European refiners face margin headwinds over lagging jet, gasoil recovery

European refiners are facing further downward pressure on margins in the near term as middle-distillate cracks continue to suffer from the pandemic-hit aviation sector and congested global supply lines dent diesel and gasoil demand, according to analysts and refining industry players.

With COVID-19 travel bans continuing to cast a long shadow over the global recovery in jet fuel demand, many refiners have been diverting the lighter components of jet into gasoline and heavy naphtha streams as well blending jet into the diesel and gasoil pools.

But as global oil demand continues to recover, refiners are struggling to minimize jet yields as they ramp up crude runs, according to OMV's head of supply and trading Vladimir Langhamer.

"The refining system will be able to cope with it but it won't be an easy one," Langhamer told the Platts Global Executive Petroleum Conference this week. "If they want to ramp up runs it will become increasingly challenging to dispose of the jet."

While demand for road fuels is bouncing back strongly this year, Langhamer estimates that global jet fuel demand remains some 3 million-4 million b/d below pre-pandemic levels.

S&P Global Platts Analytics doesn't expect global jet demand to recover to pre-pandemic levels until 2026 despite aviation activity returning to 2019 levels two years earlier, Platts Analytics' head of EMEA Cross-Commodity Analytics Nicole Leonard told the event. The lag in jet demand recovery to activity, however, reflects more ongoing efficiency improvements in the aviation sector, she said.

But with European refiners strongly configured towards diesel production, signs of demand weakness for middle distillates may cap any uplift in product cracks from directing the jet glut to other fuels, Leonard said.

There have been signs of congestion at ports, rail, and other key supply lines as the global economy recovers, she said, which could dent the diesel and gasoil demand recovery into 2022.

"There is a risk to the demand recovery that we anticipate, particularly in Europe where refineries are dependent on those $15-$20/mt [diesel/gasoil] cracks," Leonard said "This poses a risk to European refiners profitability."

Behavioral change

Product cracks in Europe have been supported by refiners slashing utilization rates, idling capacity, and closing down amid an ongoing conversion to biorefineries.

But while product crack swap levels have improved thus far in 2021 as demand improves, they have slipped back since the beginning of June as crude prices rose to 14-month highs.

Cracking margins for distillate-heavy Urals crude in Northwest Europe fell back to $2.54/b on June 16, the lowest since late January, after having recovered to a post-pandemic high of $5.6/b in early April, according to Platts data.

Langhamer said he remains upbeat, however, that regional refiners will mitigate weaker gasoil margins by being "very creative" with crude slates and plant configurations, perhaps by also cracking some of the surplus gasoil into gasoline.

Further out, the extent to which behavioral changes as a result of the pandemic will have permanently lowered fuel demand is a big uncertainty.

Despite a major shift away from offices in urban centers to more home-based work, Leonard said Platts Analytics has seen robust gasoline demand in the key US and European markets.

"The loss of demand we might get from more people working from home is offset, not only by the record-high light-duty truck sales and recreational vehicles being bought in the US and Europe, but also the fact that consumers working from home have the opportunity to travel more during the day," Leonard said.

In October, the IEA forecasts a net demand increase of 50,000 b/d from pandemic-related behavior changes by 2030 as a shift from public to private transport, the delayed replacement of old cars, and demand for fuel-hungry SUVs swamps the impact of less air travel and more remote working.

In Spain, Repsol's chief economist Pedro Antonio Merino said car sales are moving from diesel to gasoline while a slump in public works has depressed diesel demand in the construction sector. He said that while the dynamic has pushed Spanish gasoline demand above 2019 levels, he is confident that a resumption of investment in public works will start to support diesel demand also in the near term.

Merino said another issue hanging over refining margins in Europe is the question over access to heavy crudes suited to the region's mostly deep-conversion refining assets.

OPEC+ cuts of heavy crudes and tougher European CO2 emission regulations could increase the cost of processing heavy and carbon-intensive crudes in the coming years, he said, depressing margins.