PETRO REFINING: Falling Margins Dim Growth Prospects

Although crude oil prices soared over 25% in the threemonth period July-September 2012, petroleum refiners have not been impacted adversely. In fact, tight supply of products helped refinery margins to stay high, boosting the valuations of Indian standalone refiners. But a prolonged weakness in refining margins could prove to be a drag on their valuations. A recent report on the industry by financial services firm IDBI Capital says that the Singapore complex gross refining margins, or GRMs, rose 22% month-onmonth in August 2012 to $9.9 per barrel, led by a rise in gasoline, gasoil and Jet-Kero crack spread driven by shutdowns of few key refineries. The strong margins were driven by refinery shutdowns in the US and Venezuela, the report said.
There were production shutdowns in the US Gulf of Mexico in the wake of hurricane Isaac, which took nearly 1 million barrels per day refining capacity off stream. Venezuela’s largest refinery, which suffered a blast and the fire killed nearly 40 people in August, had to be shut down. These incidents pushed the prices of refined products higher benefiting refiners globally.
There are already concerns that the boost to refinery margins would be shortlived. According to a JP Morgan report, refinery margins have demonstrated extraordinary strength recently, underpinned by the combined resilience of gasoline and middle distillate cracks. This appears at odds with the tepid oil demand growth and the precarious state of the global economy, raising the question as to whether the strength is sustainable, the report says.
A prolonged weakness is likely as new refineries get added over the next few years, while those expected to undergo a permanent closure resume operations after ownership changes.
An industry update put out by SBI Caps says that its analysis of major refinery projects expected to come onstream shows that after delays of several years, the majority of large projects are on track to be commissioned in the next two to three years. During 2011, around 1.4-mbpd refining capacity was added, taking the total refining capacity to near 93 mbpd compared to an incremental demand of 0.8 mbpd. In 2012, around 1.6 mbpd refining capacity is likely to come on-stream, compared to the expected demand growth of 0.8 mbpd, according to the report.
Shares of Indian standalone refiners — RIL, MRPL and Chennai Petro — gained around 6-16% during July-August, but analysts are not very positive on their outlook. For instance, a recent report by Kotak Securities said that it expected refining margins to soften further once several Asian refineries restart operations These companies may once again underperform the markets if refining margins continue to weaken further.