Caltex refineries under the pump

Caltex's Julian Segal has provided a deeper insight into the decision to write down the value of the group's refineries and to review their future, a review that will probably lead to the closure of the Kurnell refinery in Sydney and Lytton refinery in Brisbane.

Last year's decision by Shell to close its Clyde refinery and convert it into an import terminal was generally seen as the inevitable conclusion to a discussion that had been occurring for well over a decade.

The seven Australian refineries – now six – had been seen as increasingly sub-scale and uncompetitive against new refineries in Asia and the Middle East, some which have capacity similar to that of the entire Australian industry. It is also an issue for the local refineries that Asian refineries generally produce petrol as a by-product as the primary demand for transport fuels in the region is for diesel.

The position of the domestic refineries has been exacerbated by the strength of the Australian dollar. It is a reasonable presumption, and one that would be factored into any decision-making, that the dollar will remain stronger for longer – it is probably not a temporary factor.

In his results presentation today Segal added another dimension to the discussion by outlining the likely supply-demand scenario over the course of the next few years.

In 2012 and 2013, Caltex expects Asia Pacific capacity to grow roughly in line with demand. After 2013, however, it says it expects new capacity to significantly out-strip growth in demand, with most of that extra capacity being added within China.

Given the already-stressed position of the remaining Australian refineries, that is a daunting and destabilising prospect. The only advantage the domestic refineries have over imports is in transport costs but their already-marginal competitiveness will be overwhelmed if there is another big wave of new capacity added within the region.

It isn't that Caltex has been standing still. It is engaged in a program to pull $100 million a year of costs out of the refineries by the end of this year but in the context of the pressure on refiner margins that's not going to be sufficient to create a structural change in the business's competitiveness.

Caltex hasn't come to a concluded view about the future of the refineries. It expects to make a decision in about six months and says the options range from investment to closure.

Its decision is somewhat more complex than Shell's given that Shell itself owns and operates refineries within the region and therefore has control of the security of supply for its marketing business.

Caltex, while 50 per cent owned by Chevron of the US, isn't part of an integrated oil major. It would presumably have to reach an arm's-length commercial arrangement with Chevron to be assured of continuity of supply for its marketing operations, which supply about a third of Australia's transport fuels and which are performing exceptionally well.

Given its own conviction of a regional over-supply after 2013 it could, of course, take a view that the market would ensure supply of relatively cheap product but it is improbable, indeed inconceivable, that Caltex would leave its marketing business exposed to some sort of interruption to supply.

The six remaining Australian refineries have survived longer than expected against the challenge posed by the mega-refineries in the region.

The structural shift in the value of the Australian dollar and, if Caltex is right, another burst of additional capacity within the region have, however, tightened the screws on the sector significantly.

Given the implications for national energy security, and the apparent willingness of the Gillard government to write big cheques for industries facing adverse structural change, it will be interesting to see whether there is government intervention to prevent what otherwise looks likely to be, like the Shell decision last year, an inevitable conclusion from the review.