While long-term cycles in the refining business may come to a slow end in the latter part of the 2020s, the short term cyclical movements are remarkable as we head towards IMO.
Gasoline cracks have seen a stunning rebound, lifting refining margins globally. Everyone is asking whether it can last. We think it can, but it will be a mixed bag for products.
A string of planned and unplanned refinery turnarounds quickly reduced gasoline supplies in the Atlantic Basin. Record high US inventories now seem a distant memory, with stocks seeing a massive drawdown (29 mmb) over the past eight weeks to below year-ago levels. Spot demand from India and Indonesia, combined with lower Chinese exports, offered additional support.
Indeed, gasoline cracks have recovered from barely parity with crude in January and February to over US$9/bbl in Singapore, currently. The recovery has been even more startling in the US, where the benchmark NYH gasoline cracks have improved from US$7-8/bbl to over US$20/bbl, lifting European values along with it.
In a reversal of fortunes, both middle distillate and fuel oil cracks have fallen to some extent. Fuel oil cracks were the star of the show last year, especially in Singapore where they were positive for much of 4Q, although have come off temporarily.
The European diesel crack averaged US$19/bbl late last year, whereas currently it is at about US$14/bbl, and could easily be lower if it were not for the strike action at the 400 kb/d Pernis refinery in the Netherlands. Other regions have seen similar weakness in distillate cracks.
After a brief period of some pain, particularly over winter, this gasoline-led recovery has seen refining margins recover. While refiners are used to the ups and downs of margin cycles, is it smooth sailing from here through to IMO 2020?
Refinery turnarounds in the Western Hemisphere have temporarily turned the gasoline market very bullish. However, we continue to maintain a less rosy view over summer as supplies return to the very high levels seen late last year.
Gasoline stocks in the US could begin building once again, even during the summer driving months, as we expect US demand to decline 1% y-o-y, partly due to high prices (which are already approaching the US$4/gallon level in some parts of the US).
While this could trigger some downward pressure on gasoline cracks, heavy planned refinery maintenance in Asia will come to the rescue to some extent. China may help as well. China’s exports retreated sharply in February on the back of limited quota availability. China’s gasoline export quotas were reduced further as several NOCs swapped their gasoline quotas with other petroleum products. Some Chinese refineries did not anticipate a recovery in gasoline cracks and hence decided to shift towards maximizing distillate exports. All of these factors, together with heavy maintenance, should keep a lid on China’s gasoline exports for the near term.
Connecting these dots, gasoline cracks are forecast to inch up a little from current levels, stay relatively flat over the next few months and should struggle to reach last year’s levels.
Moving down the barrel to gasoil, the Atlantic Basin cracks should continue to weaken slightly as refiners ramp-up after the full conclusion of maintenance activities. However, the trend will stabilize over the summer. Over in Asia, planned turnaround activities in several countries including China, India and South Korea will support the strength in gasoil through to 3Q. That said, seasonally lower demand in the Western Hemisphere could counteract this to apply downward pressure occasionally.
Lastly, fuel oil cracks will remain robust until the later part of 3Q as supplies tighten further on intensified US sanctions on both Iran and Venezuela, while more residue upgrading capacity comes online. Most recently, the Ruwais RFCC has fully returned to service taking almost 100 kb/d of SRFO off the market. Putting it all together, refining margins should be good but not great over the summer, barring a very active (USGC) hurricane season or some other sort of major refining hiccup.
The Next Big Tipping Point for the Refining Industry Is Undoubtedly IMO!
IMO brings with it a new product; 0.5%S bunker fuel oil, which could be distillate or residue-based. We think it will be predominantly distillate-based, especially in the early months, given the concern over the compatibility of residue-based fuels. This gives refiners an extra lever to pull on refinery optimization.
In this regard, refiners should be able to produce more distillate by forcing gasoline precursors into the distillate pool to a considerable extent. We call it molecule management!
The IMO impact will be very much felt from 4Q this year as the market starts to transition to the new low sulfur bunker mandate. Unlike what many think, it is not going to be a cakewalk for refiners, it will be stressful. In our view, the market has yet to fully price-in this difficulty; we continue to believe that gasoil prices need to be higher and fuel oil prices lower.
Distillate cracks are likely to increase towards US$30/bbl (and may well drag gasoline upwards with them) while HSFO values will collapse. Overall, complex refiners with little or no fuel oil production will benefit strongly while simple refiners with high HSFO yields will struggle.
So, in refinery planner’s terminology, refiners will start a journey from a local optimum to a new and better one.