Refining margins jumped after Hurricane Harvey, due to the sudden disruptions of a significant chunk of the world’s refining capacity. In fact, the outages highlight how tight global refining supply actually is—with limited spare capacity, there’s not much room for error.
The disruption of about a quarter of U.S. refining capacity led to a spike in the share prices for refiners unaffected by the Hurricane. Refining margins have soared and demand for gasoline has spiked, incentivizing refiners around the globe to ramp up operations to fill the void left over by the flooded refineries in Texas. The result has been a windfall for refiners not impacted by Harvey. For example, PBF Energy, a company with refining assets in the U.S. Northeast and Midwest, has seen its share price jump by more than 25 percent since the storm hit the Gulf Coast.
The outages will be temporary (although there are still several refineries operating below capacity in Texas), but they illustrate just how tight conditions are in the downstream sector.
While refineries can ramp operations up and down to meet market conditions, total nameplate capacity is pretty inflexible. It takes years and a lot of investment to bring a plant online, so the short-term supply response can only come from running existing plants at higher rates. The problem, though, is that refineries are already running at relatively elevated levels as it is.
According to BP’s head of refining economics, cited by Reuters, global refining is maxed out with capacity utilization at 85.5 percent. But utilization currently stands at about 83 percent, leaving almost no capacity on the sidelines that can increase to meet an immediate shortfall.
“The spare capacity is not really there,” Dario Scaffardi, general manager of Italian refiner Saras, told Reuters. “In as much as consumption worldwide is growing, refinery capacity is not long at all.”
Indeed, without the construction of new refineries, the problem will only grow worse over time because demand for refined products continues to expand. Crude oil demand is set to jump by 1.6 million barrels per day (mb/d) this year, according to the IEA, before rising by another 1.4 mb/d next year. But refining capacity will only increase by 700,000 to 800,000 bpd in 2018, according to Morgan Stanley. It will take years before more refineries come online to meet soaring demand.
“You’ve got a lot of refiners running at full tilt, and they’re going to make better margins,” Sandy Fielden, an energy analyst with Morningstar Inc., said in an interview with The Wall Street Journal. “Supply and demand is effectively telling the market that there’s a big incentive to produce more.”
The result will be, if not a Golden Age for refining, perhaps a “Silver Age,” Morgan Stanley recently declared. The investment bank said between now and the end of the decade, refining profits could be unusually high due to the stress on supply. Morgan Stanley forecasts that BP’s Refining Marker Margin, one of the more transparent proxy’s for refining industry profits, will rise from just over $12 per barrel in 2017 to $16 per barrel by the end of the decade.
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On paper, there doesn’t appear to be a problem. Reuters cites data from FGE, an energy consultancy, which pegs global refining spare capacity at 14 mb/d, down from 18 mb/d a few years ago. That seems like a lot, but it’s a misleading figure. A large portion of that spare capacity is only theoretical—some plants, because of inadequate investment, can’t operate as high as their nameplate capacity suggests.
Reuters cites Venezuela, where years of underinvestment—coupled with the country’s economic crisis—mean that its refineries can only produce a fraction of what they once could. The same is true for refineries in Brazil, Mexico and Nigeria. “Are we going to assume Venezuelan refinery utilization rates will suddenly jump?” Energy Aspects said, according to Reuters. “Or are we going to rely on Nigeria’s dilapidated refineries to fill the gap? None of this capacity is available to the current market.”
Supply will be strained for the next few years, which means that a single outage anywhere could push up refining margins everywhere. Whether it’s a fire, malfunction, unusually high volume offline for maintenance, or, perhaps most significant, a hurricane along the Gulf Coast, global refining capacity could be tested in the years ahead. For the companies that manage to stay online, they could potentially reap huge profits.
By Nick Cunningham of Oilprice.com
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