European refiners look to demand recovery, plant closures to reverse dire margins

European refiners are struggling with their weakest market in decades. But some industry watchers have become cautiously optimistic that improved demand, plant closures, and longer OPEC+ supply cuts could put a floor under margins.

Although oil demand has been recovering globally from April lockdown lows, led by a rebound in China, European refining margins remain near decade lows, and have even flirted with turning negative over the last two months.

With Dated Brent crude prices surging 30% in November, pushed up by news of a COVID-19 vaccine, refined products in Europe have failed recover at the same pace as the in the US and Asia, weakening margins in the region.

Cracking margins for key European feedstock crudes from the US, Saudi Arabia and Russia were all negative in the week to Nov. 27, against year-ago levels of $3-5/b, according to S&P Global Platts Analytics data.

Underpinning the European margin weakness has been anemic transport fuel demand, exacerbated by the latest round of mobility restrictions in the region.

Europe's latest round of lockdowns removed some 900,000 b/d of road fuel demand last month, according to Rystad Energy. This year, European demand is forecast to decline by about 15%, or 1.8 million b/d on average.

But as the latest round of national restrictions begins to ease, early signs are that fuel demand is already recovering.

Average road congestion in Europe's five biggest capitals is now around 26% below year-ago levels, according to TomTom data for the week to Nov. 27, the highest level since the last week of October, before new national lockdowns were rolled out.

Europe, which remains structurally short of distillates, will likely see gasoil demand around 80,000 b/d below year-ago levels in December, according to Platts Analytics, a sharp rebound from the 200,000 b/d year-on-year drop in November.

While more robust heavy transport consumption has helped shield diesel demand from the worst of the lockdown impact, Europe's gasoline and jet markets will continue to bear the brunt of the demand impact on volumes.

Europe's jet/kerosene demand is forecast to fall 655,000 b/d in December on the year, while gasoline demand is seen 320,000 b/d down year on year due to persisting lockdowns and restrictions on movements, according to Platts Analytics.

Refining rationalization

Meanwhile, discretional crude run cuts and plant closures should also help put a floor under refining margins in the near term, according to some market watchers.

Finland's Neste became the latest regional refiner to announce a plant closure on Nov. 30, confirming that its 58,000 b/d Naantali refinery in Finland will shut down by the end of March.

"Up until a few weeks ago, we were not optimistic on the pace of rationalization for various reasons," HSBC said in a Dec. 1 note. "There are hopeful signs that the industry's rationalization is happening faster than we anticipated."

In Europe alone, Total, Galp, Petroineos and Cepsa have all mothballed capacity to mitigate exposure to demand weakness and negative margins. Globally, closures of some 1.7 million b/d of refining capacity, mostly in Europe and the US, have already been announced this year, according to the International Energy Agency.

Adding in maintenance downtime and the idling of units, around 15-16 million b/d is expected to be sidelined for November, nearly double the previous year's level, according to Platts Analytics. In Europe, however, HSBC estimates that a further 600,000 b/d of refining capacity remains at risk of permanent shutdown.

OPEC+ cuts, Libyan barrels

Nevertheless, regional refinery margins are expected to remain weak through the winter, with gradual improvement expected to start in March when the impact of COVID-19 vaccines could start being felt.

"As the European economies gradually prepare to lift their lockdowns, economic activity in the month of December should be significantly stronger than has been recorded over the past five weeks," Jefferies said in a recent note. "Enhanced social restrictions measures will remain in place, however, which suggests that our [economic activity] index is unlikely to rebound all the way to the levels reached earlier in the autumn."

Platts Analytics expects refinery margins to remain weak until the first quarter of next year before becoming somewhat higher into the Q2 gasoline season.

"Our view is that refining margins will remain under pressure from surplus capacity relative to demand in 2021 even though...refinery closures have been announced and more are likely to follow," it said in a recent note.

Although a three-month extension of the current OPEC+ output cuts has largely been priced in to crude futures prices, a prospect of constraints on medium-sour Middle East crudes means concerns over a continued near-term oil glut are fading. Brent crude futures timespreads have firmed in recent weeks, with the market structure for ICE Brent largely flat for the six-month strip.

As a result, the current oil market structure is insufficient to cover new floating storage costs and is starting to incentivize the destocking of crude, according to crude analyst Sergio Baron at Platts Analytics, who notes that the Dubai crude forward curve is in backwardation.

"We believe that the Dubai structure is outperforming the Brent structure because of OPEC+ likely rolling supply cuts for an additional three to six months, crude runs recovering faster in Asia than in the West and also Libya producing more than 1 million b/d and displacing West African and US domestic crudes in Europe."

Indeed, initial concerns of returning Libyan supplies rapidly swamping the market for sweet grades in the Mediterranean have not materialized.

Market sources have said that European refiners have readily absorbed the Libyan crudes aided by fewer cargoes of US crude arriving into the region, and as recovering Asian attracts competing for sweet crude grades such as Kazakhstan's CPC Blend and Azerbaijan's Azeri Light.