European refining margins hit sweet spot

The Sarroch refinery is located about 20km south of Cagliari on the southwestern coast of Sardinia. Owned by Italy's Saras, it has the highest production capacity of any Mediterranean refinery, at 300,000 barrels a day.

An easy destination for crudes coming from Libya, Russia, the North Sea and the Middle East, Sarroch is one of the refineries that has benefited from better margins after the price of internationally traded Brent more than halved since June to about $53 a barrel.

Lower input costs have improved the profitability of the European refinery sector after years spent in a deep malaise; the amount of crude processed fell, plants closed and jobs were lost.

"We really saw a pick-up in margins from December, which then intensified in January, February and now March," says Massimo Vacca, head of investor relations at Saras.

"The improvement is long overdue. European refineries had truly been suffering and now we have some respite and joy after a long and tough time," he says.

European refiners have battled with poor domestic demand for their products, which include gasoline and diesel, as economic weakness began to bite. The sector has also struggled to adjust to rising competition from rivals in the Middle East, Asia and the US.

Alongside refiners such as Saras, refinery operators including traders Vitol and Gunvor as well as integrated oil companies Royal Dutch Shell and Total are among those said to have benefited from improved margins.

Refining and marketing arms "have been generating reasonably healthy revenues for oil majors, offsetting losses from the upstream [or exploration and production] businesses that have taken a hit since oil prices fell", says Martijn Rats, an energy analyst at Morgan Stanley.

Wood Mackenzie's benchmark European gross refining margins data show a jump from minus 50 cents a barrel in February 2014 to $3.80 a barrel in February 2015. The numbers for the week starting March 9 show a further increase to $5.60 a barrel.

The amount of crude processed in Europe in the first quarter is expected to stand at 12.01m barrels a day, up 3 per cent from the same period a year ago, according to the consultancy. The fourth quarter of 2014 recorded a 9 per cent year-on-year rise as refiners ran hard to capture strong margins.

Jonathan Leitch, refining and oil products analyst at Wood Mackenzie, says there are many factors driving margins. "It's a misconception to think it's just to do with lower crude prices. Even as oil has rebounded recently, margins have just got stronger," he says.

Complex refineries able to process heavier crudes with greater sulphur content, like the one in Sarroch, have secured the best discounts and generated better margins.

Lower crude prices also help cut energy costs to run the refinery. Some industry experts say up to 10 per cent of crude that is bought by a refiner is used for its own consumption. The drop in oil from a peak of $115 a barrel last year implies savings of $5 a barrel.

Meanwhile, the weaker euro and stronger US dollar have helped improve profit margins for European refiners as costs are generally paid in euros, while sales are made in dollars.

Rising demand for refined products in Europe was another factor. "Tentative signs of a bottoming-out in the falling European demand trend have emerged recently," the International Energy Agency said in its monthly oil market report.

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Colder weather, a pick-up in economic growth in many northern European countries and changing bunker fuel legislation will prop up demand in the first three months of this year, the IEA says.

Support is also coming from further afield.

Venezuela has been importing more and exporting less due to refinery problems, tightening the market. A fuel crisis in Nigeria ahead of the national election at the end of this month has propelled emergency buying, bolstering demand for gasoline and kerosene. Indian stockists are building up inventories of gasoline. And in the US, bad weather and seasonal maintenance has pared back supplies of refined products and boosted imports.

But oil market watchers believe these strong margins will only endure for another three to six months, as many of these factors dissipate.

Not convinced current margins will last, Patrick Pouyanne, Total's chief executive, said during an earnings call: "We are continuing the efforts to rationalise our European exposure."

The company believes Europe has at least 1.5m barrels a day of excess refining capacity and analysts say refinery shutdowns for Total in France loom.

Ferenc Horvath, in MOL Group's downstream business, is also cautious. "With the still existing European overcapacity and the additional refining capacities coming on stream later this year in the Middle East, we cannot be dependent on improving refinery margins."

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