Europe faces the risk of a fresh fuel market crisis as surging crude oil procurement costs and shipping rates severely squeeze refinery profitability. Refining margins in Northwestern Europe plummeted from $54 per barrel in early September to as low as -$11 on October 5, and currently hover at just $3. At the same time, the global diesel market is tightening further, with analysts warning that any additional deterioration in conditions could trigger production cuts, exacerbating the risk of shortages and fresh price hikes for petroleum products.
Precipitous drop in profits
According to the Financial Times, the profitability of European oil refineries has fallen precipitously, raising the likelihood of production cuts just as the continent confronts explosive price increases for refined petroleum products. The sharp rise in physical crude oil prices alongside record chartering costs for supertankers have inflated raw material expenses for European refineries. Simultaneously, prices for certain finished products they produce, such as gasoline, have failed to rise sufficiently to offset this burden. "Crushing crude procurement and transport costs have smashed refining margins in Europe and Asia in recent weeks," points out the International Energy Agency (IEA) in a relevant report. The sharp contraction in margins, known within the industry as crack spreads, occurs amid growing tightness in the global diesel market. US President Donald Trump announced on Friday an agreement with Russia to release diesel supplies onto international markets, though analysts estimate this move will have limited impact.
Production cuts on the table
Some European refineries may soon begin evaluating whether they need to curb operations, according to analysts. "Any further deterioration in refining margins could lead to economic run cuts at marginal refineries in Asia and Europe, adding to market tightness before year-end," noted the IEA in its report.
Why refineries are feeling the squeeze
Refineries process crude oil into a spectrum of products, ranging from liquefied petroleum gas and gasoline to fuel oil and asphalt. Although prices for diesel and jet fuel have climbed significantly this year, refineries possess limited operational flexibility regarding the yield proportions of each product extracted from a barrel of crude, regardless of how profitable a specific product might be. Refining margins for naphtha and high-sulfur fuel oil—lower-margin products whose demand has lagged behind the rise in crude costs—have sunk even deeper into negative territory. This means refineries may ultimately reduce throughput, according to analysts. Gasoline refining margins also crossed into negative territory late last month. "Margins are now very, very tight, and refiners are certainly uncertain about what to do in the coming weeks," stated Benedict George, head of refined products pricing at Argus. According to him, refineries have not yet reduced runs, but may do so if margins remain depressed. "If the margin stays negative for a week, refiners probably won't change strategy. But if it remains negative for three weeks or more, they are likely to alter their behavior," he noted.
Record crude oil procurement costs
Concerns over Persian Gulf oil supplies—stemming in part from the temporary disruption of flows via Saudi Arabia's East-West pipeline—prompted refiners last month to pay steep physical premiums over benchmark prices to secure future deliveries. In the interim, however, both physical crude oil prices and freight rates have surged. Dated Brent, the benchmark for physical crude deliveries in roughly 10 to 30 days, has risen by more than 13% over the past month. This gain far exceeds the increase seen in front-month Brent futures contracts, which gained just 1.2% over the same period. The combination of higher benchmark prices and heavy physical premiums paid to secure cargoes has driven the delivered cost of crude oil arriving at refineries to record levels.
US gains, Europe and Asia feel the squeeze
The headwinds confronting refineries in Europe and Asia stand in stark contrast to conditions in the US. American refiners can utilize domestic crude oil and have consequently avoided the full impact of wartime maritime freight spikes linked to tanker shortages. As a result, their profits are projected to more than quadruple. However, according to IEA analysis, the incentive to process greater volumes of crude in the US is insufficient to offset the disincentives facing refiners in other regions. Global refinery runs are expected to drop to 81.3 million barrels per day during October, marking a seasonal low.
High freight rates impede fuel transport
For petroleum-consuming countries in Europe and Asia, the situation is growing even more challenging as the market becomes increasingly fragmented. High freight rates mean fuel cannot be economically shipped from low-price regions to destinations where prices are higher. "We are seeing significant market dysfunction as cheap fuel isn't moving to where demand is due to costs," stated Arne Rasmussen from Global Risk Management. "Gasoil is cheaper in Asia than in Europe, so under normal circumstances someone would move it to the European market. But tanker freight rates are so high," Rasmussen explained. "This means there is excessive friction in the system," he concluded, describing the dysfunctions hindering the smooth flow of fuel across international markets.
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