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Low oil prices are crushing a lot of upstream exploration and production companies. But downstream, refiners are having a field day.
The collapse in oil prices has been a boon to refiners for two big reasons. First, for oil drillers, selling oil is where their revenues come from. But for refiners, oil is a cost, not the end product. Lower prices mean lower costs. Second, cheap oil means that consumers get hooked on cheap sources of fuel. As any driver who has been to fill up their car lately would know, it is the cheapest time in years to drive a vehicle. Refiners have been experiencing inordinately high demand for their products over the past year.
In fact, the high demand for gasoline, diesel, jet fuel and other sources of refined products have refiners running their facilities at the highest rates in years. In the U.S., the refining industry briefly hit 17 million barrels per day (mb/d) of refined products in July and August, the highest level ever recorded.
That has U.S. refineries operating nearly flat out. Total refinery utilization in the U.S. has largely stayed above 90 percent since April. And running refineries at full capacity makes sense. Refining margins widened to $0.66 per gallon on July 8, the highest level in almost seven years, according to EIA data. Demand for gasoline in the U.S. was up nearly 3 percent for the first five months of 2015 compared to the same period last year.
Demand for refined products is growing around the world, as global consumers respond to low prices. U.S. refiners saw their exports jump by 19 percent in the first half of this year.
In Europe, too, refiners are enjoying good times. Downstream has not always been a source of excessive profits, but for now, the margins are attractive. In the second quarter, European refining margins were at their highest on record (for the second quarter) since data began being collected by Reuters in 1997.
"European refiners are enjoying a rare period of high margins. We think we are past the peak but that margins are likely to stabilise at a higher level than expected by the market over the next couple of years," UBS wrote in a recent research note.
In the U.S., record level refinery runs have provided an outlet for excess crude that has been piling up around the country. But even with refiners running their facilities as much possible, the level of crude diverted into storage spiked this year, a testament to how profound the glut has been. Crude storage levels have since been drawn down from their highs reached this past spring.
Despite boom times for the downstream sector, refineries have to undergo periodic maintenance, which cuts down on their ability to produce. Refining runs in the U.S. have already dropped from their highs of 17 mb/d. For the last week in August, the U.S. refining industry produced 16.3 mb/d, still above the five-year average.
Globally, seasonal maintenance could knock 5 mb/d of refining capacity offline, according to UBS, or about 7 percent of total capacity worldwide. "This together with seasonally higher demand for heating oil in colder weather and lower crude losses at low oil prices will in our view support refining margins for the rest of this year," UBS analysts concluded.
The coming spell of outages could have two effects, with varying impacts on companies depending on whether they are upstream or downstream. A temporary downturn in refining utilization could push down oil prices in the third and fourth quarter, as less crude is taken up by refiners. A faster contraction in production upstream could offset such a scenario, but given the fact that U.S. shale companies are contracting at a relatively slow pace, more crude may be diverted into storage if refining capacity shrinks. That's negative for oil prices.
Downstream, however, the effect will be the opposite. Fewer refineries operating will push up prices for refined products. For the refiners that stay in the game and keep their facilities running, the outages at some of their competitors could further inflate margins. Spain's Repsol, for example, plans on deferring maintenance at its 220,000 barrel-per-day facility on the Mediterranean Sea in order to continue to capitalize on the unusually large margins it is working in.
Refining margins are not always this high, and especially in Europe they are sometimes negative. But for the next few months, the downstream sector will continue to benefit from the oil bust.
By Nick Cunningham of Oilprice.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.