Morgan Stanley: Refining improving at the margins
After a challenging year, refining news flow is turning more positive, with progress on a COVID-19 vaccine and more capacity closures. Although spot margins are likely to remain challenged by weak demand, the case is building for a rally in deferred margins, according to Morgan Stanley.
This year, the refining sector has faced unprecedented oil demand weakness, particularly in positive margin products, and struggled to adjust capacity quickly, creating a large overhang of refined product inventories, Morgan Stanley noted. This has weighed on refining utilization and margins: the average European spot refinery margin has been around 60% lower year-to-date than the average of the last 5 years and forward margins several years out also have faced significant downward pressure, according to the firm.
In the short term, the refined product balance remains challenging. The International Energy Agency, OPEC, and US Energy Information Administration are all still revising first-half 2021 demand forecasts lower on rising COVID-19 cases and lockdowns. On top, the overhangs from large new capacity additions have been well flagged.
“Until the demand recovery accelerates, a lot of capacity will need to run at lower utilization rates or remain idled to draw down elevated product inventories – spot margins will need to incentivize this. Beyond this, we still estimate another 2 million b/d of closure announcements are needed to offset expected additions and restore refinery utilization and margins to 'normal' levels,” Morgan Stanley said.
Yet, at the margin, recent news flow is turning more positive, driving upside for forward margins from very low levels. “In particular, the announcements from Pfizer and BioNTech and Moderna raise hopes for a COVID-19 vaccine, giving us more confidence in the demand recovery, especially in key transport fuels,” Morgan Stanley continued.
On top, refinery closure announcements have been accelerating, totaling 1.35 million b/d year-to-date, offsetting some new start-ups. Yet, while equity valuations are starting to price this in, forward margins have only moved slightly. But, with stronger 2021 demand and upside if there is a faster vaccine roll-out, the firm sees upside in the US 2-1-1 margin versus WTI in December 2021.
“We also consider what the (lower probability) bull case could look like. There is a risk that OPEC and partners struggle to hold the current production deal together, particularly if more Iranian oil begins to find its way onto the market or if the US rig count continues to rise. If OPEC supply keeps the crude market well supplied at the same time that product demand picks up, the upside for refining margins could be significantly higher than we are building in,” Morgan Stanley said.
