New York — US refinery margins are expected to rise in the second half of 2021 as demand recovers and inventories tighten, but the road ahead likely will not be smooth as some capacity will be shut in.
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"The recent resurgence of COVID cases spurring increased restrictions reminds us that the recovery will be bumpy," Morgan Stanley analysts said in a Dec. 15 research note.
"After a challenging two years for refiners, investor debate is increasingly shifting to the impact of announced permanent refinery closures and what this means for global balances and refining margins beyond COVID-19," the analysts said.
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Morgan Stanley estimates that about 1.1 million b/d of US refinery capacity is "getting mothballed or permanently shut," and the possibility exists for more, with an additional 350,000 b/d "at-risk" based on location and/or complexity.
The preexisting need for culling inefficient refineries was accelerated by the coronavirus pandemic, which cut oil product demand faster than refiners could cut runs. Lack of personal mobility resulting from coronavirus lockdowns pushed US refined product stocks up to 15% over the five-year average in the second quarter and refinery utilization down to a record low 68% of capacity, US Energy Information Administration data shows.
As refined product inventories continue to tighten – currently about 5% over the five-year average -- improved gasoline demand are expected to drive a US margin recovery in early 2021, with distillate demand rising in the second half of the year.
Despite the rollout of coronavirus vaccines, the sharp reduction in air travel will continue, keeping distillate inventories at a surplus in the first half of 2021.
Jet fuel represented more than a third of overall global oil demand decline in 2020, about 3.1 million b/d out of total demand loss of 8.7 million b/d, according to S&P Global Platts Analytics.
Platts Analytics forecasts that global oil demand will grow by 6 million b/d in 2021, but remain 2.1 million b/d below 2019's total 101.9 million b/d.
RINs price risks
As gasoline demand began to strengthen in the third and fourth quarters, most US plants shifted their yield to maximum gasoline mode. Even as margins rise, they are expected to remain lower than "normal" levels seen in recent years.
"Refiners are going to continue to be squeezed. Demand is not growing fast enough to take up all the spare capacity in the market. And in addition we are seeing more natural gas liquids and biofuels being produced, which basically substitutes the need for refined products," said Chris Midgley, global head of S&P Global Platts Analytics.
An expected rise in Renewable Identification Numbers prices could also eat into margins.
RINs are credits purchased by obligated parties like refiners to make up their blending shortfall. But US refiners are still waiting for the 2021 Renewables Fuel Standard from the Environmental Protection Agency to see how much blending is needed to meet their Renewables Volume Obligations.
While the EPA RFS mandate is expected to rise to about 20.17 billion ethanol-equivalent gallons in 2021 from the 20.17 billion gallons in 2020, a recently missed deadline has created uncertainty in the market.
"The 2021 renewable fuel mandates have not been proposed yet, though the law required them to be finalized by Nov. 30, 2020. That brings additional uncertainty into the market as we enter into the new year," said Corey Lavinsky, global biofuels analyst with Platts Analytics.
"We expect an uptick in US biofuel use in 2021 as transportation fuel use rebounds and fewer refineries are relieved of their blending requirements through hardship exemptions. This usually results in an increase in RINs prices," he said.
Also a 10% drop in 2020 US ethanol production raises concerns about domestic blending supply if 2021 blending requirements are not reduced. Less ethanol means refiners will fall short of meeting the unrestricted portion of the RFS – able to be satisfied by corn-based ethanol -- which has been at 15 billion gallons every year since 2017, and has helped propel RINs prices higher.
So far in December, current year D6 Ethanol RINs are averaging 68.11 cents/RIN, up from December 2019's average price of 11.89 cents/RIN, according to Platts assessments.
Renewables and rationalization
US refiners are working to mitigate their RFS exposure by going deeper into the renewables fuel space.
Valero, Marathon, Phillips 66, as well as smaller companies like CVR and HollyFrontier have announced plans to add more biofuel capability, a trend that is likely to continue due to incentives and generally cost-effective conversions for cash-strapped refiners.
In most of these cases, it involves repurposing biofuel plants by converting existing refineries or units to make renewable diesel (RD) and sustainable aviation fuel (SAF), thus addressing the issue of excess refinery capacity while taking advantage of the incentives.
The benefit is twofold. First, refiners can repurpose capacity rather than shutting it down, creating fuel and generating RINs to meet their own RVO. Second, refiners can increase revenue by selling RINs to other obligated parties.
US biomass diesel demand is expected to reach 200,000 b/d in 2021, with RD demand making up about one-third, according to Platts Analytics.
The California market is particularly attractive. California's Low Carbon Fuel Standard (LCFS) credits create a more lucrative market for RD and SAF.
And demand for renewable fuels is will rise as other states and regions are considering transportation cap-and-trade programs and other projects to lower greenhouse gases, a trend supported by the incoming Biden Administration.