Oil demand returned to growth in 2010 and the first few months of 2011 after the contraction that followed the 2008 banking crisis and subsequent economic recession. Stronger demand has emerged despite crude oil prices that have risen sharply above $100/bbl, led by political unrest in North Africa and the Middle East which has injected a $15-20/bbl risk premium into the oil price.

Led by another year of impressive growth for China, global oil demand rose by 2.4 million bpd in 2010. Demand for 2011 looks set to grow by an additional 1.3 million bpd, despite the devastating earthquake in Japan. Against this projected demand growth, the global refining circuit saw 2010 net distillation capacity addition of just 703,000 bpd, and 2011 is expected to see a further addition of 1.3 million bpd. The imbalance created between demand and refining capacity has and is expected to continue to provide some upward pressures for margins in comparison to 2009.

• NW Europe averaged $4.25/bbl in 2010 compared to $4.00/bbl in 2009
• Singapore improved to $4.25/bbl in 2010 from $3.00/bbl in 2009
• US Gulf 3-2-1 crack spread, versus LLS, strengthened slightly to $5.25/bbl in 2010 compared to $5.00/bbl in 2009¹

The improvement in margins in 2010 was mainly the result of improved crack spreads for middle distillates in response to the upturn in global economic activity, with higher annual average cracks for heating gas oil compared to 2009:

• at Singapore, versus Dubai crude, from $7.50/bbl to $11.25/bbl
• in NW Europe, versus dated Brent, from $8.60/bbl to $10.90/bbl
• in the US Gulf, versus LLS, from $3.80/bbl to $5.60/bbl

In all regions, on an annual average basis and between 2009 and 2010, crack spreads for heating oil moved from below in 2009 to above in 2010 corresponding gasoline cracks:

• at Singapore, versus Dubai crude, from $1.10/bbl below to $1.00/bbl above
• in NW Europe, versus dated Brent, from $0.50/bbl below to $1.40/bbl above
• in the US Gulf, versus LLS, from $1.70/bbl below to $0.60/bbl above

Moreover, in the case of diesel, price premiums over gasoline amounted in 2010 to $2.50/bbl (Singapore), $4.20/bbl (NW Europe) and $3.00/bbl (US Gulf). The ascendancy of crack spreads for gas/diesel oil over gasoline has led to the resumption by refiners of maximization of middle distillate (for much of the year) in line with the experience between 2004 and 2008.

There are however some downside risks as the current market conditions are significantly different from the pre-recession period of 2008. While demand is growing in absolute terms and the world needs additional refining capacity, it is a lot less urgent than in 2006. The prospect of additional refining capacity being launched beyond 2012 makes any spectacular recovery in margins over the next several years unlikely, particularly given that a number of new grassroots refineries are already scheduled to be brought online in 2011 and 2012.

Additionally, the cost of energy has increased considerably making profitability a difficult task and the selection of feedstock essential as light/heavy differentials widen. A number of sites have planned capacity rationalizations that will decrease overall circuit capacity but eventually will boost the complexity of the refineries that remain.

The industry has also seen numerous asset sales over 2010 and a handful of closures that point to a major restructuring of the refining industry, with the exit of global majors from traditional refining markets and the entry of new players such as Russian and Asian national oil companies (NOCs), sovereign wealth funds and financial investors.

¹The replacement of the WTI high conversion margin by the 3-2-1 LLS margin (refinery margin of the sale of two barrels of gasoline and one barrel of heating oil after the purchase of three barrels of LLS) is because of the current structural weakness of WTI, which makes the WTI margin unrepresentative of the US as a whole.