Refining Margins Surge Due to Russia Sanctions... "Worst-Case Scenario Possible with Simultaneous Demand and Supply Contraction"

Refined Margin Rose Over $6 in One Week to $12
Industry Says "High Uncertainty," Cautious Outlook
Some Warn "Prolonged Conflict May Shrink Both Demand and Supply"

An apartment complex in Kharkiv, Ukraine's second-largest city, was set on fire by a Russian rocket attack on the 14th (local time), with firefighters working to extinguish the blaze. (Image source=AP Yonhap News)

[Asia Economy Reporter Moon Chaeseok] The volatility of refining margins, which significantly affect the profits of oil refiners amid Russia's invasion of Ukraine, is also increasing. Although the margin surged by more than $6 per barrel within a week, the industry is taking a cautious stance, citing growing uncertainty. Refining margin refers to the amount left after subtracting crude oil prices and transportation/operating costs from the final petroleum product prices, with $4 generally considered the breakeven point. The industry believes that the margin's wild fluctuations are due to the sharp rise in prices of petroleum products such as diesel, kerosene, and gasoline, rather than a demand surge from global economic recovery. Some even warn that if the war prolongs, the worst-case scenario of simultaneous demand and supply decline could occur.

According to estimates from the securities sector disclosed by the refining industry on the 15th, the Singapore complex refining margin in the second week of this month was $12.1 per barrel, up $6.4 from $5.7 a week earlier. The margin had stayed below $6 from 2020 until September last year but began improving from the end of last year, significantly contributing to refiners turning profitable, and this year it has been around $6 to $7.

The problem is that the increase is too steep. The refining industry’s reaction is that neither the cause nor the result is favorable. The margin fluctuated wildly from $6.9 per barrel in the last week of last month to $5.7 in the first week of this month, then jumped to $12.1 in the second week. This is because prices of kerosene, diesel, and gasoline soared amid concerns over supply disruptions of Russian crude oil due to U.S. sanctions against Russia. According to Korea National Oil Corporation’s oil price information site Petronet, as of the 14th, kerosene was priced at $121.78 per barrel, up 13.3% from $107.44 a month earlier; diesel at $123.14, up 9.4%; and gasoline at $125.39, up 13.7%.

The simultaneous rise in international oil prices and refining margins is expected to positively impact refiners’ short-term performance. When international oil prices rise, the value of crude oil inventories purchased during low-price periods increases, resulting in higher inventory valuation gains. According to securities firms, SK Innovation’s operating profit in the first quarter is expected to exceed 890 billion won, up more than 77% from the same period last year, and S-Oil’s operating profit is projected to increase by 39% to 876.4 billion won. Jeon Yujin, a researcher at Hi Investment & Securities, said, "Due to sanctions on Russia, which has a large supply share in Europe, concerns over crude oil supply disruptions have increased, leading to a notable strengthening of refining margins centered on kerosene and diesel. Although the current refining margin is excessively high at an unprecedented level, the strong trend is expected to continue due to supply disruptions."

Contrary to the optimistic views in the securities sector, the refining industry is focusing on the excessive volatility of various indicators. If the war and high oil prices prolong, the scenario could lead to cost increases → sharp rise in petroleum product prices → demand contraction → refining margin slowdown. The worst-case scenario for refiners is the simultaneous contraction of demand and supply. Typically, global companies tend to manage petroleum product supply and demand regionally, but if European buyers purchase Asian petroleum products due to sanctions on Russia within the region, Asian companies’ inventories could be depleted, leading to supply reductions. Even so, if demand remains firm, refiners can produce and sell petroleum products using stockpiled crude oil, reaping high profits from elevated refining margins. However, if the war drags on and global oil demand decreases, problems arise. In the worst case, profits of refiners could plummet as they did during the 2020 'Saudi vs. Russia production competition' period.

For this reason, pessimistic views that refining margins could turn negative and scenarios suggesting that plant operating rates might be reduced around May?considering the 2-3 month lag between crude oil contracts and actual refining supply?are being raised within the industry. The very emergence of the 'May operating rate reduction' forecast indicates that refiners do not highly expect global demand growth. An industry official said, "If the war prolongs and demand and supply decrease simultaneously, refiners can sufficiently reduce operating rates despite soaring margins. If meaningful news such as a ceasefire or end of the war emerges, signaling firm global oil demand, refiners’ performance will also improve in line with the elevated margins."

This content was produced with the assistance of AI translation services.