A bumpy start for the refining sector in 2020
This year may prove to be a strong one for the refining sector, but 2020 has had a difficult start, according to Wood Mackenzie. The market analyst expects some turbulence this year as a number of factors come together – geopolitical risk, the impact of IMO 2020 regulations, and US tight oil production slowing, among them.
Refining margins in the last few months of 2019 were weak – for many in Europe and Asia, refining margins were below historical five-year lows. Alan Gelder, Vice President, Refining and Chemicals, notes: ‘US refiners were in a better place. But this was not how it was meant to be, as the expectation was that margins would rise as 2020 approached.’
Last year proved challenging as oil product demand growth was weak, particularly during the second quarter. This set a low base for 2019 margin performance, but the real disappointment was how the transition of the shipping sector to the new IMO regulations played out.
High sulphur fuel oil prices collapsed rapidly during October and November, as ship owners stopped buying this as bunker fuel and started to transition to very low-sulphur compliant fuels.
Gelder says: ‘The fuels being purchased were low-sulphur fuel oil components from stocks built up during 2019, so while high sulphur fuel oil prices collapsed, there was no corresponding rise in the price of marine gas oil and other clean products, as there was no change in demand for them. In fact, distillate prices were depressed due to concerns about the US-China trade war and global economic growth remaining weak. The collapse of fuel oil prices with no corresponding change in the price of clean products had a strong effect on crude differentials, as the heavy/sour crudes were significantly less valuable to refiners.’
However, the widening in crude differentials has lagged the change in product values, so refining margins for refiners with less sophisticated configurations have been particularly hard hit.
OPEC added a further complication, as the group’s commitment to further restrain supplies to balance the global crude market supported the price for medium/sour crudes, as these are typically supplied by OPEC producers. This made Asian refining margins particularly weak.
Gelder says the US will play a pivotal role in many of the key changes for 2020, supporting stronger global economic growth and higher oil demand. ‘US tight oil supply growth was a key feature of 2019, with growth of over 1mn b/d. However, that growth will not continue into 2020 as rig counts decline and low capital budgets take their toll on the US E&P sector.'
‘The key sector for US supply growth for 2020 is NGLs, with even greater US LPG exports anticipated. The scale and import position of the US gasoline market means it is key to Atlantic Basin refining margins.’
‘Sustained fuel efficiency improvements and electric vehicle penetration are often cited as reasons for the decline in US gasoline demand. 2020 may well be the year in which the decline becomes evident, but it will be small, at less than 0.5%, and may be difficult to notice given seasonality and month-on-month volatility.’
Gelder also notes that a number of forecasts around IMO implementation appear robust, notably:
- Compliant low-sulphur fuels will be costly, so priced at a premium to crude oils such as Brent.
- The installation of scrubbers on ships will be economically attractive as there will be a wide pricing spread between low-sulphur compliant fuels and high-sulphur fuel oil.
- Crude differentials will change, with very low sulphur crudes attracting a significant premium to global markets, such as Brent.
He adds: ‘Critical uncertainties remain, as full global compliance is not expected. The legislative framework is far from watertight. And some countries, such as South Africa, are yet to enshrine the IMO regulations into their national legislation. Others, however, have legislated significant fines for non-compliance.'
The expectation of stronger refining margins was based upon a lack of supply of low-sulphur compliant fuel oil, he says. This is looking increasingly likely, as low availability is now being reported, along with an increase in the demand for middle distillates.
‘We will find out in the coming weeks as to how much more marine gas oil is required by the shipping sector and this will determine how much better refining margins are in 2020,’ says Gelder. ‘The outlook will, however, be masked by high volatility. The switch in the bunker fuel quality is a key driver, but there are others. Even though there has been no change yet in the underlying crude oil fundamentals, Middle East tensions have increased the risk premium on crude oil, which will weaken refining margins as it will take time for any cost increase to be passed on to consumers.’