Driving Discussions: The Impact of Covid-19 on European fuel markets and refineries (part 2)

Author Argus

The Driving Discussions series returns to Europe to examine the changes in Covid-19's impact on refineries with a special focus on utilisation rates.

Listen in as Josefine Ahlström, VP, Business Development, Europe hosts Elliot Radley, Editor, Argus European Products, and Benedict George, Market Reporter. This podcast revisits the current state of European fuel market and refineries, this time with a focus on European refinery utilisation rates.


Josefine: Hi and welcome to another podcast in the Argus series, "Driving Discussions." And today, in this episode, we are revisiting the impacts of the coronavirus on the European road fuels market. If you've followed" the Driving Discussions" podcast series, you'll remember that back in early April, we spoke about the impact of the coronavirus on the European refinery market and the road fuels market here in Europe. And now, with the market experiencing such extreme volatility in these unprecedented times, we wanted to have Elliott Radley back here to discuss with me on how things have moved on, and in particular, discuss what is the current situation that we see in the market at the moment.

My name is Josefine Alströhm. I am VP, Business Development for Europe here at Argus. And with me today, I have Elliott of course who is our editor of the Argus European product reports. But I also have Benedict George. And Benedict, he works in our European products team, and covers in particular the European refinery status. So in other words, Benedict is looking daily closely at the maintenance, the short terms, and overall, the refinery utilization rates here in Europe. So given where we are in the current market, I'm very excited to hear what Benedict's take is on this current situation. So over to our guests. So very welcome back Elliott to this podcast series.

Elliott: Thanks very much Josefine. Good to be back again.

Josefine: Good to have you here. And welcome Benedict, for the first time in this podcast.

Benedict: Hi Josefine. Thank you for having me on.

Josefine: That's a true pleasure. So to start off straight away here, Benedict, I'm quite curious to hear, do you think we're at an inflection point for the European refiners? So in other words, are we in a situation where we should expect more refiners are going to have to shut down because they basically have nowhere to store product, even if utilization rates are coming down, or is the demand recovering well enough as people are coming out of lockdowns to allow the refineries here in Europe to keep operating? What is your view on that?

Benedict: The answer is that there could be more shutdowns to come. European refiners are facing a very tough time at the moment, with demand down by as much as 80% to 90% for road fuels in some regions, and storage tanks at around 70% of capacity, with the remaining space already allocated. Refinery rates are around 70% across the region we think, but it's likely that production is still outpacing demand, even though we see some demand recovery in some countries as lockdowns are coming to an end.

I think it helps to break this question down regionally because different countries are at very different stages of the crisis. Germany is the major country with the strongest prospects for refiners at the moment. PCK says it has started reversing the throughput cuts it made at its Schwedt refinery already, and that refinery is expected to be operating normally again within two weeks. It's hard to gauge whether PCK is representative of Germany as a whole, but to our knowledge, it's the first suggestion of throughput returning to normal. And it coincides with BP's large Gelsenkirchen refinery returning from maintenance. So PCK's decision seems like a big vote of confidence in German product markets. The reason Germany is doing well is that it was one of the first countries in Europe to start lifting its lockdown about three weeks ago, and fuel demand is showing signs of recovery.

Josefine: So if there are positive signs in Germany with the demand coming back, what is the picture then for other countries? I mean, for example, in the Mediterranean where there have been very strict lockdowns for the last two months, is the picture then different there?

Benedict: So lockdowns have started to lift in the Mediterranean, for example, in Italy, and that will probably raise demand and begin to free up storage space. API is expected to restart its Falconara refinery this week after shutting it down completely at the end of March because of a lack of storage space available. So this inflection point could be around the corner in some parts of the Mediterranean as that demand begins to relieve the burden on storage, but most countries are still weeks behind Germany. And last week, traders were telling me that Mediterranean demand is still well below ordinary levels. At the other end of the scale from Germany, some countries still seem a long way from recovery. So Repsol in Spain closed a crude unit at Bilbao just a couple of days ago, and Galp Sines refinery in Portugal, and Tüpras' Izmir refinery in Turkey, both completely closed production around a week ago. And we can interpret that as a signal that those regions are still very much in crisis.

Josefine: Thanks. Thanks Benedict. That's very useful information. So over to you then Elliott, when we sat down last time to discuss the European refinery picture, it was the final days of March. So what has fundamentally changed since then? Say, for example, hearing what Benedict has described is that is the supply demand balance different now after six weeks of lockdowns, or eight weeks even in some places, due to the coronavirus? So what happens there in the supply and demand picture for the European refineries?

Elliott: That's right Josefine. Last time we spoke, we were talking sort of about anecdotal reports of how demand had fallen because we didn't have hard figures. So we were looking at some 50% to 70% declines in demand depending on the regions, as Benedict has just mentioned, it had varied quite a bit. Since then, we've had official data showing that demand declines were as much as 80% to 90% for diesel and gasoline in places such as France and Spain in the last days of March. That's likely to have recovered a bit since then, but it goes to show just how big an impact this had. Jet fuel back then was clearly under pressure given that was the industry that was first hit and hardest to be hit with widespread capacity cancellations around the globe. That remains the case, although we've seen some smaller airlines resume a handful of flights, mostly domestically. But jet cargos delivered in northwest Europe are now at discounts to North Sea Dated crude. So they're a loss-maker for refineries, and that's been going on since around the start of the month, and that's the first time we've seen that.

Back in March, gasoline was very badly hit in margin terms and that was at a discount to crude then. But in recent days, we've seen a bit of a recovery on gasoline with margins back in the positive territory. And our diesel margins, back when we were talking at the end of March, were extremely firm, something of a lifeline for European refiners, but those have now come off very heavily. So there's certainly been a change in the refining landscape since we last spoke. But Benedict will be able to tell you a little bit more about how the refiners are looking at that picture specifically.

Benedict: Thanks Elliott. So to recap the refinery utilization picture, back in March, according to "Euroilstock" in Europe, in the EU 16 which is the pre-2004 EU plus Norway, utilization was around 75% in March, and we think around half of the missing 25% at that point was demand-related throughput cuts, and the other half was maintenance and technical outages that weren't related to demand. Back then, we were estimating about 2 million barrels a day of throughput cuts. There were few, if any, refiners publicly confirming that they were cutting runs, but there was a lot of talk already in the market. There was a heavy burden of refinery maintenance at the same time. March is always the peak of the European maintenance season, with the gasoline and diesel summer spec transitions approaching. Our research found 11 full turnarounds ongoing in late March, and a smattering of other individual unit shutdowns for technical issues.

Josefine: So, thanks. Thanks for that Benedict. But what happened then in April? I mean, Elliot did, for example, the utilization rates fall further on, and if so, what triggered that fall?

Elliott: Yeah. So we have seen rates fall since then I think Josefine. As I mentioned, diesel margins dropped sharply, and as they were sort of supporting refineries at that time, throughput cuts have gathered pace. At the end of March, we had French diesel cracks to North Sea Dated of more than $22 a barrel, which was roughly a two-year high, and that of course encouraged refiners to maximize diesel output at the time. But by the end of April, margins had fallen to less than $14 a barrel, and they were just north of $7 a barrel recently. So that marked around four-year lows. So diesel has really been feeling the pain recently. For refineries generally, last time we spoke, we were talking about the 3:2:1 crack spreads as a measure of refinery profitability. So that measure assumes that for every three barrels of oil that you refine, you'll be producing two of gasoline, and one of diesel.

Back in March and April, levels for that marker were averaging around $5 a barrel which compares with roughly $8 a barrel in February, and a 2019 average of closer to $10 a barrel. But in May, we're now looking at closer to $3.50 given the decline in diesel margins we've seen. So that fall from $5 to $3.50 is certainly going to be causing some pain for refiners. Now, that's calculated looking against North Sea Dated, the prompt physical marker, we're still in positive territory. If you look at that against the futures, the Ice Brent Front Month, we've actually been in negative territory since around the start of April, with that marker averaging around $2 to $3 barrel discounts which suggests the refineries will be running at a loss. So certainly, yeah, tough times there. On top of this, for margins, we've also seen the spectre of a storage crunch growing as tanks on land and vessels offshore have been filling up with products due to this lack of demand. So that is also causing a bit of a crisis for refiners on top of these weak margins.

Josefine: So indeed, it sounds like quite some tough times. And Benedict, do you have some further detailed data on the current situation? As from a refiner perspective, we know it's very important to really understand what's going on. I mean, how, for example, has the fall in the diesel margins impacted utilization rates, and how much throughput cuts have you seen or have got indications from the market on?

Benedict: So with their one reliable source of profit, the diesel margin, now gone, refiners seem to have cut much more deeply than in March. We think utilization overall in Europe is down to around 70% or possibly even less, even though a lot of capacity has come back from maintenance work. We now have 12 European refining companies publicly confirming that they're cutting throughput or shutting down completely because of weak demand and a lack of available storage. Our researchers found a further three companies that we believe are doing so. That 70% utilization figure is based on a few calculations which I'll just quickly run through.

There's a certain window of uncertainty about utilization which we've been debating in recent weeks in the European products team, because refiners are generally very tight-lipped about their day-to day operations. But this is our reasoning. We know that at least 1.5 million barrels a day has been cut because of weak demand from refiner statements. We know that almost 750,000 barrels a day has been fully shut down because of storage running out. At the very high end, extrapolating from the run cuts that we know about, the maximum that there could be is around 5 million barrels a day in demand-related cuts. But with Falconara restarting and PCK returning to normal, as well as some countries that were simply less badly affected in the first place, the reasonable estimate that we're working with is a little lower than that, at about 3.5 million barrels a day of demand-related run cuts at this points.

On top of that, we know there are around 1.5 million barrels a day offline because of maintenance work and other technical outages. So 3.5 plus 1.5 gives a total of 5 million barrels a day offline for all reasons, that's about 30% of Europe's capacity. So we think utilization is now 70% or slightly lower down from that 75% that "Euroilstock" reported in March. The fall in utilization since March might seem surprisingly small given the extent of demand-related cuts we now know about. The reason is that the maintenance season was at its absolute peak in March, whereas a lot of that has now returned. We now think down from about 11 turnarounds in progress at the end of March, there are probably now 7 or 8 tops.

Josefine: Very interesting. And I understand difficult to pin the numbers down, and we are of course very curious to see what the official statistics will tell us. And just moving on, storage, what is the situation there? Again, difficult to know exactly where that is at the moment, but what is the indication of storage levels that you see across Europe?

Benedict: As you say, it is very hard to gauge specific numbers on this. But the brokers and traders and analysts that I've spoken to agree there's very little storage space available for products now. And this is partly because of the contango structure of the derivatives markets where the prices for prompt delivered products are well below those for delivery further out. This incentivizes storage and derivative trading. So commercial tanks have been heavily filled over the last month. It's important to note that commercial tanks get fully booked a long time before they actually physically fill up. But operators have told us that product storage utilization rates are now roughly 70% to 75% and the remainder is already booked. So empty tanks don't necessarily mean available tanks. And this has been confirmed by market sources for the last couple of weeks. They say it's nearly impossible to book commercial product tanks in Europe.

Market participants in the Mediterranean seem especially concerned. A lot of product has already been put into floating storage there, which contributed to the extraordinary spike in freight prices that we saw a week or two ago. Commercial storage operators in the Mediterranean have been saying for a few weeks that available space will be exhausted by mid-May which is obviously now imminent. And I've heard similar forecasts for the whole of Europe. It's possible that recovering demand is going to avert this crisis now that lockdowns are being eased. But even if it does, it will be a very close-run thing.

Unfortunately, the Falconara restart which might seem to be a glimmer of hope doesn't necessarily say anything about the state of commercial product storage. It only means that the Falconara refinery now has available on-site tank space. But most likely, nothing has been put into those tanks since the closure of the refinery in March. Whereas commercial tanks which were available for all traders to book have been constantly topped up over that intervening period. And that's why those commercial tanks are now facing the crisis that they're in.

Josefine: You mentioned earlier here on this podcast that it's a difference between regions. Is this the same as well on the storage? So for example, in our Amsterdam, Rotterdam, Antwerp trading hub, is the storage also becoming close to the brink there? And in other words, is it a tense situation in ARA, would you say?

Benedict: Well, the ARA trading hub is supposed to be much better able to deal with this crisis than most regions. It has more storage available and it has more potential outlets for unwanted products, both by sea and inland via the Rhine. What has raised a lot of concern is that market participants now say that even the ARA commercial tanks are close to fully booked. This is unlikely to stop refineries there from producing and it's unlikely to force emergency shutdowns, partly because a lot of those refineries in that region are already under maintenance. But the fact that the ARA is now facing its own crisis indicates how severe the situation is across Europe, across the whole continent.

Some long-range tankers that were due to arrive in ARA are now expected to wait offshore as floating storage because there's nowhere to put the product on land. And brokers at ARA have even told us that the majors have looked at booking barges on the Rhine to just sit there as floating storage, and that's very rare. The glimmer of hope for ARA is that German demand is picking up. So it's possible ARA can drain its tanks by shipping higher volumes up the Rhine into Germany, and then, it will be able to import more from around Europe which will allow refiners across the continent at the Baltic to keep up production. And the unknown at the moment is how quickly ARA will be able to clear that bottleneck.

Josefine: So if you, Benedict, would have to summarize, what does it mean to the whole European region going forward, what would you say to that then?

Benedict: Well, we can generalize that calculus for ARA, we can generalize that for the whole of Europe. So refiners' outlook now depends on the dynamic of rising demand as lockdowns get eased versus the minimum throughput that refiners can technically run without shutting down which is about 60% of their capacity. And as long as that rate of production exceeds demand, greater volumes of product are going to need to be stored, and more refiners are going to be forced to shut down units, like Repsol has just done at Bilbao. But if demand picks up to match or exceed that rate of production as we think we're seeing in Germany now, then, storage will be gradually freed up and we'll see refiners keep operating and even restart. So we're going to be keeping a close eye on German trading volumes and industrial activity to assess the time scale for that demand recovery, and we're also looking at Europe's other major economies for a similar process as and when they lift their lockdowns.

Josefine: So it almost sounds like we have a, "to be continued" podcast here coming up as the market develops. Thanks for that Benedict. And Elliott, as your reporter, the European products report, I mean, how, maybe you want to tell the listeners how they can find more information about what we just described?

Elliott: Sure. Yeah. Of course. Gladly. As you can tell from what Benedict's been talking about today, we're keeping a close eye on this and things really are on a knife edge, constantly changing with demand. You know, we're talking about retail demand here, the effect of this virus on industrial output which is a massive driver of a lot of demand is so unknown, and we're just seeing how this could affect GDP. So yeah. It's exciting times, but you can keep on top of this in the European products report where we're doing great work to keep an eye on all these developments. And Benedict in particular is doing great work on a refinery outage table that we're publishing on Fridays every week now just to track what maintenance we're seeing and what demand-related cuts and shutdowns we're seeing as well. So yeah. All of that can be found in "Argus European Products."

Josefine: So now, head to European products reports for some exciting reading here definitely on the weeks to come. And my big thank you to both of you, to Benedict and to Elliott for this very useful update on what's happening in the European market. And for the listeners, I would just like to say that if you would like to listen to other podcasts in the "Driving Discussions" series and stay updated on future episodes from Europe but also from Argus colleagues across the globe from our other offices, please visit our website. So you can find that information on www.argusmedia.com/drivingdiscussions. So thank you very much for listening and have a good day.