There may be something in Italian refiner Saras executive vice-president Dario Scaffardi’s thesis on European refining that “there is no overcapacity, just wrong capacity”.
Speaking at a business update in July, Scaffardi said the closure of a string of European refineries since 2009 was because of substandard, smaller and less-complex refineries being unable to compete in the wider market place, not simply the result of an excess in supply.
Looking around, there is evidence of wrong capacity all over the place. The refining boom of the last few months has been largely on the back of strong gasoline margins. Gasoline demand has surprised to the upside, driven by the US and China, whereas the demand response to low prices in middle distillates markets has been less marked.
Firm demand from the US following the crude oversupply-driven collapse in prices in the second half of 2014 sent crack spreads soaring. But ironically much of the investment in refinery upgrades is diesel-focused.
Diesel has been politically favoured in Europe for its fuel economy and lower CO2 emissions compared with gasoline engines. Diesel had been the big growth market, and refiners responded accordingly. Many European refiners have added hydrocracking capacity to boost diesel output for the region’s car fleet, which is biased towards diesel.
New refineries starting up this year in Saudi Arabia and India are diesel-oriented. Saudi Aramco-Sinopec joint venture Yasref is ramping up diesel exports to Europe from its 400,000 b/d Yanbu refinery in Saudi Arabia. The refinery tendered to sell 2.8mn bl of diesel for late July to early-August loading, adding to a global middle distillate surplus.
But as refineries are ramping up diesel output, political favour in Europe is turning away from diesel, as governments seek to cut emissions of harmful particulate matter from diesel exhausts in urban centres.
The surging gasoline demand has exposed another mismatch. US refiners running at high rates to capture gasoline margins are processing record volumes of light shale crude. Naphtha yields from bountiful local shale crude output can be as high as 50pc, but tend to be paraffinic naphtha, rather than the heavier grades better suited to producing reformate for gasoline production. This has left gasoline blenders scrambling for high-octane blend stock.
The US summer driving season is starting to wind down, and so gasoline margins are expected to decline. But sustained lower prices could prompt stronger seasonal spikes in gasoline demand. The IEA expects the crude oversupply to comfortably last until at least the end of next year, excluding any impact from a potential return of Iranian supplies.
Crude prices are now once again testing the breakeven point of shale production. A drop in US shale production, combined with greater availability of medium sour crude from the Mideast Gulf, is likely to constrain gasoline yields, BofA Merrill Lynch says. Wrong refining capacity and wrong crude production mean gasoline could receive further support beyond the seasonal norms to which the market has become accustomed.
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