Indian OMCs: Refining margin spike to continue

Refining margins have hit a high on the back of record-high diesel spreads. Singapore complex hovered between $ 19-20/bbl last week, while diesel spreads have been between $ 40-45/bbl.

How did this come about and is this temporary?

1) The demand-supply was already tightening, with a permanent shutdown of 3.6 million bpd, while capacity addition has lagged, with 2022 set to add over 2.4 million bpd, almost all in 2HCY22 

2) Diesel inventories across the world were short even before the crisis hit because of the sharp demand bounce back after the last Covid wave even as production was slow to catch up

3) China cut export, reducing diesel supply by about 0.5 million bpd YoY in March 

4) The Ukraine crisis and the self-sanctioning by European countries which are the largest importers of Russian diesel (~0.8 mn bpd) have effectively pushed us into this crisis.

However, some media reports suggest that the actual European product imports from Russia have not declined by much so far. Reports indicate about a 0.7million bpd of Russian product exports are already impacted.

Though the market appears to be pricing in possibly a worst-case scenario, with peak demand season round the corner, will it sustain, or is there scope for it to get better?

1) Global refinery outages already are significantly below historic averages this time around; hence no scope of relief is observed. 

2) Global refinery operating rates have a scope for improvement: the US is currently operating at 91-92%, and they have in the past operated in excess of 95%. Chinese teapots are at 55% levels, can easily operate at 75% and Chinese majors too can operate significantly higher. However, this would need crude import quotas and product export quota relaxation. Overall global operating rate improvement by 2% can contribute about 0.4- 0.5 million bpd of diesel. 

3) US gasoline demand appears to be lagging a bit likely due to high pump prices and gasoline inventory is comfortable. US refineries might look to shift the product slate in favor of diesel by 2-5% provided the crude mix can be managed. 

4) Of the 180 million bbls of release by International Energy Agency countries, about 25 million is diesel, providing some relief during peak demand season. 

5) While over 2.4 million bpd of new capacity is scheduled to be commissioned, the contribution from them is likely to be limited to possibly 0.1-0.15 million of diesel due to normal ramp-up post-commissioning and possible delays in commissioning.

6) Chinese lockdowns continue to impact demand, providing some relief to the tight market. 

While, these additional supplies under normal circumstances, should have been good enough, the situation is anything but normal, given the low inventories and risk of Russian capacity shut-in due to export constraints. Also, the Chinese may not relax its export quotas constraining operating rates. But the most important factor remains the redirection of trade flows.

If Russian volumes find other destinations overcoming vessel availability constraints and other sanctions, we could see diesel spreads settling down quickly. Otherwise, it would stretch over the next 6-8 months till new refineries ramp up production.

The very high Gross Refining Margins, especially driven by diesel is more than cushioning the marketing loss on petrol and diesel. While the thumb rule is $ 2/bbl of Gross Refining Margin is equivalent to Rs.1.1/ltr weighted average petrol and diesel marketing margins, individual companies due to their mix of refining vs marketing volumes have a slightly different balance: HPCL - $ 3.2/ bbl = Re 1/ltr, BPCL - $ 2/bbl = Re1/ltr and IOC - $1.3/bbl = Re1/ltr.