Covid created excess refining capacity, weakened cracks… 

Oil demand was up-ended this year as Covid ravaged the globe, causing some of the highest value refined products like gasoline and jet fuel to trade below crude oil prices. Refiners responded quickly to negative cracks and refining margins, cutting runs by roughly 12mn b/d YoY during 2Q20. Even after refiners took such drastic measures, refined product inventories ballooned and now loom over the recovery in the petroleum complex. Refinery margins remain near zero across most regions even as refinery utilization rates remain ~10% below year ago levels. 

 

…yet new refinery starts are set to surge during 2021-23…

As the market ponders how to work though the existing refining capacity overhang, new greenfield refineries are starting up around the globe. From 2021-23, refining capacity is set to rise more than 6mn b/d unless new refinery closures are announced. Most of this capacity growth comes from the Middle East and Asia. Collapsing light-heavy spreads and strong fuel oil and naphtha cracks have leveled the playing field for simple and complex refiners and open up the possibility of closing capacity that was previously advantaged. The current situation, where all refineries are hurting, may draw out the capacity rationalization process.

 

…and demand may take 2-3 years just to reach 2019 levels

When the dust settles, 2020 oil demand will have fallen on average nearly 10mn b/d YoY, led by the transport fuels (see Oil demand: down but not yet out). In 2021, we forecast a rather quick rebound in road fuel demand and see a longer recovery for jet fuel. For gasoline, we forecast demand to fall 3mn b/d YoY in 2020 and rebound nearly 5mn b/d in 2021 as people opt to drive over flying or taking public transit. Diesel demand held up relatively well in 2020, but jet fuel will delay the full recovery for middle distillates until 2023. In aggregate, oil demand could take 2-3 years to reach pre-Covid levels, but this will be heavily dependent on when a vaccine is readily available.

 

Margins face a long recovery path, but gasoline has upside

In Covid's aftermath, we expect diverging trends for refined product cracks. Remarkably strong driving activity next summer should push gasoline cracks above the forward curve. 2021 diesel and gasoil cracks sold off more than $12/bbl since the start of the year and we think they will remain near current depressed levels as the market continues to blend excess jet fuel volumes into the diesel pool. Finally, we expect low sulfur fuel oil cracks (1%) to weaken throughout 2021 as refinery runs continue to recover. However, increasingly complex refinery capacity should limit the growth in fuel oil supply, and so we take a more optimistic view on LSFO cracks versus the forward curve.