Commodities 2022: European refining fortunes improve but new challenges loom

After a crash and recovery roller coaster since 2020, Europe's beleaguered refiners are facing even more uncertainties in 2022 with fresh challenges due to high natural gas prices and by renewed COVID concerns.

Just as the sector's fortunes appeared to be turning in Q3 2021 amid recovering margins and stronger demand, the discovery of the omicron variant has sent a ripple through oil markets.

Northwest European crack spreads and refining margins softened in early December reflecting market volatility over concerns that new travel restrictions over omicron would curb demand for road fuels and jet.

Even in a case where COVID proves to be more disruptive than expected, S&P Global Platts Analytics expects global oil demand to increase by almost 3 million b/d in 2022 as vaccinations continue to build particularly in countries with high GDP per capita.

"The strength in demand will push refinery runs and utilization rates (even including increased refining capacity) close to their historical ranges, improving margins," Platts Analytics said in a note.

But with European natural gas and carbon prices lingering close to record highs, regional refiners could face tougher headwinds.

"European refiners are especially exposed compared with other regions, as refiners in certain Asian countries use fuel oil, and US refiners are benefitting from cheaper Henry Hub prices," according to Platts Analytics.

European refiners normally use some 65 million-80 million cu m/d of gas, Platts Analytics estimates, for power generation and boiling crude. Record regional gas prices have already seen gas-to-oil switching in Europe average 160,000 b/d in October and November, with expectations for it to rise slightly to 170,000 b/d in December.

Platts Analytics expects higher potential for run cuts for Mediterranean refiners that are "unable to hedge exposure to high natural gas prices" while runs in Northwest Europe are expected to improve in Q1 2022 on 2021 but will remain below 2019.

"We expect runs to reach 1Q20 levels starting only in 2Q22," Platts Analytics said.

Carbon liability exposure for European refiners is also creating pressure on margins. Carbon prices under the EU Emissions Trading System gained 164% since the start of 2021, hitting a fresh record high of Eur90.75/mt CO2e on Dec. 8.

New capacity

European refiners also remain exposed to new export-oriented capacity coming online elsewhere in the world.

Kuwait's giant 615,000 b/d Al-Zour refinery started test runs in late 2020 and is expected to be fully online around May 2022. Saudi Arabia's 400,000 b/d Jazan plant is also ramping up, although its full complete start-up schedule remains uncertain for the moment.

In 2021, Kuwait's KNPC completed the Clean Fuels project at its Mina al-Ahmadi and Mina Abdullah refineries which will increase their overall capacity and "open new markets."

Meanwhile, the long-awaited 650,000 b/d Dangote refinery in Nigeria appears to be on track for early 2022 start-up. Once online, it is expected to compete with European refiners for the key US gasoline export market.

At the same time, however, low plant utilization rates and units closures due to the post-COVID demand collapse appear to be in the past for now.

Refinery downtime in Northwest Europe "is expected to fall to more normal levels within the 5-year historical band" in the first quarter of 2022, according to Platts Analytics, after peaking at around 22 million b/d in early 2020.

Those expectations are an improvement on 2021, which brought with it the threat of more refinery closures, such as Norway's Slagen refinery, announced in April by ExxonMobil and carried out in June.

But other shutdown projects are less imminent, with Shell planning to stop crude processing at the Wesseling part of its German Rhineland refinery in 2025, and Eni likely to stop crude processing at Italy's Livorno at the end of 2022.

Shell's announcement adds to the 640,000 b/d of European closures already announced since the start of the pandemic, the International Energy Agency estimates.

Margins outlook

Refiners able to circumvent inflated natural gas prices will also benefit from run cuts by other refiners.

However, "a weak margin environment for European refiners may encourage further run cuts, giving cracks some uplift," Platts Analytics said in its European Market Forecast.

"The market is already tight for most products, and lower regional output will only make it tighter. Still, demand remains the key unknown, and margins for these refiners will mainly prosper with healthy product consumption," Platts Analytics said.

Overall, European margins should see a modest improvement in 2022, Platts Analytics estimates, albeit remaining at a discount to most US margins. Reference case margins for refining Forties crude with an FCC and visbreaker plant in Northwest Europe are expected to average $3.90/b in 2022, up from $2.49/b in 2021. Refiners using feedstocks priced on a high fuel oil equivalent basis will continue to benefit from a $4-$5/b margin premium compared to refiners purchasing spot natural gas as an input, however.

Diesel cracks, traditionally the biggest marker for refining margins in the region, are expected to average $11.29/b in 2022, up sharply from $6.8/b in 2021, lagging US and Singapore diesel cracks by around $2/b.