European refining margins rise but outlook still cloudy

Falling crude prices have bolstered European refinery margins in recent days, most notably for middle distillates, but the sector's short-term prospects remain challenging.

Crack spreads for gasoline, middle distillates, and fuel oil all jumped up yesterday, with gasoline and fuel oil margins registering day-on-day gains of $1.48/bl and 93¢/bl respectively. Jet fuel margins hit a four-month high and margins for diesel rose to the highest in 10 months.

The immediate trigger was a $3.22/bl fall in the North Sea Dated crude price, itself sparked by the increasing prospect of Iranian sanctions relief as counterparties edged closer to reviving the nuclear deal and data showing rising US crude inventories.

And spreads should find support moving into the European summer, as some movement restrictions are eased. In the UK, where constraints are being rolled back, demand is on the rise. Other major consuming nations such as France and Germany are also relaxing lockdown measures. Middle-distillate margins had already risen by nearly $2/bl this month before yesterday's crude price fall, and gasoline margins have been in double-digit territory since April, albeit primarily led by robust export demand in March.

Notably, demand destruction caused by lockdowns this year has been far less severe than in the initial wave in 2020. French road fuel demand in April, a time of nationwide travel restrictions, was down by 19pc on 2019 levels but more than double the levels of 2020, for example.

European refiners walk the tightrope

Nonetheless, Europe's refining sector faces a balancing act in the months to come.

Demand, particularly for road fuels, should trend higher, and the supply overhang built up in 2020 has by now largely dissipated according to the latest IEA figures.

But the mammoth stock draw over recent months was achieved only by refiners worldwide slashing utilisation rates, idling capacity, and in some cases temporarily ceasing to operate — as in the case of Total's 222,000 b/d Donges refinery, one of France's largest. Other refiners have converted crude capacity over to biofuels production, such as at Swedish firm Preem's 220,000 b/d Lysekil plant.

And after a year of minimal profits, refiners may be incentivised to maximise any margin increase by running hard — which could tip products markets back into oversupply.

A recent slump in gasoline margins is indicative of fragility in the European fuels market. Crack spreads lost nearly $3/bl over four sessions as they fell to a two-month low as recently as 14 May, as export demand waned again. While yesterday's $7.43/bl diesel margin may have been the highest in 10 months, it is only marginally above the $5-6/bl cost of production and would have been the lowest since 2016 without the effects of the pandemic.

Fourth-quarter Ice gasoil crack spread swaps are pricing at around $9/bl, rising to over $10/bl for full-year 2022 — still around 20pc below the $12.75/bl average in 2015-19.

The extent to which the Covid-19 crisis will have permanently lowered fuel demand is a major uncertainty, particularly in the middle distillate market where diesel's share of the passenger vehicle fleet continues to decline and aviation demand is unlikely to recover for several years. Combined demand for gasoline, diesel, and jet — the primary sources of refinery profits — will remain below 2019 levels as far out as 2026, according to IEA projections.

Meeting robust demand growth over the next few months, while navigating longer-term structural headwinds as well as the fallout from a year of Covid-19, will ensure that the trading environment for European refiners over the remainder of 2021 remains a challenge.

By Harry Riley-Gould

Premiums to North Sea Dated crude $/bl