Oil plunge may support margins, but demand weighs on refiners

The sharp correction in global crude oil benchmarks may offer some support to dwindling margins for refiners in Asia, but market participants said it may not do much to significantly boost demand that remains bogged by a slowdown in economic activity because of the coronavirus outbreak.

Refiners in general welcomed the price correction Monday although many were cautious that the quantum of decline may negatively impact profits, at least in the near term.

"The loss on the inventory we're facing is going to be massive," a senior executive with a state-owned Indian refiner said, referring to stockpiles the refiners typically hold for operational reasons.

"It's going to wipe out my margins for the entire quarter," he said, noting that other Indian refiners may face similar issues as they prepare to close their books for the financial year ending March 31, 2020.

Front-month Brent crude futures were trading at $33.90/b during the Asian afternoon, down by more than 25% from Friday's settlement levels.

In the medium term, the oil price decline is likely to have little effect on improving the demand outlook for oil, as consumption trends for transportation fuels remain weak, refining executives said.

In South Korea, industry sources told S&P Global Platts that GS Caltex, S-Oil and Hyundai Oilbank are also considering cutting their operating rates to cope with weakening demand for refined products.

A source at SK Innovation said the price cut is unlikely to prompt the refiner to buy more crude as its main refining unit, SK Energy, is reducing its crude run rate to 85% until the end of March, compared with 95% a year ago. It is also considering additional run cuts in April.

In China, which has seen the biggest demand destruction as a result of the coronavirus, refiners have cut run rates by more than a million barrels a day and there was little incentive at the moment for refiners to scale up operations, a trader with Sinopec's trading unit said.

Another source at Sinopec, Asia's largest refiner, said the company may increase its purchases from Saudi Arabia going forward, mainly due to the sharp cut in Saudi's official selling prices, but it would need to balance domestic demand and storage availability.

"Refiners may look at increasing runs, but this now depends on demand. Demand has improved a bit in China with the COVID-19 situation under control, but whether to increase runs remains tricky," a second trader with a second Chinese firm said.

Storage Demand

The sharp decline in prices on Monday was driven in large part by Saudi Arabia's weekend announcement of deep cuts to its crude OSPs for customers across the globe.

The news of lower prices and potentially higher Saudi oil output helped nudge the oil complex slightly deeper into contango -- a market structure where oil for delivery in forward months is worth more than oil for prompt delivery -- on Monday.

As in the past, the deepening contango may spur demand for storage from companies who buy oil in the prompt and place them in tanks on hopes of selling them at higher prices a few months later. In 2016, the last time Brent was trading close to Monday's levels, demand for storage played a significant role in supporting oil demand.

However, traders pointed out that the prevailing contango in the crude oil market is relatively mild compared with 2016. On Monday, the spread between Month 1/Month 2 Brent contracts was about 60 cents/b in contango, compared with a contango of $1.36/b at its widest in 2016.

And many are also wary that another major price cut by Saudi could cause a big loss to those who choose to store oil in order to take advantage of the contango.

"For contango, the threat now is you may put crude in storage as the contango works, but you have to weigh it against whether Saudi will do this again," the trader with the second Chinese firm said.

"They could go and mess up storage economics for everyone by cutting [prices] again next month."