European refiners have been plunged back into a challenging economic environment following a downturn in refinery margins, with crude run cuts widely touted as markets assess the potential impacts of the new Omicron strain of the Covid-19 virus.
Transport fuel margins plummeted in the second half of November amid growing concerns of another winter marred by Covid-19 restrictions. European 321 crack spreads — which compare three parts crude with two parts gasoline and one part diesel, used as a proxy for overall refining margins in Europe — hit their lowest since March on 23 November at $6.12/bl, and closed the month at just $6.95/bl after starting November at $15.53/bl. Margins have nosedived even despite a crash in crude prices over the same period — North Sea Dated lost 16pc over the course of the month to end November at $70.98/bl, its lowest since August.
The recent collapse in refining margins is likely to lead to widespread crude run cuts at European refineries according to traders, with some estimating cuts as high as 10pc. Some traders also remarked on lower fuel supplies on offer in the region — a sign of reduced production. In addition to weaker crack spreads, refiners may also be mulling production cuts to adjust for weaker demand if lockdowns do return across the continent this winter. Austria became the first European country to reimpose a full national lockdown on 22 November, and since then the fuel demand outlook has suffered a fresh blow with the discovery of the Omicron strain, which sparked one of the sharpest price drops in the history of crude futures trading on 26 November.
Northwest European gasoline shed just over $200/t in outright terms — and $11/bl against Dated crude — during November, ending at $635/t. During that time the market structure in the paper market flattened rapidly from a $45/t premium of front-month Eurobob oxy swaps over second-month contracts — known as backwardation — a month ago to less than $5/t yesterday. The gasoline market has moved rapidly from a market characterised by tight prompt supply at the beginning of the month, to concerns that runs will be trimmed to compensate for falling demand.
Middle-distillates margins have also fallen, albeit less sharply than gasoline. Diesel margins to Dated retreated to around $10/bl by the end of November, from as high as $14/bl during the month. Backwardation on the gasoil forward curve has seen independent diesel storage volumes at ARA hit their lowest since before the pandemic, although backwardation is now flattening and free tank space could provide one outlet for traders if demand is curtailed by lockdown measures.
Jet fuel crack spreads ended the month at $9.19/bl over Dated — dipping as low as $6.72/bl on 26 November, a three-month low — from over a $12/bl average in October. The news of a new variant of the virus, and consequently the potential for wholesale travel bans, would turn October's recovery on its head as passenger confidence wanes and demand for air travel falls off again. That will probably push refiners to divert jet fuel into the diesel pool, as was commonplace earlier in the pandemic, which could help to curb supply and provide a floor to spot prices. Imports from east of Suez remain relatively high though — around 1mn t of jet fuel is expected to hit Europe in December, just below November levels.
But refiners could find some solace in other products. Prices of key gasoline blending component naphtha fell by less than those of gasoline, supported by the likelihood of continued firm demand for the product from the European petrochemical sector. Northwest European naphtha refining margins to Dated rose to four-week highs of $2.42/bl on 30 November.
And fuel oil margins to crude also diverged from other transport fuels, as the prospect of lower output because of refinery run cuts buoyed margins, in tandem with steady marine fuel demand. Very-low sulphur fuel oil premiums to front-month Ice Brent hit a five-week high of $6.27/bl yesterday, while high-sulphur fuel oil discounts to Ice Brent reached a five-week high of $13.69/bl.
Cutting crude unit runs was paired with higher throughputs of secondary feedstocks in cracking units earlier in the pandemic, as it gave refiners the flexibility to produce enough fuel to meet downstream contracts while reducing exposure to an overall weak margin landscape, as well as helping to minimise jet fuel production. Fresh run cuts could provide some support to vacuum gasoil (VGO) demand — used as a feedstock for cracking units — at a time of seasonal weakness. VGO demand typically dwindles as the end of the calendar year approaches because of an annual trend to run down inventories in the US in particular, but also in Europe.
But unlike earlier in the pandemic, operating costs for hydrocracking units in particular have ballooned since the natural gas price spike, which coupled with low gasoil margins could disincentivise refiners from raising runs in those units. Hydrogen was costing refiners around $5-6/bl of crude processed in October according to the IEA, up from just around 60¢/bl in 2019. It is unclear how refiners will navigate this issue, although it could provide a ceiling to high-sulphur VGO demand.
