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Refiners and finance: who's winning and where?

Companies that splurged on sophisticated capacity additions, like Repsol and Tüpraş, and the majors with balanced upstream-downstream portfolios will benefit most

While upstream oil and gas have harvested most of the corporate headlines over the past year, the often-overlooked oil refining sector has been delivering both volume and value for its backers. Analysts believe that value could continue to accrue for some time to come.

Consultants Wood MacKenzie note that their 2017 Global Composite Margin, which gives an indication of crude oil refining margins worldwide, registered its second highest average since 2010—at $6.40 a barrel. This was only lower in 2015 when it registered $7.20/b, during the oil price crash. Wood MacKenzie forecasts that the margin won't dip below $6/b until after 2020.

In this context, large diversified refiners operating complex plants able to upgrade heavy products to prized middle distillates will thrive, particularly in areas where there is little surplus capacity. According to the International Energy Agency, that means most OECD countries. The OECD average refinery capacity utilisation rate at the end of last year was 91%, with peaks of over 95% in the US, France, Germany, Spain, Japan, and South Korea, where refineries ran at 103% of nameplate capacity.

Some analysts believe this trend is here for the medium term and will likely be buttressed by refinery retirements in Europe, mainly in the UK and the Mediterranean, where a significant number of facilities lack sufficient deep conversion capacity such as cokers or catalytic cracking.

40%—Mexico's capacity utilisation rate in past year, giving a boost to US exports

Morgan Stanley, in a recent report, referred to a coming "Silver Age" for refining. The bank argues that the combination of relatively low crude prices, strong product demand, and only modest amounts of new capacity coming on stream is a recipe for continued strong margins. In Morgan Stanley's view, likely increased middle distillate demand from the marine sector, which under IMO Marpol Annex VI regulations must move to 0.5% sulphur content fuels from the current 3.5% fuel limit, will only support these trends.

In consequence, Morgan Stanley believes those European refiners that have heavily invested in conversion capacity, such as Spain's Repsol and Turkey's Tüpraş, are likely to benefit disproportionately from the market's dominant trends. Among major oil companies, analysts believe those with balanced upstream-downstream portfolios—for example Shell, BP, and Total—will outperform those which are upstream-heavy, such as Statoil or Eni.

A similar outlook appears to be the case in the US. There, major oil companies with balanced portfolios and deep conversion refineries have benefitted from strong domestic margins, as well as from exports, particularly to Mexico, whose troubled refinery sector the IEA reports to have been operating at less than 40% capacity last December. US refiners with a strong Mid-Continent presence such as Marathon have been able to take advantage of short-haul inland crude and condensate availabilities and earn margins considerably higher than those on the US Gulf Coast. IEA data suggests a January 2018 cracking margin for WTI crude of $11.48/b, compared with a cracking yield for a LLS/HLS blend on the US Gulf Coast of $7.92/b.

Oil industry officials say such differences fed through to earnings for most Mid-Continent refiners. Unfortunate plants such as the Philadelphia Energy Solutions refinery at Philadelphia are seen as having suffered from bad financing rather than from poor margins.

Despite analysts' generally favourable outlook for oil refiners, they point to some potential headwinds. They note that a significant recovery in Mexican refinery runs will choke off one of the primary US export outlets, particularly for gasoline. Also, US crude exports, while likely helping upstream investors, may lead to higher crude prices for US refiners as domestic surpluses are shipped to other destinations.

This article is part of an Report series on Refining. Next article: Middle distillates take centre stage

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