(This is the first in a series of columns focusing on downstream markets.)
Happy days are here again for refiners, not only in the US but worldwide as well.
Will they stick around? While the heady margins of March may not be sustainable, all the indicators point to sustained recovery in the long-suffering refining business.
There are some dark clouds on the regulatory horizon from an operating standpoint for refiners, but those very threats amount to bullish market factors for the refiners that survive the ensuing shakeout.
The marketing side of the business still has some recovering to do, as retail margins continue to be squeezed by the lag effect in product street prices vis a vis the recent softening of crude oil prices.
Refining margin recovery
US refining margins are staging a dramatic comeback after collapsing to 15-year lows in 1999.
They were pulled down in part by the recovery in crude oil prices that began last year, as product price increases failed to keep pace. The other key factor was the even worse performance in European and Asian refining sectors, fueled by the surge in refining capacity additions that continued-albeit somewhat slowed from earlier rates-despite the repercussions from the economic downturn in Asia that had helped cripple oil markets in 1998.
Typically, refining margins increase when crude oil prices increase, but lag the former by as much as a year. Thus the crude oil price recovery that began in 1999 is just now being felt on the refining side of the business, and that comes at a time when crude oil prices have fallen by about $9/bbl in recent months (but it is important to note that crude prices' recent plunge was from an unsustainable high level to a level that is comfortably high for producers yet still not so high as to cripple demand).
All that translates into a big jump in refining margins. In the US, estimates Merrill Lynch, US refining margins during the first quarter are about 66% higher than they were in first quarter 1999. (The analyst also estimates that refiners' earnings per share will be up over 180% on average.). It took a little whole for refining margins to catch up, but they are finally beginning to reflect the ideal market circumstance for refiners: moderating crude oil prices, low inventories, and a tight balance of supply and demand.
What largely fueled the recovery in US refining margins was the bounce from heating oil price spikes in January, a tightening supply-demand balance in Europe (pulling more product to that market, this tightening balances even more globally), and the surge in West Coast margins. The latter factor is especially significant because it points to the cuts in runs by Asian refiners (especially Singapore) after a long and terrible trough in the market, which in turn has reduced the call on imports into the West Coast. Given the amount of refining capacity that has shut down there, especially in California, and the general tightness elsewhere in the US, that has meant a real bull run in the West Coast refining sector, where margins at one point recently rocketed to as much as $14/bbl.
There is every reason to believe that this situation will persist well into 2001, as OPEC struggles with ratcheting supply up and down to maintain crude oil prices within a band of $22-28/bbl (It is likely to remain close to the lower end of that range if the Saudis have anything to say about it, and they have more than most to say about it). While US refiners are scrambling to get more product on the market ahead of the start of the driving season, the already low stock levels suggest that product balances will remain tight throughout the season. It is likely that the need to build heating oil stocks late in the year will create a similar situation for distillates. While normally distillate demand is not a big factor in the US compared with gasoline demand during the summer, there is a big pull on the global distillate market because of the spike in demand for diesel in Europe, where it remains a much more important transportation fuel than in the US.
All of this sets the stage for an analyst such as Merrill Lynch to predict that all US refining market regions will enjoy, on a long-term historical basis, near-average margins for this year and next. Not only is that a remarkable turnaround from 15-year lows just 9 months ago, the strong showing in the first quarter of this year indicates that the analyst's forecast for this eventuality jumps forward a year. In short, Merrill Lynch had not expected this kind of recovery to occur before 2001.
With the refining sector rebound continuing in Europe and Asia and tightness continuing in stocks in the US, and with the likelihood increasing that crude oil prices will continue to be moderate-perhaps even drop another $2-3/bbl as more OPEC crude comes onto the market in the next few weeks-look for margins in the US to average about $2.65/bbl on the Gulf Coast, $4.45/bbl on the West Coast, and about $9/bbl on the West Coast this year, according to the Merrill Lynch forecast. Next year, East and West Coast margins look to be down just a few cents from this year's level, but Gulf Coast margins are likely to jump another quarter.
Next week, we'll look at refining markets outside the US.
OGJ Hotline Market Pulse
Latest Prices as of April 28, 2000
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Nymex unleaded
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Nymex heatin oil
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IPE gas oil
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Nymex natural gas
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