End of a golden era for refiners?
Refiners may struggle to keep making the profits of recent years, but there's life in the sector yet
Like upstream, the refining sector has been undergoing consolidation over the past decade. Bigger players are holding on to plum assets and smaller independents have adopted agile business models to eke out profits from what's left.
Those who stuck with it when oil prices were over $100 a barrel and margins were correspondingly slim have reaped the benefits since crude prices slid in late 2014. Now they are wondering how long the good times can last.
A little longer, at least, seems to be the answer, as
high US shale oil production is keeping crude prices in check. But the overall picture is nuanced and complex.
Opec's production cuts may not have brought the price impact the group wanted, but they have reinforced a crucial global trend for refiners: some displacement of heavier crudes by light oil. Much of the crude cut by Opec has been of less-profitable heavy or medium grades, giving more space to lighter oil like that produced in the US.
The tightening of heavier supply means facilities built to process heavier crudes into lighter varieties are struggling to pick up the price discounts that their feedstock once offered.
The preponderance of complex refineries on the US Gulf of Mexico coast tooled to take the heavier crudes that used to be the region's staple feedstock is well known. But the mismatch between current feedstocks and refining technology is not restricted to the US.
"There are complex refineries around the world. Current crude differentials just don't support the investment made in costly equipment," says Jonathan Leitch, head of refining research at
Wood Mackenzie. "Previously they were getting a $2-3 discount on those heavy and medium crudes, but that discount has disappeared, so they aren't making much more money than a simple refinery buying light sweet crude."
Still, the refining sector as a whole has been in something of a golden era of late, supported by strong demand for refined products, especially in the US and Asia.
"Despite global refinery runs tracking higher year-on-year by over 0.7m barrels a day in the first half of 2017, products stocks are falling fast, indicating stellar demand," consultancy
Energy Aspects noted in a July report.
Restricted refinery runs in Asia and some other regions, in part due to maintenance, have also supported product prices. The global crude surplus also helped bolster prices, as increased oil production in Libya and Nigeria—along with rising US tight oil production—continued to offset the impact of
Opec's and Russia's cuts.
But the picture differs by region. Whereas much of that supply from Africa supported margins among European and US refiners, it made less of an impact in Asia, which felt the effect of Opec production cuts more.
Gasoline continued to be the main driver behind strong margins in the first half of 2017, but fuel oil cracks also provided a boost for less complex refining facilities. As a result, first-half margins were stronger than some had forecast. Wood Mackenzie's global composite gross refining margin averaged $6.20 a barrel, which was $1.60/b higher than its start-of-year forecast.
US Gulf coast refiners fared better than most; their margins supported by strong product exports to Latin America—and, of course, relatively cheap crude feedstock. Maintaining such strong margins is expected to prove difficult in the rest of 2017, as gasoline stocks increased in the second quarter.
Restricted refinery runs in Asia and some other regions, in part due to maintenance, have also supported product prices
European refiners enjoyed strong margins in the first half of the year. They were able to take advantage of the continent's role as a swing producer for gasoline, which meant they could pick up the slack created by lower-than-anticipated runs in the Middle East and Latin America. If that situation persists, European refining margins should remain strong.
Slow demand at the start of the year hit Asian refiners, but solid demand growth since then has meant that Dubai-based margins are likely to recover above the five-year average in the second half, according to Wood Mackenzie. Support is likely to come from strong fuel oil crack spreads, limited export quotas in China and a low level of refinery capacity additions coming on stream in the short term.
While margins are set to remain higher in late 2017 than levels typically seen last year, seasonal factors and the return to operation of several refineries closed for maintenance in India and other Asian countries could yet take the edge off.
In July, Wood Mackenzie forecast a global composite margin of $5.80/b, down slightly on the first half, but still $1.10/b higher than a year earlier. Energy Aspects expects a similar overall trend of margins becoming weaker, but still solid compared to historical levels.
Forecasting further ahead is much more difficult, given a plethora of factors that can trigger volatility in the refining market, from unplanned shutdowns to government energy policy decisions—and, of course, Opec quota changes.
Another variable affecting US refiners is the need to purchase Renewable Identification Numbers (Rins): fuel credits that effectively support the blending of biofuels with gasoline or diesel. Refiners and fuel importers that don't want to blend in biofuels with their fuel must buy Rins from companies that have done so, either denting margins or putting up prices for their customers.
The Trump administration wants to reduce the amount of biofuel blending—a move which could help the bottom line for US refiners—and the
Environmental Protection Agency (EPA) has been pushing for it. But in late July, a US appeals court rejected the EPA's effort to cut the required level of biofuels and, indeed, its findings could even require that biofuels level be raised rather than lowered.
That news was welcomed by the powerful US corn industry and boosted the price of Rins. It also deflated the share price of US independent refiners, such as
PBF Energy and CVR Energy. The EPA said it would review the decision.
Such unexpected turns have taught industry veterans to be cautious. Ferenc Horvath, downstream executive vice president at Hungary's
Mol, says 35 years in the energy business had taught him not to trust the forecasters, but he said there were some relatively clear trends for the sector fundamentals.
"Current refinery margins are quite favourable for the refineries. But at the end of the year, the gasoline margins will probably be lower and the negative margins on heavy fuel might be higher," he told
Horvath said that if the external environment worsens for refining, his job was to make sure that the company could still deliver what it promised to its stakeholders. In Mol's case, its plan for coming years outlined in its "2030 strategy" is based on a refining margin of around $4/b, which Horvath notes is considerably lower than it is now.
He also believes that the sector is safe from a return to the even lower margins of yesteryear. "At the current crude price level, I don't think we will see $1 or $2 refinery margins anymore."
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