Just when it seemed that returns in the refining sector could not get worse, recent months have seen a further deterioration in European and US refining margins. Cold December weather however has provided a modicum of support.

In Singapore, gasoil/diesel cracks remain stuck at low levels. The improvement in high conversion margins from around $1/bbl in November to December’s $2.50/bbl level was due to higher light distillate cracks. Gasoline cracks improved to $2/bbl and naphtha to $4/bbl. European high conversion margins remained close to $2/bbl. Slightly stronger middle distillate cracks were the temporary result of cold weather and they offset a seasonal easing in gasoline cracks. To put this in perspective, (except for December 2006) margins in Europe have been at their lowest level since August 2002.

The tenuous nature of any margin recovery is apparent in Asia. The December uptick clearly encouraged an increase in South Korean throughput. However, a large amount of refinery capacity still remains offline worldwide and is waiting for the first sign of positive net margins. At the first hint that operating costs are being covered, output immediately rises.

This ‘watching and waiting’ game is likely to continue to cap any improvement in margins. In the US, refinery utilisation remains just 80%. The closures of the Delaware City and Eagle Point refineries will remove only 350,000 b/d capacity. With a return to growth in domestic oil demand likely to be limited, substantially more US capacity will need to be closed to bring utilization rates back to a level that will suggest more economically healthy margins.

In practice, further closures are likely to be few and thus significant amounts of refining capacity will be effectively held in reserve. As and when margins work higher, we would expect that spare capacity to return to operation and cap the margin increase. There is likely to be a similar pattern of developments elsewhere. In Asia at least, we expect modestly better support from the strong regional demand growth for petroleum products.

Globally distillate stocks remain high both on and offshore. At the end of December, nearly 95 million barrels of distillate were in floating storage worldwide. Gasoline stocks are also high and thus only continued unusually cold weather can help support high conversion margins. Any return to more normal temperatures thus will only renew downward pressure on refinery margins.