Petro Refining: Don’t read too much into rising margins

THE global refining industry’s woes may be coming to an end, with margins inching up. However, investors should not read too much into reports relating to rising margins — at least not yet — since the structural problem of overcapacity still prevails. BP’s global indicative margins have improved from $1.5 per barrel in the quarter ended December ’09 to $5.1 in early March ’10. However, it was the extended cold weather in the US and Europe, refinery strikes in France, refinery-run cuts and stagnant crude oil prices that supported the improvement. With winter waning, the demand for refined products is expected to weaken, which can put further pressure on refining margins. Although early signs of a shakeout are becoming evident, with a few refineries closing down, it will be months before gross-refining margins see a significant increase. Given the state of the industry, a number of European refineries are either closing down or are up on sale.
Europe has undergone a “structural and permanent decline in petroleum products demand”. The company is also looking for a buyer for its 220,000 refinery in the UK and aims to cut its overall refining capacity in Europe by 500,000 by ’11.
Petroplus, Europe’s largest independent oil refiner, recently closed its 117,000-bpd refinery in Teesside, UK. Shell is negotiating with India’s Essar Oil to sell off its three refineries — two in Germany and one in the UK — with a combined capacity of 340,000 bpd. Also on sale are Shell’s 78,000-bpd refinery in Sweden; Eni’s 85,000-bpd facility in Italy and Chevron’s 210,000-bpd refinery in the UK. In most cases, loss-making operations are expected to shut down, while tank farms and marketing infrastructure can continue to operate.
Benign crude oil prices and a rise in heavy-light differentials also played a key role in improving margins. While the benchmark WTI and Brent crude oil prices remained in the $75-80-per barrel range, the discount of heavy over light oils rose to $8.3 per barrel from $5.2 in December ’09. In the Indian scenario, the government’s move to raise fuel prices of Euro IV auto fuels to be introduced in 13 metros starting on April 1 will add to GRMs of domestic refiners. However, a negative duty protection created on LPG, kerosene and aviation fuel in the latest Budget was a key negative.
Although there are some positive indications of an improvement, one should not read too much into it. A permanent return of strength is unlikely until the painful process of consolidation, under which inefficient, old and small units would close down, establishes a demand-supply equilibrium. Economic growth may not directly lift the industry’s fortunes, as increasing usage of bio-fuels and hybrid, electric and CNG vehicles will continue to take away a portion of the incremental energy demand.