Regional refining margins: 2016 update

September 2016 | Tim Fitzgibbon, Anantharaman Shankar, and Cherry Ding

2016 is proving to be a worse year for refining margins than 2015 across all regions. In Asia, slower demand growth and higher refining capacity have pushed the market to visbreaking breakeven early in the year. In Europe, pressure from imports has also pushed utilization down to visbreaking levels. US Gulf Coast margins have compressed as product premiums have declined in line with Europe and a tight crude market increased crude prices relative to benchmarks.

Asia margins

At the start of 2016, Asia margins were fairly strong, with topping capacity at breakeven as outages in the region allowed available plants to run at high utilization. As the year progressed, margins declined to hydroskimming and visbreaking capacity being at breakeven in March and April. In June, conditions improved somewhat, with hydroskimming capacity returning to breakeven.

Exhibit 1: In early 2016, Asia margins fell to visbreaking breakeven

SOURCE: Platts, OilDesk

This is in contrast to a much stronger 2015 when topping and hydroskimming capacity were at breakeven through most of the first half of the year. Conditions in 2015 were supported by high growth in product demand (in reaction to low crude prices) and a pause in the startup of major new refining capacity.

Market conditions in first half of 2016, however, have been pointing in the opposite direction. Overall, product demand growth has slowed as the effects of lower crude prices have diminished. Even though India showed robust growth in demand, demand growth in China was lower than expected due to the slowing economy.

On the supply side, throughput is up in China, Korea and India. The increase in China was largely due to independent “teapot” refineries being allowed to import crude oil. This has encouraged many refiners to increase run rates. In Korea, refiners are running at a higher rate to serve increased domestic product demand as well as to make up for lost capacity in Singapore due to upsets. India’s increase is at least partly explained by the startup of the Indian Oil Corporation’s new Paradip refinery.

European margins

In 2016, margins in Europe have consistently been at breakeven levels for visbreaking capacity.

This is in contrast to 2015 when utilization was higher and hydroskimming capacity was at breakeven for several months in the year. This shift in marginal configuration translates to about a USD2-3 per barrel (bbl) compression in margins for refiners.

In 2016 crude throughput in European refineries is down by around 300 thousand barrels per day (kbpd). This is in comparison with 2015 when utilization rose by close to 700kbpd. This still puts utilization above the very low levels of 2014, but accounts for the shift to a more complex marginal configuration and lower margins.

The primary driver of this shift appears to be imports. Imports of light product into Europe are up by more than 400kbpd, with the majority of the increase coming from the Middle East. This appears to be a redirection of Middle East exports that otherwise would have gone to Asia.

Exhibit 2: European margins have been consistently at visbreaking breakeven in early 2016

SOURCE: Platts, OilDesk

US Gulf coast margins

The US Gulf Coast refining system has maintained essentially full utilization in 2016. However, there has been a noticeable fall in margins.

Prices on the Gulf Coast are set by a netback from European prices and not by breakeven for marginal refining capacity. The US continued to export 500kbpd of diesel to Europe, so declining margins in Europe have backed into the Gulf Coast. At the same time, product differentials compressed as transport rates fell and the effective cost of moving barrels was lowered by the growing opportunity for gasoline backhauls to the US East Coast.

Also, crude markets in the Gulf Coast in 2016 have been tighter resulting in higher prices relative to Brent, adding to the squeeze in margins. Light sweet crude prices on the Gulf Coast were up around USD3/bbl in 2016 versus 2015 relative to Brent.

The combination of lower product premiums and higher crude costs have compressed cracking margins by around USD5.7/bbl compared to 2015, but still resulted in cracking margins of USD3/bbl for 2016.

Exhibit 3: US Gulf coast prices remain linked to Europe in 2016

SOURCE: Platts, OilDesk

Outlook for the remainder of 2016 and beyond

Barring an unexpected return to higher product demand growth rates, refiners should expect these lower margins to persist and potentially weaken further. Refining capacity growth has slowed but is still projected to exceed the growth in refined product demand, resulting in increasing oversupply of refining capacity.

For US refiners there is the potential for some upside from better crude pricing. A potential return to growing domestic crude production and an end to crude stock building could push Gulf Coast crude prices back to a discount to the international market, widening margins by USD1-2/bbl.

However, refiners should generally be planning for persistent margins at current lower conditions, with the likelihood of a further downside.


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This article is based on the market perspectives provided in PriceDeck Crude and Products Price Scenarios, published quarterly by Energy Insights.


About the authors

Tim Fitzgibbon is a senior industry expert with McKinsey’s Oil and Gas Practice in Houston.
Anantharaman Shankar is a specialist and Cherry Ding is a senior analyst, both with Energy Insights in McKinsey's Houston office.

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