One of the surprising outcomes from the almost halving of oil prices in the last 11 months was the increase in refinery profit margins over the same period.
But when going into the details, one will find this is not such a surprise after all.
The refinery margins are the result of the products’ values minus crude oil cost and minus refining cost of a barrel.
Traditionally margins are low most of the time, which makes decisions to invest in the refining industry often difficult. But this trend has somehow changed marginally for the better due to the complexity of modern refineries and their ability to convert low-priced products, such as heavy fuel oil, to higher priced products such as gasoline and distillates.
At the same time modern management approaches have helped reduce refining costs, or at least not let it rise in the same way that capital costs have gone up.
With the exception of last December, refinery margins have been higher than before the decline in crude oil prices.
The Financial Times noted: “Wood Mackenzie’s benchmark European gross refining margins data show a jump from minus 50 cents a barrel in February 2014 to $3.80 (Dh13.95) a barrel in February 2015. The numbers for the week starting March 9 show a further increase to $5.60 a barrel.”
Refiners in Europe were helped by a higher production run and signs that the decline in demand may be over. In fact, even the improvement in crude prices did not arrest the gains in margins.
For complex refineries, their ability to refine cheaper heavy crude is a factor. The fact their fuel volume could be as high as 10 per cent means that energy costs are lower and can therefore lead to better margins.
In this situation, the business model of integrated oil companies has gained additional credence as BP and Shell — active in all sectors of the oil industry — have found refining profits to cover some of their losses in upstream as a result of falling prices.
It is said that BP “loses about $275 million in annual pretax operating profit when Brent’s price drops $1” and “For each dollar-per-barrel of improved profit margin for refined products, BP generates $500 million in extra pretax operating profit annually”.
The same goes for Total, the French integrated oil company, which increased its refinery throughput by 14 per cent to 1.9 million barrels a day (mbd) to gain from improved margins. Argus reported that “Total’s European refining margin indicator (ERMI) rose to $47.10/t ($6.41/bl) in the first quarter, a sevenfold increase from a year earlier and over 70 per cent higher than the previous quarter.’
Softening of margins
The International Business Times reported on April 16 that the refining company Reliance is “estimated to post a net profit of 5 per cent for the last quarter of fiscal year 2014-15, on the back of improved gross refining margins”.
Even the softening of margins in the US during April could not take the lustre of the generally higher margins. Opec’s latest Oil Market Report, “The refinery margin for WTI crude on the USGC (US Gulf Coast) showed a loss of more than $3 to average around $10/b in April.”
Given all the above, The existing complex refineries in our region — and especially those modern refineries that have come on stream lately in Saudi Arabia, which use heavy crude feedstock — are benefiting from improved margins given that a large portion of their products are destined for exports.
There are more high capacity refineries to come by 2020, such as in Fujairah, Duqm in Oman, Jizan in Saudi Arabia and Karbala in Iraq and perhaps Al Zur in Kuwait among others.
However, refiners have to be prudent as the refinery boom could change again due to the surplus capacity in some regions, especially in Europe where in spite of many refinery closures there is still more to be done.
Total for instance is targeting a reduction of its refining capacity by 20 per cent in 2017.
Another point to consider in our region is the necessity of increasing the conversion capacity at existing refineries to reduce the production of fuel oil as demand for this product is destined to fall.
Let us not forget that in 2005 refinery margins were equally good — if not better — but later faltered.
The writer is former head of the Energy Studies Department at the Opec Secretariat in Vienna.