A rally in fuel prices that has mirrored the strong performance of crude since the start of the year is set to push U.S. refiners' profits high this year as demand continues to outpace supply. The first data is already in: Valero reported a twofold increase in its refining margin for the first quarter, which helped it book income that beat analyst expectations. The strong performance of one of the largest U.S. refiners was supported by tightening refining capacity, Reuters reported, on top of the already tight global supply of fuels.
Strong performance reports are likely to continue, and not only for the first quarter, Reuters noted in a report on the U.S. refining industry. One reason for this was the oil price rally that began last year as global demand rebounded from pandemic lockdowns faster than most expected.
Yet another big reason for the benefits that are still being reaped by U.S. refiners specifically was the gas crunch in Europe. With soaring prices for the commodity, which is used in refining processes, many European refiners had to cut their run rates, which meant a decline in the supply of products made with the participation of natural gas, notably distillates.
U.S. refiners, on the other hand, had no such constraints thanks to ample domestic gas supply and enjoyed greater revenues from distillate production. In fact, distillate fundamentals have been so much in their favor that, Reuters reported earlier this month, refiners were planning to ramp up jet fuel and diesel fuel production this summer at the expense of gasoline.
This may aggravate pain at the pump for drivers, but it will be in keeping with what businesses normally do when a product is in short supply and its price is higher: produce more of it.
"Geopolitical dynamics should support U.S. refiners on wide natural gas spreads, though some impacts may be less visible with first-quarter earnings than in future quarters," a refining analyst with Cowen told Reuters.
It is worth noting that the prices of natural gas in the United States are also on the rise because of the strong increase in exports of liquefied natural gas. However, even with a more than twofold increase in the benchmark price since November last year, natural gas remains a lot more affordable for U.S. refiners than it is for their European counterparts.
The divide may yet deepen further after news broke this week that Gazprom has started suspending natural gas shipments to Europe, with Poland and Bulgaria the first to feel the pain. The news is bound to push up natural gas prices even further, affecting refiners' production. At the same time, it may boost the share of U.S. fuel marketers in Europe further as well.
The U.S. is already exporting a lot more diesel to Europe than it used to, thanks to the industry tremors amid the war in Ukraine. With European refiners likely to remain under strong pressure from gas prices, these may increase substantially, especially in light of U.S. refiners' plans to boost diesel and jet fuel output this summer.
"The U.S. is now acting as the barrel of last resort for an Atlantic Basin that scrambles to find alternatives to shunned Russian crude oil and petroleum products," Citi analysts said last week in a note. Meanwhile, the Energy Information Administration reported that exports of distillate fuels over the last two weeks had reached the highest since the middle of 2019, at more than 1.6 million bpd.
What this means for Europe is that it is deepening its energy dependence on the United States, turning to its biggest ally for both gas, in the form of LNG, and oil, crude, and in the form of fuels. What it means for the U.S. is a huge new market for refiners' output at a time when prices for local consumers are already elevated because of crude oil's fundamentals.
Eventually, these high prices may begin to cut into refiners' margins, especially as they combine with regular spring maintenance, Reuters noted in its report on the refining industry. High crude oil prices mean high refinery feedstock costs, and at some point, these may offset the cheaper natural gas used in the production of distillates.
"Actual price outcomes will depend on the degree to which existing sanctions imposed on Russia, any potential future sanctions, and independent corporate actions affect Russia's oil production or the sale of Russia's oil in the global market," the EIA wrote in its latest Short-Term Energy Outlook on the topic.
In the same report, however, the EIA said it expected Brent crude to average $108 per barrel in the second quarter of the year, falling to $102 per barrel during the second half of the year. Yet, with the EU considering an embargo on Russian oil and Russian oil production falling more sharply than expected, prices may turn out to exceed this projection, dragging with the fuel prices as well.