Viewpoint: Europe's refiners pin hopes on IMO effect

European refiners' fortunes will remain broadly tied to the strength of the middle distillate market in the first half of 2019, given a persistent regional gasoline oversupply and increased demand for gasoil ahead of a lower sulphur limit on marine fuel emissions from the start of next year.

In the short term, refiners will continue to enjoy greater returns on middle distillates than on gasoline, but persistent weakness in the latter market will cap overall margins. During the second half of 2018, strength in northwest European diesel prices failed to offset a regional gasoline oversupply, which pushed the latter to discounts to crude. The northwest European 3:2:1 crack spread — a rough measure of regional refining margins — averaged $9.59/bl in the second half of 2018, down from $12.12/bl in the same period a year earlier, according to Argus calculations. In October, the spread averaged $5.87/bl — the weakest monthly average since at least 2008.

European refiners broadly enjoyed stronger diesel margins during the second half of 2018. Robust Asia-Pacific middle distillate and US diesel demand reduced long haul flows into northwest Europe, as did a drop in seaborne loadings from Russian Baltic ports during October-November. A gasoline oversupply emerged in Asia-Pacific and the Atlantic basin, as global end-user demand growth slowed while rising US light crude production and Opec output restraint lightened refinery crude slates, boosting light distillate yields.

In the northwest European barge market the low-sulphur diesel premium to gasoline rose on 26 November to its highest since 2012, at more than $22/bl.

Diesel's strength relative to gasoline found a reflection in the feedstocks market, as demand shifted away from lighter low-sulphur VGO typically run in FCC units for the production of gasoline streams, and towards heavier, high-sulphur VGO typically run in hydrocracker units for middle distillate production. On a delivered northwest European cargo basis, high-sulphur VGO's discount to low-sulphur product averaged around 50c/bl in November 2018, compared with around $2/bl a year earlier.

In the EU-16 countries, refinery throughputs declined in January-November 2018 compared with the same period in 2017, according to Euroilstock. In addition to scheduled maintenance and planned shutdowns for upgrade work in several European countries, unplanned disruptions in Germany lowered refinery runs. Persistently low Rhine river water levels — and high water temperatures during the European summer heatwave — capped German runs, as did the 1 September explosion at the 120,000 b/d Vohburg refinery, which is unlikely to restart until the first or second quarter this year.

The approximate 40pc drop in crude prices during the fourth quarter of 2018, alongside a relatively light forecast refinery-maintenance schedule in the first half of 2019, could support European refining runs, although persistent gasoline price weakness could counterbalance this. That said, the effect of the Opec and non-Opec output agreement forged in early December has yet to be seen.

Northwest European refiners are likely to face intensifying competition for market share, from new refinery capacity in the Mediterranean and east of Suez regions and strong competition from US refiners with access to domestic crude output. In Turkey, commissioning of Azerbaijan state-controlled Socar's 200,000 b/d Star refinery is largely complete, with commercial product sales likely to commence imminently. In China, new refineries and increased capacity at existing plants — alongside bigger product export quotas in 2019 — are likely to push more refined product volumes into other regions, including the Atlantic basin. With US crude output likely to hit a record high in 2019, US Gulf coast refiners will continue to enjoy a feedstock cost advantage.

However, demand growth could slow. The IEA forecasts global refinery throughput to continue exceeding refined product demand into 2019, with global oil demand growth estimated at only 100,000 b/d in 2019, driven by slowing economic growth within the OECD as well as in China. The European Commission forecasts eurozone gross domestic product (GDP) growth to slow to 1.9pc in 2019, from 2.1pc in 2018.

European refiners' key short-term challenge is the 1 January 2020 imposition by the International Maritime Organisation (IMO) of a 0.5pc sulphur cap in shipping fuel emissions, which will sharply cut demand for high-sulphur fuel oil (HSFO) and boost demand for low-sulphur gasoil streams for the blending of compliant bunker fuels. The consequent diversion of gasoil away from the production of motor diesel and towards bunker blending will lend significant price support to diesel in 2019. HSFO prices are likely to weaken significantly.

Many refiners have made investments in new upgrading units to alter their output. In October 2018, Shell started up a solvent deasphalting unit (SDA) at its 420,000 b/d Pernis refinery in the Netherlands, and ExxonMobil started up a new 50,000 b/d delayed coker unit (DCU) at its 310,000 b/d Antwerp refinery in Belgium. The latter resulted in a sizeable drop in the plant's HSFO production, which in turn contributed to a significant tightening in the RMG Rotterdam fuel oil barge market in the fourth quarter of 2018.

These new units followed the 2017 start-up of SDAs at Total's 310,000 b/d Antwerp refinery and Neste's 197,000 b/d Porvoo plant in Finland.

More units will begin operations in 2019. Swedish refiner Preem plans to start up a new vacuum distillation unit (VDU) at its 220,000 b/d Lysekil plant in the first quarter. In Poland, Lotos' 210,000 b/d Gdansk refinery will start up a new DCU in the second quarter, and a DCU will come online by end-2019 at NIS' 110,000 b/d Pancevo refinery in Serbia.

PKN Orlen's 325,000 b/d Plock refinery in Poland will start producing 0.5-1.0pc sulphur fuel oil blending components in 2020, following an H-oil unit upgrade and the start-up of a 1.1mn t/yr visbreaking unit. Spain's Cepsa is targeting a 2022 start-up of a new $2bn residue hydrocracker, to convert heavy feedstock such as vacuum residue into middle distillate, as part of a strategy to produce low-sulphur bunker fuel in the strait of Gibraltar market — a key Mediterranean bunkering hub.

The investment economics of new units to produce less high-sulphur residue and more low-sulphur fuel oil (LSFO) or distillate streams have not proven uniformly attractive for all refiners. In August 2018, trading firm Gunvor abandoned plans for a DCU at its 80,000 b/d Europoort refinery in the Netherlands, and Shell said in April it would not pursue an SDA at its 140,000 b/d Wesseling plant in Germany.

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