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The weakness in refining margins and the possibility of run cuts are dominating conversations, yet there are no signs of run cuts. Indeed, not all margins are weak. Generic refining margins based on benchmarks increasingly do not reflect true conditions given a three-tiered fuel oil market (LSFO, HSSR, cracked HSFO), with prices for each of these reflected in premiums rather than benchmark prices.
Given the strength in low-sulphur straight-run fuel oil, simple refineries that can access light sweet crudes with a high atmospheric residue cut―such as Ekofisk and Azeri―are boasting of strong margins. Complex refineries that can squeeze profit from costly feedstock are also faring well. The refineries that are suffering are those in the middle of the complexity spectrum configured to process sour crudes and that cannot fully convert residual fractions into clean fuels.
Moreover, while run cuts are occurring, the reduction is far lower than the theoretical maximum implied by models, especially given real-world constraints. For instance, refiners that have to supply domestic markets, such as in Thailand and India, will have to run regardless of margins. There has been some trimming of runs in Singapore, Korea, Italy, Rotterdam and parts of Latin America, but the total reduction in runs is likely around 0.3 mb/d. With new refining capacity ramping up in Asia, this volume of run cuts will be easily offset.
In theory, crudes most at risk from the current margins environment are light sours with high-sulphur vacuum residue, such as Forties and Murban, but given yet another small Urals export programme in December and a resumption of Chinese buying, Forties is soaring. Together with strong Ekofisk values, prompt Brent spreads are in triple-digit backwardation. If VLSFO prices weaken, Ekofisk will come off, but the downside is limited with supplies driving the crude market.
|Fig 1: North Sea differentials to Dated Brent, $/barrel||Fig 2: LSSR vs LSVGO, CIF NWE, $/t|
|Source: Argus Media Group, Energy Aspects||Source: Argus Media Group, Energy Aspects|