Oil refining margins will recover from their current slump and the sector will then enjoy an extended rosy patch, but it could be its last as improving fuel efficiency and the aggressive shift to electric vehicles in the huge Chinese market take their toll.
That’s the view of Fereidun Fesharaki, founder and chairman of respected consultancy FGE, who recently explained his outlook for the sector to the Caltex board.
“The refining business will be a great business until 2025 or 2026 … then it is the end of the business, this is the last cycle,” Dr Fesharaki said in an interview.
“The Chinese are planning to suppress oil demand in a huge way over the next five years.”
FGE, like many other industry watchers, expects a global clampdown on sulphur content in shipping fuel, due to take effect from the start of 2020, will help Asian refining margins recover in the near-term from the five-year lows they hit early this year.
Hayberry Global Fund’s Matthew Blumberg agrees the International Maritime Organisation’s new standards will provide a boost. “I believe both distillate margins and gasoline margins, which together largely explain refining margins, should improve as the year goes on and as we get closer to IMO 2020,” he said.
Caltex’s refining margin, its gross profit on converting a barrel of crude oil into a barrel of petrol, diesel and other refined fuels at its Brisbane refinery, rose to $US7.34 a barrel in February, up 11 per cent from January but 26 per cent lower than in February 2018.
Caltex and ASX-listed peer Viva Energy last month also referred to a broad view among analysts of a likely rally in margins towards more normal levels later in 2019, and are not fazed by the current weakness, while holding off from offering any forecast themselves.
“The global refining indy does have an amazing ability to rebalance over time,” Caltex chief financial officer Simon Hepworth said last month.
“There is a lot of flexibility in the global refining industry to make proactive changes. I’m not suggesting margins will immediately and amazingly recover to previous levels but we’ve seen it before: margins over the last 10 years have been higher than this 98 per cent of the time.”
Viva chief executive Scott Wyatt pointed to a unique set of circumstances that drove margins lower in the second half of 2018, including depressed regional demand, high oil prices, the slowdown in China and a shortness in heavier grades of crude, which helped drive production of lighter crudes and hence more supply of gasoline, where demand has been soft.
Dr Fesharaki also points to the supply side as a key contributor to the current weakness, in particular the surge in China’s gasoline exports, to about 500,000 barrels a day last year compared with 100,000 barrels a day in 2016, swelled by increased output from so-called “teapot” refineries – small, privately owned plants – and more subdued domestic demand.
He said margins should recover properly in the September or December quarter and that the cyclical upturn would be different and more prolonged this time. That’s because refiners stayed on the sidelines in the last peak in margins in 2015-16, rather than rushing to build new projects, partly because of uncertainty over how long oil demand will continue to grow given improved vehicle efficiency and the rise of EVs.
As a result, overbuilding has been avoided this time round, meaning relatively tight spare refining capacity globally and healthy plant utilisation rates, setting a base for several years of healthy margins.
But by 2026, refining margins globally are likely to be on the decline, Dr Fesharaki says, influenced by softening gasoline demand.
For Australia’s four remaining refineries, meanwhile, the key determinant for the future of plants is expected to be the timing of introducing tougher sulphur limits in petrol, where Australia lags behind Europe and most other developed economies. FGE estimates that between $300 million and $500 million could be required to upgrade each to meet a 10 parts per million limit in unleaded petrol compared to the current 150 ppm limit, investment that looks unlikely given the long-term outlook.
Extracted from AFR