US refining margins, cracks remain strong, but refiners' 'Platinum Age' losing some luster

A look at US refiners' second quarter earnings shows quarterly refinery margins hovering just under 2022's record highs, and with global demand growth for transportation fuels outpacing new capacity additions, margins will remain robust for at least the next year.

Net supply additions have lagged demand growth, leading to a sustained period of market tightness, and "these trends are prolonging a period of unusually high margins, which we have termed the 'Platinum Age' of refiners," S&P Global Commodity Insights said.

That Platinum Age for refiners came as the result of import bans on Russian refined products put in place following Russia's invasion of Ukraine in February 2022, the shutdown of refinery capacity during the low-demand coronavirus period, and the delay of planned refinery expansions; all of which are contributing to refiners' struggles to meet increasing demand.

Since 2019, about 4.5 million b/d of global refinery capacity was shut as a direct consequence of the coronavirus. Most of the rationalized refinery capacity was in the Atlantic Basin, giving it an advantage over other regions.

And a result, the regional lower refinery capacity combined with faster demand growth is sustaining higher margins for US and European refiners than their Asian counterparts, who are faced with higher costs including skyrocketing tanker rates to bring crude into their refineries and ferry products out to export markets.

In the US, gasoline cracks are higher than they were a year ago. US Gulf Coast CBOB cracks are averaging $27.99/b so far in the third quarter of 2023, compared with $17.52/b in the third quarter of 2022, according to S&P Global data.

And while diesel cracks have fallen from 2022 highs when markets were scurrying to replace banned Russian diesel barrels, they remain above historical averages.

So far in the third quarter of 2023, USGC ULSD cracks are averaging $35.80/b, below third quarter 2022 cracks of $57.28/b but well above the $15.80/b in the third quarter of 2019, S&P Global data shows.

But with new refining capacity poised come online, refinery margins are expected to soften.

"I think really the overall narrative on refining side is really that we're going to start slowly stepping down from the very high cracks and margins we have seen over the past 18 months over the next 18 months," said Dan Evans, vice president of refinery consulting at S&P Global.

Product tightness could ease as new capacity grows

S&P Global expects an increase in both global gasoline and diesel supply through the end of 2024 as new global refinery capacity comes online.

Between 2022 and 2024, S&P Global expects global gasoline and diesel supply to increase by 300,000 b/d and 500,000 b/d, respectively, while global demand for gasoline and diesel is forecast to rise 1.2 million b/d and 627,000 b/d, respectively.

Tightness in the diesel market is expected to ease in the first half of 2024 as new refining capacity comes online, while gasoline markets are dependent on the startup of new refinery capacity, most notably Nigeria's Dangote refinery.

First oil from the Dangote refinery, which was officially commissioned in May, is expected in the first quarter of 2024, with a ramp up to full capacity in 2026.

However, S&P Global believes there is a risk factor associated with the start of new greenfield refineries, with a "non-negligible risk" that projects will be delayed.

Factoring in that risk, S&P Global has raised its outlook on global diesel and gasoline cracks by $2-$3/b over the last month, as Atlantic Basin margins remain above historical levels.

"We expect strength to persist through August, before margins fall away seasonally," S&P Global wrote.

Low inventories drive higher US margins

One key factor in the strength of US refined products are lower-than-average inventories of gasoline and diesel, which have persisted through the year.

Virtually every US refiner said on their second quarter results call they expected the tight supply/demand scenario for both fuels to continue into 2024, due in part to low stocks of gasoline, diesel and jet.

US refined product inventories remain below the five-year average, as refiners were unable to bulk up gasoline and diesel stocks builds traditionally done during the low-demand shoulder season at the beginning of the year.

A freakish cold weather event just before the new year shut down refineries along the US Gulf Coast, the US Midwest as well as the Rockies and US Atlantic Coast. This cut refinery utilization from 92% to 79.6% for the week ended Dec. 30, 2022, according to weekly US Energy Information Administration data.

Refineries which shut down with very little notice faced problems restarting, delaying an uptick in utilization. And combined with a heavy maintenance season planned for refineries, some of which had been delayed by the coronavirus, US refinery utilization did not move back solidly over 90% until late April.

US distillate stocks remain 16% below the five year average, with US Atlantic Coast diesel inventory 36% below the five year average, for the week ended Aug. 11, most recent weekly EIA data shows.

"Given the low inventory levels and product shortages, we believe it's safe to assume there is meaningful upside to Q4 2023 estimates," UBS analyst Manav Gupta wrote in an investor note.

"If we get a rough hurricane season or a cold freeze (like Dec 2022) or a colder winter (last year was unusually warm) there could be serious product shortages, driving cracks even higher than current level," he wrote.

"We also believe based on where the cracks are there is upside to consensus numbers for [H2] 2023 and 2024; however, in the near term, we could see a 10%-15% correction in cracks,."

While Gupta also expects cracks to remain above mid-cycle levels based on global refinery capacity delays creating product shortages, he said the high price of crude oil could dampen demand.

"Crude is over $80/b and cracks are over $40/b," he noted. "We are heading for demand destruction. Unless crude comes down, we could see weaker demand on a go forward basis."