Downstream Crisis Goes Up Stream
Downstream oil and gas production and distribution companies are friendly interfaces in a sense between customers and oil drilling companies. They touch everyday life of end users, heating their homes, fueling their vehicles and etc. Refiners, for instance, are pure downstream players on the supply chain. Distribution companies are also in the same side of supply chain. On the other hand, upstream business segment commonly associated with exploration and production stage of oil.
Oil prices, although have recovered somewhat since the beginning of April, were down after OPEC’s conflicts and political disputes, creating great uncertainty and volatility in the market. As anyone predicts, if low prices are sustained, revenues and cash flow of oil producing companies will be swept away.
Under normal circumstances, low oil prices mean more production and higher demand for finished products. Typically, decreasing oil prices are an advantageous for refiners because they get crude oil cheaper and turns it into gasoline, jet fuel, and diesel, selling those products at higher prices. The end user also tends to consume more when fuel is less expensive. As a result, the profit margin for refiners tends to increase.
Sustainability is the key factor in the correlation between low oil prices and refinery margin.* Markets and indirectly economic growth are very sensitive about this sustainability issue. As a motto, oil stability is a compulsory for market predictability.
As we all learned from Refinery 101 lesson, the determinants of profitability for refinery economics are the type of crude oil, refinery size, trade, configuration and complexity, logistics and transformation, operational efficiency and regulatory environment. For refineries, to stay competitive despite the volatility in supply and prices of crude oil, they should be able to work with different quality parameters under an affordable cost burden. Operational excellence is key to the success for their competitive edge.
However global coronavirus pandemic turns everything upside-down. It has led to a historic drop in consumption. Sealed borders, banned flights, and abandoned streets mean decreasing gasoline/diesel use and almost no Jet fuel consumption. The sector can expect global demand to fall further still.
In that case, first strategy of refiners would be to change their processing mix to focus on a product where margins have not declined too much yet. However demand collapsed for all types of fuels. With no demand, Refiners might face curtail or lay off production as they fill up their storage capacity. After 2-3 months, ultimately, which means that oil drillers will have no place to sell their oil.**
Market dynamics play an important role in determining refinery yield’s reaction to the decrease in oil prices. Sometimes, especially light product prices fall more slowly than the crude prices, which gives Refineries enough time to benefit from low oil prices. To say differently, product price changes are following crude oil prices in delay. This short term cure is valid only up to one month. After then, decrease in processed oil products will catch up with the decline in the prices of crude. What makes the situation irrevocably desperate is the steep drop in demand. Refineries will simply sell the crude oil that they had in transit at sea, if they manage, rather than allowing the cargo to arrive at its refineries, which might imply negative prices for upstream producers in the near future. Lack of demand deteriorated the situation where oil prices were volatile putting refiners at considerable risk and narrowing their profit margins.