Oil Products: Prices Fall, Margins Narrow, On Weak Global Demand
BMI View: We forecast that crude prices will fall steadily through 2016, which will have a knock-on effect on refined fuel products. Lower prices, as well as lower demand amid a global growth slowdown, will lead to a shrinking of the high margins refiners have enjoyed in 2012. This will benefit consumers as relatively cheaper fuels will relieve some of the pressure on slumping demand.
Since we last published our Global Oil Products Outlook in June 2012, crude prices have enjoyed a multi-month rally, before retracing and entering a period of volatile, sideways trading in recent weeks. We forecast sustained volatility throughout the rest of 2012, and despite considerable political risks to the upside, downward pressure due to weak global demand will push crude prices lower in 2013. The primary drivers of this scenario remain unchanged: a sustained deterioration in the eurozone debt crisis, a hard landing in China, and a weak recovery in the US. Moreover, a market which just months ago looked dangerously tight now seems to be fairly well supplied; Iraqi output continues to rise, Saudi output remains close to 10mn barrels a day (b/d), and US crude production is forecast to continue rising on the back of increased unconventional production and more deepwater blocks being opened to offshore drilling.
In light of these developments, we left our benchmark crude forecasts unchanged in October 2012. Although US$110/bbl average for Brent in 2012 may end up being slightly lower than the realised average for the year, September's average of US$113.03/bbl was only a US$1.00 increase on the price in August ( see our online service, October 3 2012, 'Weak Demand Will Battle Supply Fears In Controlling Prices). This confirms our view that the market has already priced-in government stimulus to support the global economy, including QE3 in the US and supply outages in Iran due to Western sanctions. Our US$102 average for Brent in 2013 remains in place as well, as we expect a further weakening of demand throughout next year. Similarly, our forecasts for WTI remain on hold at US$95 in 2012 and will fall to US$92/bbl in 2013.
Our refined products forecasts methodology is based on estimating the future spreads between each product and its regional benchmark: WTI for products sold at New York, Brent for Rotterdam and Dubai for Singapore. We had adjusted our spreads in June 2012, primarily at the light end of the barrel in Europe and Asia. No further changes have been made to the spreads since.
|*f = forecast. Source: Bloomberg, BMI|
|Bunker Fuel 180|
|Bunker Fuel 380|
|Bunker Fuel Average|
Our fuels price forecasts are indicative of a symbolically striking, albeit small, divergence with our benchmark crude forecasts: with the exception of New York Gasoline prices, all of our refined fuels forecasts for 2012 are higher than the 2011 averages, while our benchmark forecasts indicate marginally lower average prices in 2012. This discrepancy is noteworthy, and underscores the improvement in the outlook for refiners through 2012 at the expense of their customers, as well as a much-awaited recovery in refining margins takes place. Of course, this comes with a caveat. As will be discussed further on, we see a lot of regional discrepancies in profitability, therefore broad generalisations should be taken in with caution.
The recovery in refining margins has been especially pertinent in the US, as those refiners with access to cheap unconventional production have benefitted significantly ( see our online service, August 3 2012, 'Refiners Enjoying Strong Margins...For Now'). However, we expect the outperformance of US refiners to moderate in line with a forecast narrowing of the Brent-WTI spread. Indeed, we forecast the Brent-WTI spread will shrink from US$15 in 2012 to US$10 and then US$8 in 2013 and 2014 respectively, as additional oil transportation infrastructure comes online in the US.
With regard to customers, we have identified the four main markets using the products they each utilise most often: kerosene in the aviation sector; gasoline and diesel for retail users and land freight operators; naphtha in the petrochemicals industry; and bunker fuel for the shipping sector. All of these sectors are set to suffer from record-high fuel prices in both the short term and the longer term. Indeed, although we anticipate prices will begin to recede in 2013, our forecasts suggest that they will remain elevated above 2010 levels for the foreseeable future due to high crude prices and wider crack spreads.
Customers will be offered some relief in 2013, as crude and fuels prices begin to recede from their 2011 and 2012 highs, although refiners will see a narrowing of spreads as a result. Our forecasts suggest a sustained, slow and painstaking recovery process that will see many plants struggle, particularly in mature markets, characterised by overcapacity. This is representative of a move away from the supportive price dynamics that refiners are experiencing in the second half of 2012, particularly in the US, which had allowed for some recovery in the segment.
Consumers will be grateful for falling diesel and gasoline prices over the coming years, although European and Asian prices will fall faster than those in the United States. Falling prices may delay the rise of alternative fuels, however, including some early movement towards LNG and biofuels, which we have seen in the shipping and airfreight industries.
Refiners: Faltering Light At The End Of The Tunnel
With regard to downstream operators, BMI sees three main geographical blocks emerging: North America, emerging markets and Europe.
In the US, cheap domestic crudes in the Midwest, Rockies and on the Gulf Coast have generated very high margins. The country's evolution into a net exporter of refined products is also highly supportive of refiners, which enjoyed record-high utilisation rates of more than 90% in the summer of 2012.
These benefits have not been shared with those on the East Coast, however. This is despite signs that the downstream decline suffered in the Northeast is now being contained. Some of the most promising signals include Delta Air Lines' purchase of the 185,000b/d Trainer Refinery in Pennsylvania for US$150mn in May 2012, and the creation of a joint venture (JV) by private equity fund Carlyle Group to acquire the 335,000b/d Philadelphia refinery ( see our online service, May 1 2012, 'Delta Flies In To Rescue Pennsylvanian Downstream' and July 9 2012 'Indian Summer For East Coast Refining'). However, these remain highly unorthodox investments which fail to address the region's lack of competiveness, raising the possibility that such moves may not succeed as hoped and that the plants might eventually shut down in the coming years. This risk remains particularly true at a time when our forecasts suggest further shrinking crack spreads, including a 30% fall in the jet fuel spread, a 36% fall in the diesel spread, and a 9% fall in the gasoline spread between 2012 and 2016.
Despite high margins, Gulf Coast refiners must still address many challenges. The most prominent of these is the inadequacy of the region's high-complexity infrastructure, which has been adapted for the processing of heavy crudes amid the growing domestic supply of light shale oil. Processing light crudes would leave many new and expensive units underutilised. Therefore, the Rockies and Midwest downstream sectors are best placed to benefit from the current US downstream trends as they have access to secure feedstock from Canadian tar sands, adequate infrastructure, and a captured local market.
|Emerging Downstream Powers|
|Refining Capacity, Percentage Change (y-o-y)|
The multi-year trend for rising crude prices has forced many governments to revise their fuel subsidies, or spend an increasingly large amount of money on maintaining them. Although we still expect many refiners to incur losses in 2012, as they will still be expected to perform their 'national duty' and provide cheap energy to fuel growth, their prospects are clearly improving. Indeed, Brazil, India, Iran, Nigeria, Indonesia and China, among others, have all - or are expected to - liberalise prices (to different degrees). In other states, particularly those in the Middle East, fears of domestic unrest since the Arab Spring have stalled fuel and further price liberalisation.
This price effect is nonetheless likely to be offset by the significant expansion in refining capacity which is expected to take place over the coming years. Indeed, OPEC has estimated a 1.3mn b/d and a 1.7mn b/d increase in global refinery capacity in 2012 and 2013, the lion's share of which will be located in non-Organisation for Economic Cooperation and Development (OECD) countries. The diversity of planned projects underscores this trend: in July 2012 Sinopec announced plans to build a 642,000b/d refinery in Jiangsu province ( see Downstream Ambitions May Lead To Drowning, July 10 2012). If realised, this facility would be the nation's largest. Additional refinery projects are being financed around the world, including recent examples ranging from a US$3.6bn refinery in Egypt, a US$6.5bn refinery in Nicaragua, and US$25bn in downstream investments in Qatar. With all of this new investment into downstream capacity, there is an emerging risk of overcapacity, particularly as demand growth continues to slow.
Importantly, cracks are beginning to show with regard to investment in the maintenance of downstream capacity in some emerging markets. The most recent and glaring example of this was the Amuay refinery explosion in Venezuela, which poses considerable risks to our forecasts for the downstream segment ( see 'Refinery Blast Presents Downside Risk To Forecasts', August 27 2012). While an extreme example, it underscores the need for ongoing investment into maintenance at existing plants amid a broad-based push for the expansion of nameplate refinery capacity worldwide.
The outlook for Europe is much bleaker, with low margins and slumping demand forcing many plants to shut down or be mothballed ( see Eni's Stoppage Signals More Woes For Europe's Refiners, April 18 2012). Europe's largest independent refiner, Petroplus, was forced to file for insolvency in January 2012 ( see Credit Crisis To Trigger Downstream Supply Squeeze, January 4 2012). High financing costs are also becoming a significant issue, as the eurozone debt crisis weighs on credit in addition to demand. Furthermore, neighbouring emerging markets, rather than offering greater potential for the export of volumes, are a source of competition, as Russia, the Middle East, North Africa and even India, enjoy cheap feedstock and are constantly raising capacity and standards. Mediterranean refiners will continue to suffer much more than their north-western European counterparts, as they are more exposed to this direct competition.
Jet Fuel: Middle East Posts Strongest Demand As Global Air Traffic Slumps
We forecast that jet fuel prices will fall steadily through to 2016, in line with our other fuel products forecasts. Between 2012 and 2016, prices are forecast to fall 4% in Singapore, 3% in Rotterdam, and 2% in New York.
According to the International Air Transport Association (IATA), seasonally adjusted air passenger traffic has remained flat since June, and carriers are moderating their rates of capacity expansion to account for approximately 4.1% growth. European growth remained strong (despite the economic situation) due primarily to the demand for international routes, while the Middle East and Latin America posted the largest amount of growth. The weakest growth areas were the Asia Pacific and North America.
|Africa||Asia/Pacific||Europe||Latin America||Middle East||North America||Global|
|YTD passenger growth||8.3||5.4||6.2||9.1||16.9||1.4||6.6|
In contrast to passenger traffic, air freight volumes were down 0.8% y-o-y in August, although certain regions are maintaining elevated demand relative to others. While Asia-Pacific registered the biggest decline, with a 5.5% drop in volumes, the largest amounts of air freight transport were recorded in the Middle East and Africa.
This ties-in with what we have been seeing with companies operating out of the Asia-Pacific region to Europe. The fall in demand for air-freighted electronic goods, coupled with the rise in jet fuel prices, has hit operators hard. Indeed, with the US recovery since the global economic crisis of 2008/2009 remaining sluggish at best, and the eurozone entering recession, in part because of its inability to deal with its sovereign debt crises convincingly, global demand for air freight has fallen.
|Asia-Pacific Records Biggest Slump|
|International Air Freight Traffic, Percentage Growth (y-o-y)|
Gasoline And Diesel: Demand Destruction Takes A Toll
Our average global gasoline price for 2012 now stands at US$119.47/bbl compared to our previous forecast of US$123.86/bbl. Despite the downward revision, the new figure corresponds to a 1.3% y-o-y rise, significant enough to cause demand destruction. This has been particularly notable in the US where, according to the Energy Information Administration (EIA), gasoline prices in October 2012 were nearly 11% higher than October 2011, with consumption falling nearly 4%, from 8.96mn b/d to 8.63mn b/d.
Miles travelled in the US slowed throughout 2012, as highlighted in our previous Global Oil Products Outlook. Year-on-year growth declined by 0.03% in July, with the strongest drop-off in growth posted in the northeast, which registered a 0.06% decline. This is in line with our demand destruction scenario. Meanwhile, y-o-y growth is positive at 0.09%, although a further slowdown over the coming months could drag that number down.
|A Slight Rebound|
|Annual Vehicle-Distance Travelled (Billion Miles)|
In Europe, demand destruction has mostly been the result of the ongoing debt crisis, and the austerity measures that have been introduced. However, retail prices for both gasoline and diesel remain high as the shutdown of many refineries across the continent has caused supply to shrink. The 2012 average diesel price is currently 2.5% higher than the 2011 average, at US$935/metric tonne.
In the medium-to-long term both sectors offer opportunities. Growth in diesel demand will continue to be buoyed by tightening fuels standards across the globe. Hart Energy estimates that diesel engines carry vehicles 25% further per tank than gasoline engines. Although diesel only powers about 3% of US passenger vehicles, this figure could reach 8% by 2025, according to Allen Schaeffer, executive director of the Diesel Technology Forum. Meanwhile, gasoline production could be boosted by the growing availability of cheap unconventional light oil production. The case for growth in car fuels consumption is weakest in Europe where austerity measures and the ongoing debt crisis will continue to take their toll.
Naphtha: Asia Stays Afloat While Europe Sinks
Unlike light and middle-distillates, naphtha trends closer to benchmark crudes. We are projecting an average global price of US$105.41/bbl in 2012 compared to US$104.26/bbl in 2011. The rise in prices will be fuelled both by higher crude prices and by narrowing spreads. According to our forecasts, Rotterdam will see its naphtha crack spread (compared to Brent) increase from US$-4.98/bbl in 2011 to US$0.50/bbl in 2014, while Singapore will see its naphtha crack spread rise (compared to Dubai Fateh) from US$-3.69/bbl in 2011 to US$0.33/bbl in 2014.
A stronger appreciation of naphtha in Europe will hurt the continent's already-ailing petrochemicals markets. In reality, naphtha's relatively small price differential with regional benchmark crudes implies similar trends for profit margins in the petrochemicals industry and in the refining sector.
Much like the downstream segment, the European petrochemicals industry is facing a cyclical downturn, which implies that Indian and Middle Eastern operators could strengthen their presence on the continent. Furthermore, as our Asian naphtha forecast is indexed to Dubai Fateh crude, Middle Eastern petrochemicals operators will benefit from lower feedstock costs than their European counterparts that use Brent-indexed naphtha.
Bunker Fuels: Trans-Pacific Route Rebound Amid High Prices
Our global average forecast for bunker fuel (the average of the 180 and 380 grades global price) now stands at US$101.00/bbl, which is up slightly on the 2011 average of US$98.10. Shipping companies had been hard hit by the rise in bunker costs in 2011, where the cost of bunker fuel globally - calculated based on an unweighted average of Bunker fuel 180 and 380 for each of the three regions we cover - rose by 38.0% on 2010 levels. This, coupled with the excess capacity in the global shipping fleet across the traditional shipping sectors (container and dry and liquid bulk shipping), meant operators have suffered, with many reporting consecutive quarterly losses.
Global shipping data for 2012 indicates a growing disparity between two of the primary global shipping routes, with trans-Pacific trade growing 0.8% y-o-y, while Asia-Europe trade has fallen 1%. This is in line with our view that there will be a slow economic recovery in the US, while the eurozone crisis continues to ripple through European economies. Traffic through the Suez Canal has also been in decline since early 2011, with an acceleration in the rate of decline in growth in recent months, despite rising volumes. Indeed, August 2012 saw an 8% y-o-y decline in throughput growth.
|Volumes Rising Despite Higher Costs|
|Suez Canal Container Ship Throughput (Net Tonne 000), and Y-o-Y % Change|
As was the case during the last bunker fuel price peak in 2008, carriers are looking to alternative fuel sources - with liquefied natural gas (LNG) now being considered as a possible shipping fuel. Det Norske Veritas (DNV), a ship classification bureau, estimates that 19-45% of ships will be powered using LNG by 2030. Meanwhile Maersk Line wants to test biofuels and NYK Line is trialling a solar power-assisted car carrier. We believe that the most likely alternative to bunker fuel will ultimately be LNG. However, this remains a long-term prospect and high fuel costs over the coming years will place a great deal of pressure on carriers and shippers alike.
Our forecast for a decline in bunker fuel costs will offer shipping companies some relief and take the pressure off their bottom lines in the coming years, although prices will remain high by historical standards. As such, we believe that companies will continue to slow steam in an effort to conserve fuel and cut expenditure.