Refining outlook brightening again--after 2001

Is it heresy to suggest that good times are ahead for the world's refiners again? It isn't, if you concentrate on the longer-term outlook. That's the gist of a new study by Energy Security Analysis Inc., Cambridge, Mass., focusing on the outlook for refining margins after 2000.

Refiners worldwide probably can't see the 1990s end soon enough. Refining sectors in the US and Europe have grappled with poor margins for much of the decade. As bad as it has been in those two regions, it has been worse of late in Asia, where refining overcapacity and collapsing demand resulting from a 2-year economic downturn have squashed margins to their lowest levels ever-and circumstances aren't likely to improve much anytime soon, given another round of regional capacity additions in the offing.

ESAI sees a return to prosperity, but not without some stuff challenges ahead for refiners. Chief among those are yet another round of tough new fuel specifications to be introduced in the name of environmental concerns during the next 5 years in Europe and the US; these will call for mammoth new outlays for new facilities and new technology. Also posing a tough challenge for refiners is the dwindling market share for fuel oil and heating oil, which continue to lost ground to natural gas around the world. That share will shrink even further as governments impose new environmental taxes, particularly while invoking the holy mantra of global warming.

Major trends

In its new study, ESAI has identified six major trends or issues that will almost certainly have some impact on global refining margins over the next 10 years.

It concludes that, "?Even though refining margins will remain under the burden of too much supply chasing too little demand in the short term, growing gasoline and diesel demand throughout the next decade, combined with restricted refining capacity and an increasingly tight market for clean product components, will ultimately yield significant upside for many refiners.

"The upside will be sustainable as early as 2001 in the transportation-oriented US, while the upside in Asia may not be felt until 2003 or 2004. Europe will be caught between the two, tracking US margins more so than Asia's, but still rising the most when both Asia and the US are improving. Not all refiners, however, will benefit or suffer equally. Where one fits in the refining food chain will depend ultimately on the combined factors of geographic location and technological capability.

Asian refiners' woes

While there are some promising signs of a turnaround in Asia, oil products demand remains mired in the doldrums-especially for the most important product in that region, diesel.

The rebound in demand will come, but in a spotty manner, says ESAI: Singapore and Taiwan will come bouncing back sooner (this analysis was developed before the devastating earthquake in Taiwan) than countries such as Indonesia, Malaysia, Thailand, and South Korea, which were hit the hardest. And no Asian countries are expected to see a return to the precrisis boom days of double-digit annual growth in oil demand.

ESAI estimates that overall oil demand growth in Asia could reach as much as 750,000 b/d/year by 2001-02 (a large jump compared with a drop of roughly 300,000 b/d in 1998, but less than the 900,000 b/d-plus increases posted in the mid-1990s).

In the meantime, however, ESAI warns of a new bubble of Asian refining capacity-particularly in India-on the horizon that will keep product markets, especially the critical diesel market,very weak.

The upshot for Asian refiners, says ESAI, is paltry margins persisting during 2000-01, and with it the likelihood that more refining capacity will be shut in. Reviving demand growth will come to the rescue by 2003, however, and together with that consolidation of excess capacity, will mean a return to healthier margins. ESAI sees the benchmark Singapore refining margin bottoming in 2001 and then rebounding by $2/bbl over the next 10 years.

A wild card for Asia will the shift of regional influence to Japan's refining sector and away from Singapore's, as Japan's refining industry undergoes a radical restructuring in response to deregulation-with a substantial loss of capacity part of the change-amid the once unheard-of prospect of gasoline price wars and the elimination fuel oil tariffs.

As competition accelerates because of the changes in Japan's refining sector, says ESAI, look for that country to become more of a price-maker than a price-taker, as it has been in the past, deferring to the Singapore market.

Next week's column will focus on changes ahead for Atlantic Basin refiners.

OGJ Hotline Market Pulse
Latest Prices as of October 15, 1999

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