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For refining, more volatility is on its way

Margins will remain healthy in northern Europe and the US Gulf Coast until September. But a slide is coming

The collapsing oil price has been brutal for operators in the upstream, but refiners have been making hay. Brent’s slump was especially good for European product producers in 2015, when margins recovered strongly after years of weakness.

Last August, European Brent crack spreads reached a three-year high of over $10 a barrel, their highest level since margins of more than $12.31/b were reached in September 2012. Behind last summer’s surge was the ever-cheapening price of Brent crude and a stellar showing from American drivers, who sent US gasoline demand sharply higher. This propelled European refiners – the main foreign supplier of gasoline to the US – to maximise production of the road fuel. Unplanned refinery outages in Latin America and delays to new capacity additions in the Middle East also helped push margins to their recent peak.

Within that segment of the refining business, northwest European plants did especially well: between July and September their margins hit a 12-year high. Total’s European Refining Margins Indicator, which measures margins for a hypothetical complex refinery in Rotterdam, averaged $54.80 a tonne during that period. Back in Q4 2009, when Brent was trading in the high $70s, the average was just $5.70/t.

Soaring margins in the second half of 2015 encouraged profit-hungry refiners to process at break-neck speed, pushing their utilisation rate globally to 81.5% in the final quarter of the year – its highest level since 2007. For Q4 2015 and Q1 2016, refinery throughput of 79.9m b/d and 79.6m b/d, respectively, is expected to be about 1.4m b/d higher than a year earlier, reckons the International Energy Agency (IEA).

Refining margins forecast

But it’s not all good news for refiners. While they’ve been maxing out, production global oil-demand growth has been slowing. In Q4 2015, crude consumption was up by just 1.3m b/d compared with a year earlier, says the IEA. That was a sharp fall from the 2.2m b/d year-on-year rise seen between July and September 2015.For the entirety of 2016, global oil demand is expected to rise by just 1.2m b/d, as the effect of cheap crude prices, which boosted demand in 2015, wanes.

Naturally, high crude and oil products output, together with slowing demand growth, has pushed stocks higher. For the week ending 8 January, oil-products stocks in the Amsterdam-Rotterdam-Antwerp trading hub stood at 49.46m barrels, said investment bank BNP Paribas, citing data from PJK International. Although that was a draw of around 540,000 barrels from the previous month, levels remain 27% above where they were a year earlier.

For that same week, US crude stocks also remained more than a quarter higher than year-earlier levels, at 482.56m barrels.

No margin for error

This combination – high stocks, sluggish global oil-demand growth and weak crude prices – means 2016 will be a volatile year for refining margins. Energy Aspects, a consultancy, expects average Brent cracking margins will tumble to just $1.50/b between January and March before rising to $5/b and $5.50/b, respectively, in the second and third quarters. In the fourth quarter, the margin will fall to just $1/b.

For refiners buying Russia’s Urals crude in northwest Europe and the Mediterranean, margins might even be negative by the end of the year. This is because the Russian crude yields high amounts of diesel, which is in a state of chronic oversupply in northwest Europe.

Margins for hydroskimmers – simple refineries that produce gasoline and also an excess of fuel oil – in northwest Europe are expected to remain negative throughout this year, expects Energy Aspects.

The volatility in margins throughout 2016 will be an outcome of a recovery in crude prices towards the end of the year. Energy Aspects forecasts that Brent will reach around $69/b by Q4, as global oil production growth starts to slow down.

“The margins situation is going to be crazy this year,” says Robert Campbell, head of Oil Products Research at Energy Aspects. “In the 2015 market the crude surplus was clearing through the products market as it was more economic to refine it (crude) as products than to store it. So the requirement to clear the crude surplus through the refining industry will diminish as the year goes on.”

A global oversupply of diesel, meanwhile, will leave margins for refiners on the US Gulf Coast especially vulnerable, because the region depends heavily on exporting diesel to Europe. US Gulf Coast cracking margins are expected to fall to $3/b by the end of the year, down from $8/b in Q3 2016. European middle-distillate prices have already fallen as US diesel exports compete with rising supplies from Russia and the Baltic region, leaving stocks brimming full. Mild winter weather in the US and Europe hasn’t helped drain the inventory.

The story for gasoline might be different. There are some supportive factors for European refining margins in the short term, such as expectations of strong US demand for gasoline. Energy Aspects expects US gasoline consumption to be around 180,000 b/d higher in the first quarter of 2016, than a year earlier. What will drive prices higher isa global shortage of octane – needed in gasoline to keep car engines working properly – which will persist throughout 2016, according to Energy Aspects.

Despite last year’s boost from cheap crude oil, the longer-term outlook for Europe’s refining capacity is not as positive. Margins will remain healthy until this year’s summer driving season, believes David Fairhurst, a partner in EY’s oil and gas division. But the fundamentals beyond then are less encouraging. Overcapacity will continue to affect the prospects of any sustained recovery in refining margins, he says. “More closures may be needed to restore parity with demand.” While global oil demand is expected to rise this year, consumption in Europe, which rose by 300,000 b/d in 2015, is likely to stall at last year’s level of14.4m b/d.

Slower demand growth this year – seen also in the US, China and Japan – and persistent supply-side strength, including Iran’s return, should be good news for European refiners’ feedstock costs. But a mild winter in Europe and the US, amid already high stocks, has curbed demand for heating oil and diesel, and a slowdown in refining margins has already begun, according to BP. By mid-January, the firm index of margins showed they had slipped to $12.5/b, down from $13.2/b in Q4 2015 and well below Q3 2015’s high of $20/b.

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