RIL refining margins to improve on global regulatory changes

For the last few quarters, analysts have been expecting refining margins of complex refiners like Reliance Industries Ltd (RIL) to dip, as the benchmark Singapore GRMs (gross refining margins) have been declining. RIL has managed to surprise on that front, even though the benchmark Singapore GRMs have steadily declined.

In the June quarter of this year, Singapore GRMs declined $0.4 a bbl sequentially to $5.8 a bbl. RIL's GRMs, too, declined from $9.3 a bbl in the March quarter to $8.7 a bbl in the June quarter but were higher than the previous year's $8.4 a bbl. While there is little consensus among analysts on the road ahead for complex refiners in Asia, a handful believe RIL's GRMs are expected to tick up from 2014-2015 on key regulatory changes across Russia and China.

The first regulatory change expected to impact refiners has played out in Russia, which in June proposed to increase the export duty on fuel oil export from 66 per cent to 76 per cent of the crude oil level in 2015, to 82 per cent in 2016 and to 100 per cent from 2017. While the proposal is yet to be approved, analysts believe if it goes through, it would lead to closures of simple refining capacity in Russia as margins would collapse. Russia is discouraging the export of fuel oil as domestic demand for gasoline has been steadily rising. Russia matters in the context of global refining because it accounts for six per cent of the global refining capacity, most of which is simple.

Closures of simple refineries in Russia after the imposition of high export duties would positively impact complex refiners, as Russia would have to upgrade refineries or use lighter crude oil to process gasoline, which would lead to higher spreads between lighter and heavier crude oils. In the last few years, the spreads between light and heavy crude oils have been narrowing, which has also impacted RIL's GRMs, which have declined from peak levels. According to Axis Capital's analysis, weakening fuel oil fundamentals would reduce the demand for heavier crude oil, further widening the light-heavy differential, beneficial for complex refiners like RIL.

Refiners and experts believe the regulatory changes are under way and potential gains take time to play out. Refining margins are very volatile and are expected to remain so. Vandana Hari, Asia editorial director of Platts, a leading provider of information on the energy sector, says: "Regardless of the uncertainty round the export duty reform, observers and analysts believe Russia’s large-scale refinery modernisation plan would continue. That means simple refineries have to invest in fuel oil upgrading units, or shut, though now the deadline has shifted down the road by a couple of years. The shift, under way in Russia, would increase the country’s supply of ultra low sulphur diesel (ULSD) and other clean products to the European markets."

The collapse in the fuel oil demand would be accelerated from 2015, as new emission norms set by the International Maritime Organisation (IMO) would make shipping fleets abandon fuel oil. While this would impact state-owned oil marketing companies (OMCs), as 11 per cent of their product slate is fuel oil, private complex refiners like Essar Oil and RIL would gain. By 2015, the sulphur emission of tankers would go below one per cent and an IMO study said the sector would have to largely abandon the use of fuel oil and move to expensive and cleaner fuels like gas, oil or diesel. In keeping with this trend, last month, Hari said ExxonMobil had announced a $1-billion investment in its Antwerp, Belgium refinery to install a coker to convert heavy oils into marine gasoil and diesel, a rare adoption of a longer-term perspective than short-term economics.

For many reasons, refineries are expected to process expensive light crude oil to produce gas, oil and diesel, which would increase the differential between light and heavy crude oils. RIL has been shoring up its margins by processing the cheaper heavy crude. Over two years, it has moved towards processing heavier crude oil grades. According to Axis Capital, RIL’s average American Petroleum Institute gravity through 2007-2011 was 29 (light crude), which has reduced to 26 (heavy crude) in first nine months of 2013. Analysts say RIL's crude oil sourcing has helped the margins and the company may have saved $2 a bbl in its crude sourcing costs.

But GRMs in the current year are expected to be volatile, with Singapore GRMs correcting sharply even in the current month. Like RIL, China's GRM moved up to $7.07 a bbl in 1Q2014 and $6.28 a bbl in 2Q2014 from an annual average of $4.49 a bbl in 2013 and $5.36 a bbl in 4Q2013. A UBS report dated 4 August said the Singapore complex refining margin dropped further last week, down 21 per cent to $2.8 a bbl, the lowest weekly average margin level since late August 2013. The complex refining margin has quickly contracted, by 50 per cent over two weeks, mainly due to weakening gasoline crack spreads, as supplies came back to market after several key suppliers (CPC and FPCC in Taiwan, SK Innovation in Korea) resumed operation in July, while the summer season demand is peaking out. The outlook may be robust over 2015 but the this year might see some volatility, claim analysts and refiners.