One swallow doesn’t make a summer

Author Jack Wittels

As the first quarter’s results begin to roll in, it is already clear that Europe’s refiners have enjoyed a strong start to this year. But how long will the good times last?

As the first quarter’s results begin to roll in, it is already clear that Europe’s refiners have enjoyed a strong start to this year. But how long will the good times last?

In northwest Europe, reference margins for Hungary’s Mol, Poland’s Lotos and the Czech Republic’s Unipetrol are all up on the year. The story is the same in the Mediterranean region for Spain’s Repsol, while Portugal’s Galp yesterday upped its benchmark margin forecast for 2017 by 50¢/bl to $3/bl, following a strong first quarter.  Total has also reported stronger first-quarter margins, as have BP and Finland’s Neste.

The reasons behind the margin gains are clear enough. Falling Russian exports started to push fuel oil margins up in June last year and they have remained high since. Gasoil margins are also higher than a year earlier, largely thanks to a colder winter spurring demand for heating oil.

But what lies ahead for Europe’s refiners?

As April rolls into May, margins are still fairly buoyant. The northwest Europe 3-2-1 crack spread is still some 60¢/bl above where it was this time last year, despite a sharp fall over the last couple of weeks. The switch to summer-grade gasoline has helped, giving the usual seasonal bounce to margins. Strong diesel demand is providing further support and pulling up gasoil prices, with the knock-on effect of strengthening the premium of jet fuel — which is priced off gasoil — to crude. Fuel oil crack spreads remain high. Only naphtha margins are lacklustre, hit by seasonally weaker demand from steam cracker operators and a drop in interest from gasoline blenders.

Run rates in Europe are likely to ramp up over the coming months. Refiners are returning from their spring cleaning, looking to capitalise on attractive margins. Globally, a similar story is expected to play out — the IEA forecasts global refining runs to rise steadily until July, when they will hit a new global peak of 82.4mn b/d.

But higher refining runs mean more oil products. And while the global product glut is widely acknowledged to have stopped growing, stocks are still historically high. In its latest report, covering February, the IEA put total OECD industry product stocks at 1.52bn bl, down by 500,000 bl from the same month last year, but up by 139.1mn bl from February 2015 and 198.3mn bl higher than in February 2014. So the big question facing Europe’s refiners is will demand be strong enough to maintain a healthy margin? Or will new excess supplies stifle profits, as happened in much of 2016?

In the coming weeks, lingering maintenance at BP’s 82,000 b/d Lingen plant and PKN Orlen’s 327,000 b/d Plock refinery will provide some support for Europe’s refiners. The latest manufacturing data for the eurozone are also supportive — growth is at a six-year high — particularly for fuels with industrial uses, most notably diesel.

Longer term, big-picture supply and demand trends will do much of the deciding. BP said it expects a continued rebalancing in 2017, thanks to strong global demand growth, adding that much will depend on Opec production cuts and the response of US tight oil producers to a more favourable outlook.

But for Europe’s refiners, more localised issues may prove just as significant. Opec and non-Opec production cuts have helped narrow the Brent-Urals spread during the first quarter by some 60¢/bl from a year earlier. It could well narrow further if additional cuts are agreed. For Europe’s simpler refineries, most notably those without heavy upgrading units, the narrowing spread is good news. The light feedstock they rely on is — relatively speaking — cheap. But for those that have invested in costly upgrading equipment, the opposite is true. As a region, Europe’s refineries are generally less developed than their competitors in the US and the new capacity coming on line in the Middle East.

Rising shale oil production in the US could also prove important for Europe’s refiners, particularly gasoline exporters. Tight oil is typically paraffinic with a high naphtha yield. The naphtha produced is less suitable as a feedstock for catalytic reforming units than heavier grades that have more naphthenic and aromatic molecules. Blending the surplus shale naphtha directly into the gasoline pool forces suppliers to add increasing amounts of expensive higher-octane blendstocks — such as reformate and alkylate — to meet exacting summer-grade specifications, bumping up gasoline values. This phenomenon was partly behind the exceptionally strong gasoline margins seen in the summer of 2015.