number of acquisition/joint ventures targets and conducted initial due diligence to identify the most suitable prospects for taking to the next stage

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Relevant Project Credentials Market Assessment Downstream Expansion Study

To identify available downstream expansion opportunities for our client refiner, RPS conducted a detailed analysis of global market dynamics, refining margins and product off-take options. A further in-depth assessment developed a series of strategic growth and investment options covering trading dynamics, pricing mechanisms, logistics, and downstream markets (retail, commercial, aviation) for different major economic regions.

Downstream Market Entry Study

To support a client’s market entry strategy into the Middle East, RPS performed a detailed market assessment of the downstream sectors that included:

Commercial Fuels Market Study

To identify and assess future growth opportunities for a refiner/marketer in a major European country, RPS delivered a detailed assessment of the commercial fuels retail market. Analysis included detailing all market participants, their competitive positions and infrastructural capabilities.

Refinery Commercial Studies

RPS has carried out a number of refinery commercial studies where it performed full assessment and provided expert views to support the commercial and economic evaluation of potential greenfield refineries in Africa. The studies covered the key topics that drive the refinery’s configuration and economic return, including:

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Setting up a market leading Retail presence Construction of a medium-sized refinery Creating a lubricants business (including manufacturing) Creating an LPG business

 Local and regional product demand and supply, to inform and identify potential off-take opportunities  Product quality specifications in potential local and export markets  Crude & product prices for local and export markets, refinery margins  Overall commercial inputs and insight for development of alternative options

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Relevant Project Credentials Supply, Trading, Terminalling & Storage Supply Logistics Network Study

To optimise and maximise their supply and marketing opportunities, RPS conducted a detailed structural and economic study of the refined products supply infrastructure (including terminals, depots, pipelines, rails etc.) in a major European country for a refiner/marketer in their key market.

Trading Evaluation and Enhancement Implementation

To help a European refiner improve revenue streams and margins from their trading organisation, RPS carried out an evaluation of the current state of their trading organisation and an assessment of additional potential opportunities. We then supported the implementation of various profit enhancing initiatives, while managing the associated risks.

Trading Unit Feasibility Study

A European refiner/marketer engaged RPS in a feasibility study for a potential structure of a Trading Unit focused on entrepreneurial trading, with an aspiration to profit from the market and take out-right positions over and above the commercial optimisation of its existing assets. Following a comprehensive step-by-step approach RPS carried out a detailed competitor benchmarking study, an evaluation of the existing positions and the potential trading options, and delivered a complete design for the approved trading organisation.

Trading Processes and Procedures

RPS supported a European Refiner in developing the appropriate processes and procedures to manage the consequences associated with the trading activity they undertake. RPS built a database of "best practice" processes and procedures referring to deals management and control in the oil trading sector and set the standard for the customer. We also provided a benchmarking calibration to demonstrate how an oil integrator versus an energy commodities trading house apply these processes and to what extent.

Terminal Assessment and Review

RPS, with extensive experience of the Trading, Storage and Terminaling business, carried out an independent market assessment and review of a feasibility study of a terminal expansion project in the Middle East Gulf. The scope includes full study of the current and future storage markets in the region, market competitiveness, players positioning, and hire rates. RPS then reviewed the various technical and financial outcomes of the feasibility study, regarding jetties, draught, and capital costs. As part of the review we also made recommendations on how to progress with various elements of the project that are still under discussion.

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Relevant Project Credentials

Performance Improvement Improving Underperforming Refinery

The new owners of a Med Refinery wanted to improve the efficiency, performance and reduce operational costs. A detailed assessment identified a number of performance improvement opportunities worth >$0.5 per bbl without additional capital investments. These include production planning and scheduling, plant optimisation, zero based cost budgeting, energy conservation, organisational redesign, identification of ‘ad hoc’ improvement projects, and development of a strategic plan. Multi-year implementation of initiatives is now underway to deliver improvements across all elements of the Client’s Refinery Operations. First year delivered twice the expected incremental value.

Refinery Cost Savings Review

Supported a detailed evaluation of the cost savings options for a major European refinery and developed practical implementation plans to deliver material savings across the refining organisation.

Commercial Fuels and Supply and Logistics Optimisation

In order to determine ways in which to increase its participation in the UK commercial fuels market, an IOC commissioned RPS to complete a series of market assessments, identify strategic options and make recommendations on optimising it supply and logistics operations. Scope included mapping the fuels operations in the UK (refineries, terminals), estimating throughputs, detaining the competitive landscape and modelling supply and transport solutions.

Business Organisation

With the NOC client seeking to re-organise and transform its downstream operations to improve returns, RPS acted as subject matter expert (SME), providing leading specialist knowledge and expertise to formulate a new market strategy.

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