Viewpoint: European refiners cautious on cusp of 2022

European refinery output has climbed back towards pre-pandemic levels over 2021, but growth could stall in the first months of 2022 as a result of renewed lockdown measures to curb the spread of the Covid-19 Omicron variant and high natural gas prices.

Middle distillates, which account for half of European refinery output, have been trading at margins of $12-14/bl to crude in December. That is proving enough to justify refinery utilisation at the bottom end of the 2019 range of 78-85pc. In November, crude throughputs in the EU-15 and Norway returned to around the 9.41mn b/d recorded in August, according to Euroilstock. That was the highest of the pandemic era and put utilisation at 78.1pc. This compares with throughput of 9.84mn b/d in November 2019 and utilisation of 78.6pc. But with the Netherlands introducing a full lockdown, uncertainty over other countries following suit and seasonally low gasoline demand, there will be little incentive to increase runs any further until driving activity picks up again after the spring maintenance season.

Perhaps the greatest risk for refiners in the early months of 2022 is that countries could reinstate travel restrictions and massively reduce jet fuel demand again. In 2020, the surplus of jet fuel supply was so severe that some plants had to halt crude distillation because they could not sell the product and they had exhausted their capacity to store it. France has blocked entry from the UK unless travellers have compelling reasons. If the US and other European countries were to make similar moves, then a fresh build up could result.

Electricity prices and hydrogen production costs are likely to remain elevated going into next year, on the back of high natural gas prices, and this will continue to put pressure on European refiners. Hydrogen is used in hydrocracking and hydrotreating units. TotalEnergies and UK-Chinese joint venture Petroineos have both switched off hydrocrackers in recent months, possibly for this reason. Hydrogen in the autumn this year cost refiners as much as $5-6 per barrel of crude processed, compared with around 60¢ in 2019, according to the IEA.

High natural gas prices have also contributed to a rapid rise in the cost of EU emission allowances. The IEA forecast in December that the allowances could cost as much as 90¢ per barrel of crude processed in 2022, up from around 75¢ at the end of 2021 and just 20¢ in 2019-20. Refiners of sour crude grades need the most of these allowances and also need the most hydrogen, meaning their profit margins are now under particular strain.

As 2021 draws to a close, product margins to crude are strong enough to make up for these unusual costs for most refineries. But if new lockdown measures were to push those margins down with natural gas still in short supply, hydrocracker units and refiners of sour crude grades may find themselves on thin ice.

Margins will receive little support from the spring refinery maintenance, which is likely to be relatively light, just like the autumn maintenance season in 2021. Firms conducted as much maintenance as possible during 2020 and the spring of 2021, while product margins to crude were still very low. And some refiners brought forward maintenance programmes, which has left a lighter load outstanding.

More European refinery capacity will probably come under threat over the coming year, but the pace of closures could slow down now that economics have substantially improved. More than 800,000 b/d — more than 5pc of the continent's crude distillation capacity — has already exited the market or been earmarked for closure since the start of the pandemic. Some of these sites are being converted to process biofuels.

The pressure to decommission or convert units is not only a result of the pandemic devastating margins, but in fact a long-term trend as capacity expands in the Middle East and Asia-Pacific, where operating costs are lower. For example, Saudi Aramco will bring a new 400,000 b/d refinery online next year at Jizan in Saudi Arabia.

Oil majors have been steadily trimming their exposure to Europe's refining industry, in another gloomy signal for the sector's long-term future. In 2021, Shell confirmed the sale of the 70,000 b/d Fredericia refinery in Denmark to US firm Postlane Partners. It has also sold its 37.5pc stake in the 226,000 b/d Schwedt refinery in Germany to Russia's Rosneft. This leaves the company with three fully-owned facilities in Europe, of which one is scheduled for permanent closure in 2025. TotalEnergies and Shell have shed 10pc and 15pc of their European refining capacity, respectively.

By Benedict George