(Bloomberg) — Crude oil is the world’s most important commodity, but it’s worthless without a refinery turning it into the products that people actually use: gasoline, diesel, jet-fuel and petrochemicals for plastics. And the world’s refining industry today is in pain like never before.
“Refining margins are absolutely catastrophic,” Patrick Pouyanne, the head of Europe’s top oil refining group Total SA, told investors last month, echoing a widely held view among executives, traders and analysts.
What happens to the oil refining industry at this juncture will have ripple effects across the rest of the energy industry. The multi-billion-dollar plants employ thousands of people and a wave of closures and bankruptcies looms.
“We believe we are entering into an ‘age of consolidation’ for the reﬁning industry,” said Nikhil Bhandari, refining analyst at Goldman Sachs Inc. The top names of the industry, which collectively processed well over $2 trillion worth of oil last year, are giants such as Exxon Mobil Corp. and Royal Dutch Shell Plc. There are also Asian behemoths like Sinopec of China and Indian Oil Corp., as well as large independents like Marathon Petroleum Corp. and Valero Energy Corp. with their ubiquitous fuel stations.
The problem for the refiners is that what’s killing them is the medicine that’s saving the wider petroleum industry.
When U.S. President Donald Trump engineered record oil production cuts between Saudi Arabia, Russia and the rest of the OPEC+ alliance in April, he may have saved the U.S. shale industry in Texas, Oklahoma and North Dakota, but he squeezed refiners.
A refinery’s economics are ultimately simple: it thrives on the price difference between crude oil and fuels like gasoline, earning a profit that’s known in the industry as a cracking margin.
The cuts that Trump brokered lifted crude prices, with benchmark Brent crude soaring from $16 to $42 a barrel in the space of a few months. But with demand still in the doldrums, gasoline and other refined products prices haven’t recovered as strongly, hurting the refiners.
The industry’s most rudimentary measure of refining profit, known as a 3-2-1 crack spread (it assumes three barrels of crude makes two of gasoline and one of diesel-like fuels), has slumped to its lowest level for the time of the year since 2010. Summer is normally a good period for refiners because demand rises with consumers hitting the road for their vacations. This time, however, some plants are actually losing money when they process a barrel of crude.
Just a few weeks ago, the outlook appeared to be improving for the world’s biggest oil consumers. Demand in China was almost back to pre-virus levels and U.S. consumption was gradually rebounding. Now, a second wave of infections has prompted Beijing to lock down hundreds of thousands of residents. Covid-19 cases are also on the rise in Latin America and elsewhere.
With demand in the U.S. now showing signs of heading south again as coronavirus cases flare up in top gasoline-consuming regions including Texas,…