Refiners turn to low-sulfur, distillate-rich grades

Responding to the persistent structure of refining margins through the first half of 2008, refiners reacted by turning to low-sulfur, distillate-rich grades and shunning gasoline-rich grades.

"We have a bizarre situation where the distillate crack is practically the only positive spread...this has led to a polarization in grades...it changes what we are used to on the relative value of grades," a market source said.

"The only thing that props up margins is the distillate crack so this is what you want to maximize. A hydrotreater can only take so much sulfur. If you feed in high sulfur product you have to lower throughput in order to produce a lower sulfur diesel. Alternatively you could buy low sulfur," another trading source explained.

As refiners in Europe favored distillate-rich grades, (see chart: Gasoil Front Month Crack Spread, Jan - July 2007 / 2008) premiums to forward Dated Brent on these grades rose sharply reaching a series of record highs. The premium for the distillate-rich Norwegian grade, Gullfaks reached a record above $7/b in late June.

August barrels of North Sea Oseberg, another distillate-rich grade, were reportedly traded at a record high premium of $3.60/b. In the Mediterranean, Azeri premiums on a CIF Augusta basis reached a high of Dated Brent plus $4.30/barrel on July.

At the same time, the value for gasoline-rich grades lagged well behind. Premiums on the gasoline-rich Mediterranean crude Saharan Blend fell behind year-ago levels as demand weakened.

The spread between gasoline-rich and distillate-rich grades as well as sweet and sour grades widened steadily.

The spread between Saharan Blend (FOB Skikda, Algeria) and Azeri (CIF Augusta) averaged a high of $1.85/b in June. Azeri was consistently assessed above Saharan blend from March 2008.

The distillate crack spread began to come under pressure in mid July while the gasoline crack spreads (see chart: Gasoline Front Month Crack Spread, Jan - July 2007 / 2008) began to recover a little ground. The impact on the European crude oil markets was a narrowing of the spreads between the respective grades. Although the distillate crack spread still leads the complex, it has fallen back considerably since May's highs, while the gasoline crack spread has meanwhile recovered some ground.

Following this move, the spreads between respective crude oil grades in Europe has also narrowed. This move can clearly be illustrated by the premiums for Azeri to Saharan Blend which averaged $1.60/b below July levels in the first half of August.

But the news that the American Petroleum Institute has discerned a 4.2% decline in US gasoline demand, prompting a 30% fall in imports through July 2008 will offer little in the way of comfort for Europe's refiners.

Coupled with that, the expectation that India is likely to start flexing its refining muscle is compounding the concerns of the European industry. Reliance's new 580,000 b/d Jamnagar facility (listen to podcast: Impact of India's Jamnagar refinery on European diesel) is set to open in the fourth quarter of 2008, and the product supplied from there is intended wholly for export.

Trading sources already believe the new facility has European markets firmly in its sights, particularly for diesel, while its gasoline output brings a significant new threat to Europe's remaining export markets.

Together, the emerging picture for the global refining sector is one littered with significant obstacles -- obstacles that a recent report by analysts at Credit Suisse expected will bring "a prolonged period of low refining margins which will eventually force the closure of less efficient refineries in the US and Europe."

The world's refiners, the report concludes, have left behind a golden age and are entering a new, far more turbulent, Dark Age.