While the COVID-19 pandemic and the conflict in Ukraine have triggered extreme volatility and uncertainty in the refining product and fuel markets, the transition to a low-carbon economy continues to bring significant challenges and opportunities to the refining sector. Increasing national and industry climate commitments and technological improvements, as well as changing consumer preferences, will shape the outlook for refining in the next two decades.1
In this article, we explore what the refining industry could look like across a spectrum of potential outcomes for the energy transition. The potential scenarios around the size of the refining industry and its profitability are based on McKinsey Energy Insight’s proprietary market balancing, oil pricing, and refining margin models.
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Global liquids demand is expected to peak in the next decade across energy transition scenarios
Global liquids demand is expected to peak in the next five to ten years, depending on the pace of technological innovation and the net-zero ambition levels of governments.1 In the Current Trajectory (CT) scenario, the current trajectory of technology improvements, particularly in electric-vehicle (EV) battery technology, continues, supported by the climate policies and targets announced at the end of 2021.
In the Further Acceleration (FA) scenario, improvements in battery costs and more stringent government targets in transport advance the peak several years earlier. Biofuels, H2-enabled synfuels, and carbon capture, utilization, and storage (CCUS) make more meaningful contributions to demand and emissions-reduction targets by 2040. Beyond previously announced legislation, this scenario assumes that recently proposed net-zero pledges (as in the United States [US] and China) are also achieved in time.
In the Fading Momentum (FM) scenario, the global transition away from fossil energy is delayed in the next decade by prolonged disruptions in global supply chains and muted government ambition. Oil demand does not peak until the early 2030s and most of the developing world is still reliant on fossil oil through the 2040s.
Road transport is the main driver of peaking liquids demand across scenarios
Road transport is the main driver of the liquids demand peak, accounting for 90 percent of the decline in global liquids demand between 2019 and 2040. The pace of EV adoption makes up most of this decline by the next decade, once most of the impact of improving engine efficiency on demand is realized.
In the CT scenario, EV sales reach around 50 percent of new vehicle sales globally across all vehicle segments as early as 2030, when battery costs for EVs reach parity with internal combustion engines (ICE).
In the FA scenario, further reduction in battery costs and widescale internal-combustion-engine bans across major economies raise EV penetration to 70 percent of new vehicle sales. Adoption is rapid even in developing countries and regions such as India, Africa, and Southeast Asia.
In the FM scenario, the pace of EV adoption is limited by supply-chain issues, and EV penetration surpasses 50 percent sometime after 2035. By 2040, demand is 15 million barrels per day (mbd) higher in road transport than in the FA scenario.
Refining capacity in OECD regions is most at risk across scenarios
The outlook for net capacity growth follows the demand outlook by scenario, with global capacity growing in the FM scenario by eight mbd, while the CT and FA scenarios would see significant capacity rationalizations of ten mbd to 24 mbd by 2040 to balance demand.1
Refining capacity in North America and Europe is most at risk due to the earlier expected peak in global liquids demand relative to the rest of the world. While refiners in the US have a competitive advantage owing to relatively low energy and feedstock costs and proximity to growing export markets, they are nonetheless exposed to falling margins in the European market, which sets prices in the US. As a result, between 5 and 41 percent of refining capacity in North America could face negative net-cash margins by 2040, depending on the scenario.
In Europe, total capacity at risk of closures and conversions is greater due to the faster expected decline in regional demand, higher energy costs, and rising CO2 prices under the EU Emissions Trading System (ETS). Even in the FM scenario, around 20 percent of European refining capacity would face the pressure of negative margins by 2040, compared to 60 percent in an AT scenario.
The biggest variation exists in Asia, where the market either grows in the FM scenario or shrinks in the CT and FA scenarios, depending on assumptions for China. While strong demand growth supports net-capacity growth in the FM and CT scenarios in China through 2040, Chinese oil demand peaks earlier in the FA scenario. Net exporters would likely need to rationalize capacity or increase competition with the US Gulf Coast to place products in the last few remaining growth regions (such as Latin America and Africa).
In our analysis, we expect refineries most likely to close or undergo a terminal or biofuels conversion if they have some of the following characteristics: a simple configuration, coastal location with exposure to export competition, non-integration with petrochemicals, or private ownership.
Wide range in regional refining value pools by 2040
By 2040, the global refining industry could either retain its size or lose as much as 75 percent of its value on an EBITDA-equivalent basis, depending on the scenario. In the FM scenario, the value-pool decline in OECD regions is mostly offset by growing value pools in the rest of the world, led by Asia and the Middle East. The global refining value pool stabilizes at around $150 billion on average between 2030 and 2040, versus an average $156 billion between 2015 and 2019.
In the CT and FA scenarios, the global refining value pool falls by between 60 and 75 percent of average historical levels. In these scenarios, a growing momentum in government policies and technology could help countries transition from fossil fuels to a primary energy mix dominated by renewable electricity by 2040. Refineries will also likely play a key role in the new low-carbon energy system as suppliers of green hydrogen and biofuels.
