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Are BP and Royal Dutch Shell Refinery Segments in Trouble?

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By Muhammad Ali Khawar on Feb 26, 2016

The oil and gas companies have been severely hit by a more than 70% crash in crude oil prices over the past one and a half year. Their only saving grace, however, is the high refinery margin. In 2015, the falling revenue of oil giants from the upstream segment — the likes of Exxon Mobil Corporation (NYSE:XOM), Shell, and BP — was offset by the high margins from the refinery segment.

Bidness Etc here discusses whether in 2016, the energy companies will continue to enjoy the oil refinery boom, or the glut in the downstream segment would weigh down the energy companies’ performance.

Impact of the Commodity Market Crash on Oil Refiners

The commodity market has remained depressed since June of 2014. The global crude oil prices have dropped from above $110 per barrel to below $40 per barrel. Currently, Brent trades at $39.54 per barrel, while West Texas Intermediate (WTI) trades at $33.69 per barrel.

As crude oil is the primary raw material for the production of refined products, the slump in crude oil market positively affected the downstream segment. Low oil prices reduced the cost of production for oil refiners, improving their margins in the process.

As crude oil prices dropped below $40 per barrel last year, the demand for gasoline products also went up. People bought more cars and the number of road trips escalated. According to Reuters, in 2015, the gasoline demand jumped to 1.8 million barrels per day (bpd) — a 2% increase annually.

The increased gasoline demand positively affected the several companies’ earnings. Last year, BP recorded an underlying pre-tax replacement cost profit of $7.55 billion in the downstream segment. In 2014, the energy corporation had net profit of $4.44 billion.

Meanwhile, Royal Dutch Shell plc.’s (ADR) (NYSE:RDS.A) downstream segment recorded net earnings of $9.75 billion in 2015, compared to net earnings of $6.27 billion in 2014. The improvement in the refinery segment profit helped the Hague-based oil company to compensate for the plunging profits from the upstream segment. The energy corporation earned profit of $1.8 billion from its exploration and production (E&P) activities in 2015, down from $16.51 billion in 2014.

Will the Refinery Segment Continue to Outshine in 2016?

Crude oil prices are not expected to recover any time soon. However, people do expect the refinery boom to come to a halt eventually. In its 4QFY15 earnings call, BP plc (ADR) (NYSE:BP) discussed his assumption that the “refining margins in the first quarter are expected to be lower than the fourth quarter.”

The IEA also expects the demand for refinery products to drop to 1.2 million bpd this year, as the Chinese economy fails to show any signs of recovery, and global car purchases are also projected to fall. The low demand may put an end to the benefits the oil refiners are currently enjoying from low cost of production.

The commodity market downturn has forced many energy corporations to expand their operations in the downstream segment so much so, that several of them have already set up refineries in Asia and Middle East, according to news sources. This expansion has not just increased the level of competition in the industry, but has also increased the total supply of refined products. In 2016, the production of gasoline and other refining products is expected to increase by 1.3 million bpd.

At present, if the supply of refined products exceeds demand, the energy companies export the surplus. However, if the global supply outweighs the demand, it will not only adversely affect prices, but will also pose significant financial risks for the energy companies.

Oil companies have greatly benefited from high refinery margins over the past few months. However, if low crude oil prices persist, in the absence of substantial growth in demand, oil companies including Exxon, BP and Shell may continue to suffer from a huge fall in their earnings.

Editing by Asad Rizvi; Graphics by Omair Raza


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