We’ve been tracking refinery margins for a while, and there’s always an interplay between the input costs (i.e., crude prices) and product prices (i.e., gasoline, diesel, jet fuel, etc.). Refiners make the difference between the two and in complex refineries, can dial up or down the production of certain products. So while difficult to pinpoint exactly, it’s helpful to understand what is broadly happening.
In the past month, the coronavirus has severely impacted the crude market and driven it into bear territory on fears of demand destruction. The prevailing narrative is that the Chinese economy is frozen, and fossil fuel demand has fallen off a cliff. Demand for transportation fuel in particular has been materially affected as travel restrictions inside and outside of China have been imposed in an effort to curtail movement inside/outside of the country and contain the spread of the virus.
As we previously noted, JPMorgan (NYSE:JPM) estimated oil demand in China will decline by 500Kbpd in Q1 2020. In its latest STEO, the EIA estimates total liquids consumption in Asia will decline by ~500K bpd from February to April, so roughly in line with JPMorgan’s estimates.
So logically, we’d anticipate product demand to be weak in China and product prices to weaken. Then either products would need to be pushed out of China (i.e., exported) or inventories would balloon. If they are exported, the product prices regionally should in turn decline, and net/net refinery margins regionally and globally should fall despite the fall in crude prices. Since the demand destruction isn’t small, the price cascade should accelerate.
Yet in China, Arab Medium cracking margins averaged minus $1.84/b last week. Negative yes, but an improvement from the week prior when margins fell to near minus $4/b.
Outside of China? This is what we’re seeing.
(The left side is refinery margins on a quarterly basis and the right side is refinery margins on a weekly basis).
Interestingly, refinery margins have rebounded in the past few weeks outside of the US. In the US, the trend is similar…
Now we are the first to admit that we still don’t know the total impact of the coronavirus, particularly as China is just restarting its economic engine after a protracted shut-down. Will the number of confirmed cases increase dramatically given the mass movement of people as they re-enter the workforce? How long will the quarantine of tens of millions continue, and how long will it take for the manufacturing sector and consumer sentiment to recover? Those are obviously unanswered and currently unanswerable questions. So far… dare we say, it seems to be recovering, or at the very least, the number of confirmed cases appears to be falling.
What is noticeable amongst the murky data is that refinery margins are recovering outside of China, which means product demand outside of China is perhaps stronger than the current narrative would have you believe. We’ll continue to monitor this, but if the coronavirus is contained in short order, we’d anticipate refiners inside and outside of China will quickly reverse their throughput cuts and accelerate their crude purchases to take advantage of the healthier margins currently on offer. Ultimately, this would quickly push WTI and Brent pricing higher following the recent sell-off.
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