Oil prices, refinery margins and IMO regulations

Oil prices have risen dramatically from the low point in January 2016, when Brent crude was around $27, to the current price of just over $75. Oil prices of course have an effect on the price of petrol, in turn impacting those in high petrol consuming nations like the US.

 Americans have a high dependency on their automobiles so the high price of crude which filters down to petrol prices has an important impact on consumer spending. The average US household expenditure on gasoline has recently ranged between 2% to 4% of total household expenditures. This has been during a period when oil prices have been relatively low despite the recent price spike.

A continuing increase could have a knock-on effect to the economic growth of the US and eventually the rest of the world. 

The good news for American consumers is the strengthening USD may keep up with the strengthening oil price trend, even as prices head towards nearly $100 per barrel.

Implications on refinery margins

As the Trump sanctions on Iran increase it will be more and more difficult for Iran to continue producing and exporting at the rate it has been. This is one factor contributing to the rising crude price. Of course, higher oil prices do not necessarily raise refining margins. 

In fact refinery margins move in relation to oil price often in strange and unexpected ways. It’s usually expected that when the oil price rises the refinery margins should also rise, but that is not always the case. 

When there are rapid oil price declines the refineries are often able to get better margins because they hold inventory of oil which they purchased at lower prices and delay reducing their product prices. But as oil prices stabilize the competitive pressures result in tighter margins.

Looking beyond oil prices, there are additional factors that will soon have an impact on refinery margins.

Regulatory challenges for refiners

The International Maritime Organization’s shipping industry regulation puts a cap on the amount of sulphur in ship ‘bunker’ fuels, and will have a significant impact. From January 1, 2020, the maximum sulphur content allowed will be lowered from 3.5% to 0.5%. That is a very big drop and it’s uncertain the degree to which the shipping industry will be willing to fully comply in view of the high costs of doing so. 

Large investments will be necessary by shippers who will either be forced to pay for high-cost, low-sulphur fuels or install scrubbers on their ships to reduce emissions. 

This presents a challenge for refiners, who will need to make new investments to produce more low-sulphur products as well as dealing with the residual high-sulphur fuels. Thus, there is a good chance that the difference in price between the low-sulphur and high-sulphur fuels will widen.