Refining margins look good / Oil & Gas Journal / Piper Sandler ..............................................
Feb. 22, 2022
Piper Sandler: Expect product balances to tighten, notably distillate
Refining margins are off to a strong start in 2022, and outlook for US refining remains robust, however, the market likely underappreciates the potential for market tightness, notably for distillate.
By OGJ editors
Refining margins are off to a strong start in 2022, and outlook for US refining remains robust, however, the market likely underappreciates the potential for market tightness, notably for distillate, where drivers exist for possible material upside this year, said investment bank Piper Sandler. Drivers include record industrial demand, low distillate inventories, a post-Omicron jet fuel recovery, elevated European natural gas price impacts, above average refinery maintenance, and the return of IMO.
The most encouraging driver of tighter distillate markets in 2022 is the record level of product demand, despite transportation demand that has yet to fully recover, the firm said. Robust distillate demand is mainly driven by record levels of US industrial demand, which has been about 9 million b/d year-to-date vs. 7.6 million b/d in 2019 (+19%), which is likely to remain strong through 2022. As gasoline demand recovers post-Omicron, as well as jet fuel demand, expect overall product balances to tighten materially, including already tight distillate balances, it continued.
Jet fuel
Lagging jet fuel demand has weighed on total product demand recovery, but also provided breathing room in what would otherwise be even tighter distillate markets, Piper Sandler noted. However, recovering jet fuel demand is likely to exacerbate existing tightness in distillate markets over second-half 2022.
US jet fuel demand has steadily improved over the last 18 months, including showing relatively little impact to demand from recent COVID waves (Delta and Omicron). US demand is now hovering around 13% below 2019 levels, with international jet fuel demand down 15%-20% based on refiners’ commentary.
Post-Omicron, however, Piper Sandler anticipates material improvement in 2022 jet fuel demand, driven by a meaningful increase in business travel and international travel, supported by a meaningful return to in-person corporate events and loosening/removal of international COVID restrictions. Together with record industrial distillate demand and resilient but still recovering gasoline and transport diesel use, Piper Sandler sees material upside risk to demand (and tight balances) in second-half 2022.
Natural gas
Meantime, high European natural gas prices are reducing overall European utilization, especially reducing hydrocracker throughput, which lowers distillate yields and widens heavy/sour crude differentials, both of which benefit US refiners, the firm said.
“High natural gas prices in Europe are driving a number of knock-on effects, all of which are beneficial for US refiners. European refiners have been forced to reduce utilization rates or adjust operational processes, in particular the reduction in Hydrocracker throughput. Hydrocrackers use significant amounts of hydrogen to turn heavier/sour inputs into light products, in particular diesel and jet fuel. Expensive natural gas (and by extension, hydrogen) is forcing many refiners to either reduce hydrocracker use, instead running light, sweet crudes. While this will moderate somewhat exiting seasonal winter gas tightness, we expect structurally higher international gas prices over the medium-term,” said Ryan M. Todd, research analyst, Piper Sandler.
Meantime, exacerbating the combined impact of strong demand and tightness in global refining capacity, is the fact that global product inventories, in particular distillate, are extremely tight, either back to, or well below average levels. US distillate stocks are 13% below the 5-year average, while global middle distillate stocks are at the 5-year average, having fallen by 15% since mid-2021. With limited cushion, strong demand, and limited excess capacity to accelerate, the global refining system is increasingly vulnerable to either stronger than expected demand or any type of supply disruption.
A number of other factors should also tighten balances at the margin, including: 1) elevated levels of refinery maintenance in 2022 after pandemic-driven deferrals; 2) IMO-related distillate tightness, which has been muted by pandemic-driven demand destruction for the last two years; and 3) Updated Chinese carbon emission targets to 2025, which could force the closure of 3.5 million b/d of China's refining capacity (about 20% of total Chinese capacity) by 2025, Piper Sandler noted.
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