Viewpoint: European refiners' support is fading

Refiners in Europe have enjoyed an unexpected 'mini golden age' on the back of lower crude prices and firm refined product demand, particularly for gasoline, but this may not last. Although demand has risen, bolstered by lower retail prices, other one-off supportive factors are fading. The strong global demand for gasoline, which has helped to lift refinery throughputs in Europe, is exacerbating a middle distillates surplus that is in turn weighing on diesel and jet fuel crack spreads and starting to undermine refiners' margins.

Oil product demand rebounded at the start of this year, lifted by seasonal winter demand for middle distillates and as lower prices started to filter through to consumers. This was most keenly felt in the US gasoline market, where a lower retail tax regime compared with Europe meant consumers felt the effect of lower wholesale prices more quickly. Chinese demand also soared — US and Chinese gasoline markets together accounted for 35pc of global oil demand growth in the first half of the year.

Gasoline margin strength has continued since, with a shortage of high octane blend stock supporting the market. Total's model European refining margin indicator (ERMI) increased to $54.10/t in the second quarter, from $10.90/t a year earlier, and averaged above $50/t in July with product demand receiving an unexpected boost from lower prices for all products.

Middle distillates demand was further boosted by the switch in marine fuel sulphur emission limits in January. Around 100,000 b/d of demand moved from fuel oil to marine gasoil as the sulphur emission limit in European Emission Control Areas (ECAs) in the Baltic and North Seas was lowered to 0.1pc from 1pc. But production and imports are now outpacing middle distillate demand in Europe.

Second quarter refining results were strong across Europe. Total — Europe's largest refiner by capacity — made an operating profit of $2bn in its downstream business in the second quarter, up from $675mn a year earlier. Its refinery runs were 18pc higher year-on-year at 1.909mn b/d, amid significantly stronger refining and petrochemical margins, lower maintenance activity in Europe and the start-up of the Satorp 400,000 b/d joint venture refinery with Saudi Aramco in Jubail. Italy's Eni reported a second-quarter profit of €79mn in its refinery and chemicals business, compared with a loss of €204mn a year earlier.

But these good times look set to come to an end later this year. Peak US summer driving demand will fade by the end of September, and the switch to lower value, winter grade gasoline around the same time will further undermine margins. Even if gasoline strength persists, the growing middle distillates surplus could drag margins lower.

Diesel margins have already weakened from over $20/bl at the start of the year to below $13/bl, the lowest in over a year. Seasonal autumn maintenance should provide some short-term margin support for refineries still operating, but the market looks set to weaken markedly by the end of the year.

Refinery investment programmes in Europe in recent years have been focused on increasing diesel production. Europe is structurally short on diesel and long on gasoline, importing to meet the shortfall and sending surplus gasoline production to the US. But refiners in other regions have been cashing in on the European diesel deficit.

Modern, advanced large-scale refineries coming on stream in the Middle East are sending increasing volumes of middle distillates to Europe, taking advantage of economies of scale and lower costs of production. Upgrades in the FSU mean refiners there are producing and exporting greater volumes of European-grade 10ppm sulphur diesel. And complex refineries on the US Gulf coast with access to cheap energy and cheap shale oil feedstock have a competitive advantage over their European counterparts, and are able to run at high rates and export surplus product to Europe or to compete with European refiners for export markets.

Last year's crude price collapse has helped level the playing field to some extent, but the fundamental picture remains unchanged. Europe has a structural refining over-capacity, with product demand in long-term decline as vehicle efficiency increases and population sizes stabilise.

There are some outliers who disagree. "There is no over-capacity, just wrong capacity," Saras executive vice president Dario Scaffardi said on 23 July. The closure of a string of European refineries since 2009 was as a result of substandard, smaller, and less-complex refineries being unable to compete in the wider market place, said Scaffardi, not simply because of an excess in supply. Saras expects gasoline margins to remain strong in 2015 and into 2016.

Product demand, especially for gasoline, has surprised to the upside this year.

"We underestimated the positive impact that lower prices would have on demand," said Total chief finance officer Patrick de la Chevardiere in late July. It remains to be seen whether this demand boost will be sustained, but refiners continue to benefit from depressed crude prices. A large overhang persists in the Atlantic basin, with the global crude surplus forecast at 1.4mn b/d in the fourth quarter and at an average 2.2mn b/d for the year.

But refinery closures in Europe remain on the cards, because of the substantial overhang of capacity in the region. Opec in November said it estimated a further 2.4mn b/d of European refining capacity would close by 2019. The strong margins this year have enabled some refiners to delay decisions on closure or sales, but others have fallen victim to the regional over-capacity.

Total will close its 160,000 b/d La Mede refinery in France by the end of 2016, and will halve capacity at its 222,000 b/d Lindsey refinery in the UK. Maintenance and strike action has kept La Mede shut for much of the summer. Murphy Oil shut the 130,000 Milford Haven refinery in the UK last year.

Kuwait's KPC is in talks to sell its 80,000 b/d Rotterdam refinery, and Tamoil suspended operations at the 72,000 b/d Collombey refinery in Switzerland earlier this year. Eni has cut its capacity by 30pc since 2012, and wants to increase this total 50pc. It shut its 80,000 b/d refinery in Venice in 2013 for conversion into a biofuels facility and has similar plans for its 105,000 b/d Gela plant in Sicily, which it has already closed. Its 84,000 b/d Livorno and 84,000 b/d Taranto refineries look to be at risk, but the company has kept its counsel over further closures.

In general it remains the smaller, less complex refineries that are most at risk of closure, especially coastal plants that are more exposed to competition from imports. Larger, more complex refineries and inland plants with good access to niche markets remain better placed.

Some refiners are investing to give themselves a competitive advantage. Turkish refiner Tupras started up a new 80,000 b/d coker, an 80,000 b/d hydrocracker and other upgrading units at its 227,000 b/d Izmit refinery fuel conversion project in June. Total will invest €400mn ($416mn) in Donges, France, to "capture profitable new markets with low-sulphur fuels that meet the evolutions of EU specifications". The company is upgrading its 308,000 b/d Antwerp refinery in Belgium, due to be completed in 2016, and is investing in its 210,000 b/d Leuna refinery in Germany. And ExxonMobil is investing $1bn in its 310,000 b/d Antwerp refinery, and will expand its Rotterdam hydrocracker by 30pc to 58,000 b/d.

jb/bw

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