By OGJ editors
HOUSTON, Aug. 7 -- US refining margins probably will become more volatile in coming years because the industry is approaching its effective capacity limit, said the Merrill Lynch Global Securities Research & Economics Group.
In an Aug. 7 research note, Merrill Lynch analyst Andrew Fairbanks forecast strong refining margins for US refiners through this year and into next year. The third quarter started with US refining margins running above expectations, he said.
"Petroleum product inventories remain below average, and fundamentals are supportive of strong second half 2003 downstream earnings for the majors and refiners," Fairbanks said. "The US downstream is in the midst of a significant longer-term up cycle. Strong industry fundamentals and refining margins are translating into stronger earnings for the refiners and majors."
Positive fundamentals
Fairbanks expects that inventories gradually will tighten during the next 6 months. Meanwhile, refining margins already are above Merrill Lynch's forecast in most US regions.
In addition, US gasoline imports are abating, he noted, adding that he believes imports must increase to keep US markets balanced. For example, 2003 US refining margins are running above average even though gasoline imports year-over-year have increased 10%. Yet, US inventories still are modestly below average.
"At the end of the day, we believe that gasoline imports, through high, should be fully absorbed this year and next with only modest demand growth," he said.
His long-term view of refining margins is that they must be higher than average 1990s levels in order to encourage increasing import volumes to be sent to the US, which is becoming more gasoline short each year.
Capacity creep
High refining margins also are needed "to trigger a more aggressive pace" of capacity creep in US refineries than is happening currently, Fairbanks said.
Separately, Bryan Caviness, analyst with of Fitch Ratings Ltd., has noted that a steady supply of capacity creep projects offset a loss of the capacity in the early 1990s and an increased demand. Total US refining capacity has experienced a 1.7 million b/d increase since June 1994.
Fairbanks said gasoline and diesel clean fuel standards, coupled with other environmental regulations, increasingly will play a role in plant closures and will absorb large amounts of capital that could otherwise go into capacity creep projects.
"Moreover, given the large scale of the US refined products market, even modest demand growth of 1.6% generates the need for the equivalent of two new worldscale refineries each year," Fairbanks said. "While there won't actually be any new plants built in the US in our opinion, this characterization illustrates the magnitude of incremental demand that must be satisfied by higher imports and domestic capacity creep every year."
He expects petroleum product demand growth will exceed capacity creep, requiring either increasing imports of high quality products to balance markets or else margins high enough to justify a more aggressive rate of capacity creep or major new refining units.
