Unpredictable Refining Margins... Worst Case: Simultaneous Decrease in Demand and Supply

Weekly Margin Fluctuation of $5 per Barrel
Impact of Prolonged War on Demand Decline
May Forecast Also Shows 'Reduced Operating Rate'

A pedestrian walking with a dog near a shopping center in Kyiv, the capital of Ukraine, destroyed by a Russian airstrike, on the 21st (local time). (Image source=AP Yonhap News)

[Asia Economy Reporter Moon Chae-seok] As the volatility of the Singapore refining margin, a profitability indicator for oil refiners, has increased due to Russia's invasion of Ukraine, concerns within the industry are growing. Since international sanctions against Russia began in earnest this month, the weekly average margin fluctuation has reached around $5 per barrel, significantly expanding from the usual range of $0.5 to $1 per barrel. The industry is contemplating whether to revise management decisions such as lowering plant operating rates and adjusting crude oil import volumes.

According to securities estimates disclosed by the refining industry on the 23rd, the margin for the third week of this month (14th?18th) was $7.76 per barrel, down $4.34 from $12.1 the previous week. It showed 'unpredictable levels' of volatility, moving from $5.7 in the first week of March to $12.1 in the second week and $7.76 in the third week. The margin is the amount left after subtracting crude oil prices and transportation/operating costs from the final petroleum product price, with $4?5 considered the breakeven point. From 2020 until September last year, it stayed below $6 per barrel but improved from the end of last year, contributing to refiners' return to profitability, and maintained a range of $6?7 until last month.

The situation reversed sharply after the Ukraine crisis. Refiners now face concerns about decreased consumer demand due to the large fluctuations in margins combined with the sharp rise in prices of petroleum products such as diesel, kerosene, and gasoline. The nationwide maximum gasoline retail price is approaching 3,000 KRW, and the price of diesel in Seoul has exceeded 2,000 KRW for the first time in 13 years and 8 months, all factors that could reduce demand.

At the beginning of the year, the industry expected global economic recovery to pre-COVID-19 levels, leading to increased petroleum product demand, and thus expanded crude oil imports and plant operating rates. According to the Korea National Oil Corporation’s oil price information site Petronet, the average daily domestic crude oil import volume in January was 94.792 million barrels, a 23.3% increase from 76.874 million barrels in the same month last year. The crude oil import volume reflecting the impact of the Ukraine crisis for this month is scheduled to be announced at the end of next month, with forecasts suggesting a sharp decline compared to January.

For refiners, a decrease in crude oil imports means a reduction in 'raw materials.' With raw material supply becoming unstable, a natural step would be to lower operating rates. This could lead to reduced product output and a worst-case scenario of declining performance. It typically takes 2?3 months from crude oil import to actual supply by refiners. In other words, a decrease in crude oil imports in March is expected to translate into a drop in refinery operating rates by May. The industry is thus facing a situation where operating rates, which had been raised to the low 80% range before COVID-19, must be lowered again.

A bigger problem is the possibility of a prolonged 'supply reduction' coinciding with demand decline. Russia’s invasion of Ukraine is evolving into a 'long-term, attritional war.' Military experts predict that if Russia engages in urban warfare in Kyiv, the capital of Ukraine, full-scale fighting could continue for at least two months. The possibility of deploying weapons of mass destruction cannot be completely ruled out, indicating a grim situation. The very fact that forecasts of 'operating rate reductions in May' are emerging shows that refiners do not expect a global demand and supply rebound anytime soon. An industry insider said, "If prolonged war leads to simultaneous decreases in demand and supply, refiners will have no choice but to lower operating rates regardless of whether refining margins rise. Only when news of a ceasefire or end of the war in Ukraine is reported and signals of increased global oil demand are detected will the elevated margins translate into improved refiners’ earnings."

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