There's light at the end of the tunnel for refiners
This article first appeared on Forbes.com on January 28, 2019, where Alan is a regular contributor.
The second half of 2018 was a very challenging time for refining. This weak commercial performance was due to a whole host of adverse market developments. Are these developments temporary or are they here to stay?
Two main events challenged the refining sector last year:
- The rapid rise of crude prices in the third quarter;
- A product pricing anomaly.
Crude prices rose sharply as the oil market feared all exports of Iranian crude would be lost to the global market once the US reimposed sanctions in early November. Refiners struggled to pass on the extra costs they incurred onto consumers, as consumers started to change buying patterns in response to the higher prices.
Road transport fuels are typically priced at a premium to crude, as they are complex blends of components, many of which are produced from sophisticated refinery units that are costly to build and operate. Other products, such as fuel oil, are typically priced at a discount to crude, as they are simpler to supply and in competition with other lower cost energy sources such as natural gas and coal. For a brief period during last year, in Asia, gasoline was priced at a discount to crude and was lower than fuel oil. This was due to a combination of gasoline price weakness and fuel oil price strength.
Crude price environment changes dramatically in recent months
However, the crude price environment has changed dramatically over recent months. After peaking at more than US$85 per barrel (/b), Brent crude oil price collapsed to below US$50/b, as the US administration provided waivers to Iranian sanctions at the last minute. Other OPEC countries were already producing at record levels to overcome the anticipated loss of Iranian supplies and so avoid crude prices rising further.
As a result, the global oil market was suddenly oversupplied, which combined with fears of a weak global economy, drove the crude price sharply down. OPEC has re-stated their intention to keep the oil market in balance by restricting supplies, helping stabilize Brent prices at levels around US$60/b. Despite market volatility, we expect crude to price at these levels, if not slightly higher, throughout the rest of 2019.
The product price anomaly is more structural. For the first half of the year, we believe gasoline pricing will remain relatively weak and fuel oil pricing, relatively strong.
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What's the key reason for a weak gasoline outlook?
Demand growth is modest (with China’s passenger car sales actually falling year on year) while supply is growing as a number of projects are brought on line. For example, the Middle East as a region is to shift from a net importer to a net exporter during this year. This is due to projects in Iran and the United Arab Emirates (UAE). Iran has completed the third and final phase of a project that processes domestic condensate to produce high-quality gasoline. In the UAE, a major refinery unit is being restarted after being shut-in following an explosion in early 2017.
The combination of this and strong supply growth from Asia means global gasoline supplies outpace demand, so the weak pricing structure is to remain in place. There will be the typical summer strength, due to the US driving season associated with school holidays and family vacations.
Fuel oil is also forecast to remain relatively strong for the first half of 2019. Globally, the crude oil slate is getting lighter, as US crude supplies have grown so rapidly that OPEC is again restricting its production. Middle East crudes are typically heavier than US tight oil, so contain a higher amount of fuel oil components. OPEC supply restraint reduces the supply of fuel oil components into the refining system.
The refiners, meanwhile, have been investing, and new refineries produce little (or no) fuel oil while existing refineries are, for the most part, being upgraded to convert fuel oil to more valuable transportation fuels. ExxonMobil’s investment in a coker unit in Antwerp, which is currently being commissioned, is such an example. The combination of crude quality changes and investment has reduced supply while demand has kept growing, so leading to pricing strength.
There is a fundamental change coming that will disrupt the fuel oil dynamic
The International Maritime Organisation (IMO) has introduced legislation that limits the sulphur dioxide emissions from international shipping on 1 January 2020. This is a major change that has implications across the shipping and refining sector. In this instance, it means that high-sulphur fuel oil will be displaced from the bunker market and replaced by lower-sulphur fuels, such as middle distillates. This alleviates the fuel oil supply tightness, replacing it with demand for lower-sulphur fuels, such as diesel/gas oil.
This switch in demand to lower-sulphur fuels from the shipping sector is good for refining. The transition to use lower-sulphur fuels requires some time, as ships must clean their fuel tanks to avoid contamination with higher-sulphur fuels, so the dark clouds currently over-shadowing the refining sector should start to lift during the summer, leading to a brighter 2020.