OIL
Oil Refineries Face Shutdowns as Demand Collapses
Mar. 31,
2020 09:51AM
By Nick
Cunningham
A growing number of refineries around the world are
either curtailing operations or shutting down entirely as the oil market
collapses.
Oil prices
have fallen precipitously to their lowest levels in nearly two decades.
Typically, falling oil prices are a good thing for refiners because they buy
crude oil on the cheap and process it into gasoline, jet fuel, and diesel,
selling those products at higher prices. The end consumer also tends to consume
more when fuel is less expensive. As a result, the profit margin for refiners
tends to widen when crude oil becomes oversupplied.
But the
world is in the midst of dual supply and demand shock — too much drilling has
produced a substantial surplus, and the global coronavirus pandemic has led to
a historic drop in consumption. Oil demand could fall by as much as 20 percent,
according to the International Energy Agency, by far the largest decline in
consumption ever recorded.
Consumption
of jet fuel around the world has plunged by 75 percent. Average retail gasoline
prices in the U.S. are dropping below $2 per gallon nationwide and have already
fallen below $1 per gallon in some places. They will fall further still.
In fact,
margins even fell into negative territory, meaning that the average refiner was
losing money on every gallon of gasoline produced. Refiners now find themselves
facing a painful financial squeeze.
"We're
seeing gasoline cracks at negative margins. We're seeing jet cracks even
worse," Brian Mandell, an executive with Phillips 66, said on a March 24
phone call with investors. "Cracks" refer to the difference between
the cost of buying crude oil and selling the refined product, and it stands in
as a reference point for a refiner's profit margin.
One of the
main strategies that refiners use when a particular product is oversupplied is
to alter their processing mix. Facing a glut of gasoline, refiners could switch
their operations away from gasoline to a focus on diesel, where margins have
not declined by nearly as much. "With strong price signals pushing
refiners towards diesel production, they would have made immediate adjustments
to tweak their refined product yields," RBN Energy, a consultancy, wrote
in a report.
However,
some refiners already switched over to diesel following tighter international
sulfur regulations on maritime fuels that took effect at the start of this
year, which placed a premium on low-sulfur diesel. Having already tapped that strategy,
the ability to adjust away from gasoline production is "likely
limited," RBN concluded.
Collapsing
Demand Leads to Refinery Closures
There are
around 3 billion people on some form of a lockdown around the world. In those
circumstances, refiners have seen buyers vanish overnight.
"We're
seeing even our Latin American customers asking us if they can back out of
cargoes now, so we see that the demand destruction is starting to move toward
Latin America," Brian Mandell, the Phillips 66 executive, told investors.
With no
buyers, gasoline is set to pile up in storage. Refiners are looking at no other
choice but to curtail or shut down operations.
Valero
Energy, for instance, recently announced that it would limit output at six of
its 12 U.S. refineries. ExxonMobil announced significant cuts to its refineries
in Texas and Louisiana, citing the lack of sufficient storage capacity.
Notably, Exxon said it would shut down its gasoline unit at its Baytown, Texas,
complex, the company's largest such unit in the United States.
"The
refiners are struggling mightily, due to the steep drop in demand," John
Kilduff, a partner at Again Capital LLC, told Bloomberg. "The poor
refining margins will push companies to reduce operating rates further."
The danger
for some refineries is that they cannot simply throttle back and operate at
really low levels. "In our experience, crude throughput in the 60 percent
to 70 percent range is approaching the minimum rates that a refinery can
operate without completely shutting down units," RBN said.
According
to Phillips 66, even that threshold might be optimistic. "I don't think a
good rule of thumb would be down in the 60 percent range for refiners. Most
refineries can't turn down that far," Robert Herman, an executive with Phillips
66, said on an investor call. With refiners already lowering processing,
"we're nearing kind of minimum crude rates in many of our refineries
today," he added.
In other
words, facing a mounting glut and no ability to lower output further, some
refineries may simply need to shut down entirely.
The problem
is a global one. Italy's API became the first European refiner to shutter a
facility. On March 30, North Atlantic Refining Ltd. announced the first
refinery to shut down in North America.
In one
particularly unusual move, India's Reliance Industries said it would simply
sell the crude oil that it had in transit at sea, rather than allowing the
cargo to arrive at its refineries. Reliance, which operates the world's largest
refining complex, said it would instead cut processing rates. "As of now,
the plan is to cut refining throughput in April because demand is not
there," a source told Reuters.
In the
U.S., refineries unable to switch away from gasoline are most at risk, as are
those in the Midwest and the Rockies, where access to pipelines and storage
capacity is a fraction of that on the Gulf Coast, according to RBN.
"It is
not difficult to see run cuts of 10 mmb/d (million barrels per day) soon,
perhaps peaking at 15-20 mmb/d at the height of the pandemic. This is likely to
force some refineries to close down, while others will reduce rates
severely," research firm FGE said in a report on March 30.
Running out
of Storage, Oil Prices to Crash Further
The
situation could unravel rather quickly. Consumers aren't consuming and refiners
are lowering their operations. Ultimately, that means that oil drillers will
have no place to sell their oil.
A number of
pipeline companies have already asked oil drillers to cut back on their
production because the pipeline system was becoming overwhelmed.
The estimated
20-million-barrel-per-day surplus will lead to storage filling up in the next
two to three months. To avoid such an outcome, analysts widely see crude prices
crashing even further.
"Demand
for gasoline (no driving) and jet fuel (no flying) has now crashed and
inventories for these products are already brimming. Refineries in many places
are now losing money for every barrel they process, or they have no place to
store their output of oil products," Bjarne Schieldrop, chief commodities
analyst at SEB, a Swedish corporate bank, said in a statement. "For
land-based or land-locked oil producers, this means only one thing: the local
oil price or well-head price they receive very quickly goes to zero or even
negative."
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