Nov-2024

Back to the future? Where next for refining? (ERTC 2024)

Global refining margins defied geopolitical tensions that drove their elevated status through 2022 and 2023, collapsing to below five-year historical averages by the end of Q1 2024. They now appear to be stuck at floor levels, as shown in Figure 1.

Alan Gelder
Wood Mackenzie

Article Summary

Back to the future?
Has the refining sector come full circle to pre-pandemic concerns of over-supply and the looming threat of rationalisation?

The refining sector is, by nature, highly competitive, as it sits between the global commodity markets of crude oil and refined products. The oil/refined products supply chain is highly adaptable, so despite the ongoing geopolitical tensions, current weak refining margins reflect surpluses that have appeared as:
· Oil demand is at record levels, but 2024 annual growth has been downgraded as the year progressed, particularly for the US and China. Crude oil prices have weakened, dragging refining margins lower.
· OPEC+ is restraining oil production to retain balance in the oil market, which held light/heavy crude price differentials narrow, reducing the value of refinery complexity.
· Refining capacity additions have outpaced demand growth, and these projects are now largely operational or in the latter stages of commissioning.
· Freight rates have fallen, not through the easing of the Red Sea disruption, but from cleaning crude tankers so they can move diesel/gas oil cargoes in very large parcel sizes. OPEC+ production restraint has enabled this optionality, with the freight rate reduction lowering the support for refining margins from prior trade inefficiencies.
· Even liquid biofuels facilities are suffering low utilisation from over-capacity, most evident from low Renewable Identification Numbers (RIN)/certificate prices.

Where next?
We do not consider the outlook for refining to be quite so bleak. Several factors are set to improve, notably:
· The surge in refinery capacity additions is largely complete, and demand for refined products is projected to continue growing until the early 2030s. This should improve overall refinery utilisation and lift margins from 2025/2026 onwards as demand growth outpaces capacity additions.
· This growing pull on oil will be increasingly satisfied by medium/sour volumes, rewarding refiners that have invested in complexity.
· Petrochemical margins have been weak due to the significant capacity overbuild in China over recent years, which has lowered the value uplift from petrochemical integration. As this capacity overhang is eroded, in conjunction with the rationalisation of weak standalone steam crackers, petrochemicals will return to adding value to integrated sites.
· Growing decarbonisation of ‘hard-to- abate’ sectors requires additional volumes of liquid biofuels.
We envisage a refining sector increasingly focused on being competitive in both strategic drivers of earnings (net cash margin, NCM) and carbon emissions. Refinery owners will respond to the relative position of their sites compared to peers and quadrant position, as shown in Figure 2.

Key risks and uncertainties
There are many risks and uncertainties with any outlook. Aside from geopolitical events, growing demand for refined products is pivotal to improving the sector’s health. Hence, the strength of the economy is key, as is the penetration rate of alternatives such as electric vehicles.

Refining relies upon efficient inter-regional trade, so trade barriers/restrictions (increasingly in vogue politically) distort competitive positions and regional utilisation levels. This could introduce regional winners and losers, but trade barriers generally lower GDP levels, which hurts the sector overall.

Liquid biofuels remain uncompetitive without some form of support, so government policy remains a key risk. However, the ‘old ways’ of value chain integration based on a secure supply of advantaged feedstocks is critical for initial success.

Refiners need to plan now to adapt and determine which energy transition pathway yields a competitive advantage for the future, which is likely to be site-specific.

This short article originally appeared in the 2024 ERTC Newspaper, which you can VIEW HERE