Downturn Now Hitting The Refining Sector

Watch the “crack spread.”

By Michael McDonald,

As all energy investors know, it has been a terrible year for oil and natural gas companies. Many stocks are down half or more from their 52-week highs. Yet amidst the carnage, one energy group has held up very well – refiners.

Companies like Valero (VLO) and Phillips 66 (PSX) have traded flat or even moved higher over the last year. This reality has largely been driven by the glut of crude bringing down input prices for these firms while continued stable demand for gasoline and diesel has led to better crack spreads. The crack spread refers to the profit per barrel of oil that refiners earn from turning oil into finished products like gasoline, diesel, and jet fuel.

While 2015 was a strong year for downstream operators, refiners could soon follow oil companies’ downward trajectory. Crack spreads are increasingly coming under pressure as the laws of supply and demand come into balance.

Highly profitable crack spreads are drawing more refining capacity online and leading to more supply for many derivative oil products. Established refiners are struggling to combat already high inventories of gasoline and other products by cutting production at key plants, but that effort is unlikely to help sustain cracking margins over the short term.

Energy analysts are forecasting that cracking spreads will fall substantially and margins in certain areas of the country such as the Midwest are already under severe pressure or are even negative thanks to limited storage capacity for final delivery products.

The situation is little better overseas. Asian fuel producers are facing increasing competition from China, which is exporting a surging level of refined crude products. Chinese net product exports are forecast to rise by 31 percent this year over and above robust export increases last year. Diesel exports rose 75 percent from China last year much to the chagrin of Indian and South Korean refiners.

Just like in the U.S., margins for cracking have fallen hard as new supply has rushed to take advantage of lucrative opportunities in the field. Singapore Dubai cracking margins are running around $1.90 per barrel so far for 2016 versus $3.96 a barrel in the fourth quarter of 2015.

China is hurting refiners and the global petroleum market in two ways then.

First, the sudden shift in Chinese economic models has curtailed domestic oil demand, leading to falling oil prices and falling domestic demand for industrial oil derivatives.

Second, to help Chinese refineries cope with the new harsh market conditions, China has started allowing many independent Chinese refineries to ship their output abroad. Diesel margins are particularly at risk as the product has seen a significant slowing of domestic Chinese demand and thus a very rapid build in export volumes.

With diesel exports authorized up to 1.8 million barrels per day for China, versus 900,000 barrels per day last year, there is little doubt that Asian diesel prices will fall dramatically. This may cause a chain reaction that slowly spreads west perhaps ultimately hampering margins in Europe as well.

Investors cannot do anything to stop this negative chain of events, and there is little sign of the situation improving in the near term. While crude has managed to rebound off of its recent lows, that reality is cold comfort for most investors and only serves to hide the fact that oil prices are likely at least $20 per barrel below where most producers need them to be. If cracking margins ultimately plumb the same relative depths of profitability (or lack thereof), then 2016 could prove to be a harsh year indeed for refiners. By Michael McDonald,

Desperate Measures for Desperate Times. Read…  China’s Massive Debt Cram-Down

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  12 comments for “Downturn Now Hitting The Refining Sector

  1. Mick says:

    Considering that most producers need $50+ to break even and we’ve been far below that for over a year, I’d like to know who’s taking the losses, cause somebody is, and whoever they are, they must have deep pockets.

    • Mike R. says:

      The US Government and Fed are pulling out all the stops to ‘backstop’ the fracking industry. I made this claim last year and still hold to it. We’re in a massive game of one-upmanship with Saudi Arabia and Obama will not budge. I’m not saying there won’t be talk and perhaps a few small operators go under, but by and large the industry is going to be protected. National security/priority.

      • chris hauser says:

        it’s strange that coal is now the evil and fracking is now the good.

        because natural gas is so much cleaner, blah blah blah.

        i got a call from solar city today, asking me why i didn’t take their offer. i said “too expensive.” the caller said she would note it for their records, no further pitch.

        44k for 30 panels, what a rip.

        oh the irony, all around.

        • Nick Kelly says:

          No doubt solar is a rip but there is no connection between solar and nat gas which IS cleaner cheaper safer etc.

        • Coaster Noster says:

          Coal became negative around 2003. That’s when things began to decline for coal. Predates the fracking phenomenon.

  2. rich says:

    “First, the sudden shift in Chinese economic models has curtailed domestic oil demand, leading to falling oil prices and falling domestic demand for industrial oil derivatives.”

    Actually, 2015 was not only a record year for Chinese auto sales, but the sales of gas guzzling SUVs skyrocketed. On top of that, he Chinese are probably using more gasoline than ever, because, according the the Wall Street Journal, “the average car goes 7.5 miles per hour,” and, “the ‘golden zone’ for efficient fuel use is 45-65 miles per hour.”

    In China, “Sales of crossovers and SUVs soared 52% to 6,22 million units, and MPVs increased 10% to 2,11 million sales, while sedans slumped 5,3% to 11,72 million sales.

    The share of foreign brands in the Chinese market has shrunk by 4,2 percentage points, a landslide change in such a huge market, as it means that foreign car brands only added 338.000 units of volume last year for an increase of 2,8%, while the local Chinese automakers added over 1,45 million units of volume for an increase of 23,3%. The share of local brands has floated between 28% and 34,5% in the last decade, but in 2015 it suddenly jumped to 38,1%”

  3. MC says:

    Between 2008 and 2015, the eurozone’s top three economies (Germany, France and Italy) lost between them 900,000bbl/day of refining capacity, with more scheduled to go offline in 2016 and 2017. A new refinery being built by Total in Normandy will only partially offset this massive reduction in capability.
    In spite of this loss in refining capacity, ULSD storage facilities are literally bursting at the seams, with Marathon and Exxon having suspended deliveries of ULSD to Northern Europe from their Gulf Coast refineries in December already.

    What does this tell us? ULSD is the backbone of landbased economy like bunker is backbone of marine trade. It’s used in lorries, escavators, industrial generators, combine harvesters, feller bunchers… pretty much everything.
    I keep hearing the present pains experienced by oil and refined markets are caused exclusively by a glut in supply. Yes, there’s a glut but it cannot possibly account for such a long period of such low prices.
    And if a glut is the only problem, why are we experiencing it at a time when our refining capacity has been shrinking for years? Things literally do not add up.

    My feeling is, like it always happens, this is a combination of factors: a glut developed precisely at a time when demand for refined products first peaked and then slowly but steadily started to decrease. This decline is not one usually associated with a major depression: it’s at the low end of single digit territory, but it happens quarter after quarter with no end in sight. And like Mr Richter likes to remind us, when things go to heck they never do it in a straight line.

    This is the “cooling” in economic activity many have been speaking about. It’s not “soft growth” but the start of a long correction that is the unintended consequence (just one of the many) of attempting to avoid a sharp correction in 2008.

    • Ex_MislTech says:

      A lot of the numbers are derived from government data, and as was
      seen at the Hadley CRU sometimes the government lies.

      So if some aspects of what is happening do not make sense, good
      odds it is because the data has been falsified.

    • chris hauser says:

      uh, 2008 was pretty sharp, if you weren’t ready.

  4. Ptb says:

    I’d like to see some accurate data on where the demand is really at these days. If lower prices are leading to increased demand, where is it? Oil prices have been on a sharp and steady decline for many months now.

  5. LG says:

    My naighbor said its Obama and Tesla that’s “doing this”!

    I know I gotta move.

  6. Jonas says:

    I wonder, is there a trucking freight indicator for Asia/China? Google only points me to articles, can anyone find the raw monthly data?

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