The global oil products market was hit extremely hard from the first wave of Covid-19. Now that we are beginning feel the effects of the second wave, especially in Europe, are refiners prepared?
Listen in as Elliot Radley, editor of Argus European Products and Harry Riley-Gould, senior reporter European Products, provide an update on the current refined products market in Europe and give insight on how the market and refiners might handle the second wave of Covid-19 and the winter months ahead.
Transcript:Elliot: Hello and welcome to Driving Discussions. In this series, we've been discussing the forces that affect road fuels globally. In today’s episode we will be taking a closer look at the second wave of Covid-19 currently sweeping across Europe, and the implications for the refined products market. My name is Elliot Radley, and I’m the Editor of the European Products Report here at Argus Media and with me today is Harry Riley-Gould, senior reporter on the European Products desk. Thanks for joining me today Harry.
Harry: Hi Elliot
Elliot: So to kick things off, it might be good to give us a sense of how the oil products markets reacted to the first wave of Covid back in Spring, and the position the market found itself in ahead of this more recent second wave.
Harry: Broadly speaking the impact of the first wave was extremely negative for oil products margins to crude — particularly for premium transport fuels which saw the heaviest cuts to demand as a result of widespread travel restrictions. Jet demand in particular was heavily effected, given that passenger air traffic effectively came to a standstill. Subsequently in early May jet margins fell to around a $6/bl discount to North Sea Dated, marking the first discounts on record for the product. For comparison in May 2019 jet margins averaged a little over $13/bl.
Gasoil margins actually saw a brief period of strength at the beginning of the first Covid wave as buyers looked to fill storage tanks, with heating oil in particular, and industrial activity remained relatively robust... But the slowdown in demand affecting transport fuels caught up with diesel fairly soon after, and margins have averaged around $5.50/bl since May — and hit a 21-year low of just over $2/bl in late September. Part of the challenge for the middle distillate markets is the fact that jet demand has been so low, and margins for the aviation fuel even worse, that many refiners have been blending as much jet as possible into the diesel pool, which has meant that diesel inventory levels have remained very high even as fuel demand has begin to get back to year-ago levels over the summer.
Elliot: How about looking towards the lighter-end of the barrel?
Harry: Gasoline has also been in for a particularly rough ride, with demand in some regions falling as much as by 90pc during the first wave. Comparatively to diesel, demand for gasoline was hit much harder because gasoline is overwhelmingly used in the passenger fleet — where as diesel was supported by sustained demand from the trucking and agricultural sectors, which were less affected by the lockdown measures in place. But margins for gasoline still fell to record lows of more than a $5/bl discount to crude before staging something of a recovery in the late summer, with margins to Dated even pricing at above year-ago levels around the beginning of October — although, the outlook has clouded somewhat since then. At the top end of the barrel, naphtha margins have actually proved fairly resilient, even during the height of the first Covid-wave.
Elliot: Ok – interesting that we’ve seen naphtha margins diverge from other refined products in this way. What’s the main reason behind naphtha’s relative buoyancy would you say?
Harry: Well, naphtha differs from the other refined products we’ve spoken about in the fact it has demand stemming from outside of the transport fuels market. It is used for blending into gasoline of course, but importantly it is also used as a petrochemical feedstock, and demand from that industry has been robust because of solid demand for packaging, plastics, PPE for example. The successful handling of Covid in the east and quicker recovery in markets there meant that naphtha demand from Asia, which is a major importer of European naphtha, was fairly strong. And as refiners in Europe have slowed runs in response to such poor road fuel production margins, production of naphtha on the continent has of course diminished, also helping to tighten supplies. We’ve seen a similar dynamic at play in the fuel oil market, where margins have actually been relatively strong— particularly for HSFO — as a result of refinery runs being pared back so steeply, as well as sustained export interest to the US Gulf in particular, which has propped up prices. But it’s worth remembering that fuel oil and naphtha margins have still been by and large below margins for transport fuels, and if you’re a European refiner — making the bulk of your revenue from selling diesel and gasoline — then relatively firm naphtha and fuel oil margins are unlikely to offset the impact of weak transport fuels markets.
Elliot: Bringing things back to the present, what is the current state of Covid restrictions in Europe and how is this set to impact fuels margins moving into the winter months?
Harry: On the Covid front in Europe we’ve seen numerous countries including the UK, France, Spain, Italy, and Germany all reporting fresh record high numbers of new infections in recent weeks. But so far the response has been much more varied and in most places, more relaxed than over the first wave. While some countries, such as Ireland France and Germany, have effectively reintroduced full lockdown, others such as the UK are taking a more diverse route involving regional responses to correspond with the severity of the outbreak in any given area. But it seems that, should these less restrictive responses fail, then a new series of total lockdowns is certainly on the table, although it they will likely be shorter in duration than in the Spring.
Elliot: Ok – so clearly some hesitance from governments in Europe to replicate the scale of lockdowns witnessed during the first wave given the negative effects on their economies. So it sounds as if the fall in demand during this second wave could be a little more muted – though of course we’re heading into winter this time, traditionally a softer demand season for several refined products. Have we seen the same heavy decline on refining margins yet?
Harry: The picture is somewhat mixed. On the one hand we have already seen a broad slowdown in products demand, particularly for road fuels, but indeed perhaps not quite as heavy as the first wave…yet. As I mentioned before, gasoline margins had effectively recovered by the beginning of October and even reached $8.26/bl, which was the highest since November 2019. But the spreading pandemic has taken the wind out of the sails of this recovery, and crack spreads subsequently fell back to under $4/bl a the beginning of the week – though this is of course still a premium compared to the discounts to crude witnessed earlier this year. Notably the slump in gasoline margins also pulled down naphtha margins last week from the levels seen at the beginning of the month, as naphtha is a commonly used blendstock for gasoline. But naphtha remains at a premium to crude, which is relatively high compared to historical levels. (Be good to just compare October average this year with October average last year here) – again likely due mostly to the demand pull from the petrochemical sector.
Elliot: Ok right – I suppose the collapse in crude prices in the last couple of days is also going some way to support product margins for the time being?
Harry: Right yeah, we’ve actually seen margins recover some losses, even as major buyers such as France and Germany have announced fresh lockdown measures because of the crude collapse. We saw something similar at the very beginning of the first wave, when margins – particularly for middle distillates – were briefly boosted by the sharp drop in the crude price. And similarly, this week jet margins actually reached a six-month high on 23 October — albeit of below $3/bl, which remains exceptionally low by historical standards. But clearly the crude drop is supporting distillate margins, while the prospect of refiners cutting back on utilisation rates in response to lower road fuels demand is also supportive — as is a reduction of loadings from east of Suez. The dynamic on diesel was similar to gasoline, where we saw cracks fall back to below $5/bl but subsequently rally over the last few days as the falling crude price has supported crack spreads. But I think that the important thing to remember is that we saw a similar dynamic at play at the beginning of the first wave, but the positive impact on margins was short-lived and the products markets for transport fuels subsequently slumped. So it’s likely there’s further to fall, particularly when you look at the fundamentals. Restrictions in movement look set to continue to trend upwards, so demand is likely worsen. And on the supply-side, once the current tranche of seasonal maintenance wraps up, the associated rise in output is likely to weigh on markets.
Elliot: So not the rosiest outlook for the winter. How has the refining industry reacted to these issues so far, and what’s the prognosis there?
Harry: To be blunt, for many refiners — particularly in Europe, where demand was already in structural decline and where many refineries are relatively old — the outlook is very negative. In fact the International Energy Agency recently said in a recent report, quote, ‘it is hard to overstate how bleak the outlook is for refiners in many regions’. The IEA is expecting around 2.5mn b/d of forced closures to refining capacity by 2025, most of which will be concentrated in the OECD and likely Europe. The situation is being exacerbated to some extent by the fact that transport fuels margins have been weak while margins for more flexible distillate cuts such as fuel oil and naphtha have been relatively strong — this has particularly disadvantaged many refineries which have in recent years made costly investments in order to upgrade lower value products into premium transport fuels, which have now seen that premium erode. We’ve seen refiners such as BP, Equinor, and Eni post losses in the third quarter while others including Repsol, Total, and Galp have all published negative refining margins over Q3 – so clearly this has been and will continue to be painful, and the outlook is only set to become more difficult in the coming months. And so a result we’ve already begun to see major firms announcing plans to mothball plants — as in the case of Gunvor’s Europoort refinery — or convert some refining capacity to biofuels production, with Total, Neste, and Preem all having taken the latter decision. And we’re also expecting many refiners to continue to idle units in the immediate-term, as well as extending maintenance work, which is what we saw in the spring. Already in Europe around 700,000 b/d of crude processing is switched off for economic reasons, and we’re seeing around a further 1.3mn b/d of capacity offline for maintenance work. The central issue is that the Covid crisis has accelerated a structural shift away from oil products demand in Europe, and the major question in the medium-term will be how much of this capacity is ultimately able to return to operation profitably, and how much will simply be closed for good. Of course, all of this hinges on what we see over the winter in relation to lockdowns, fuel demand, and production margins – and how long individual refineries can withstand the pain.
Elliot: Thanks for your time today Harry and a big thank you to those of you listening – let’s hope that the winter months are kinder than many are predicting. If you enjoyed today’s podcast please be sure to tune in for the other episodes in our series, Driving Discussions. For further information about the European refined products market please visit www.argusmedia.com/oil-products.