A rebound in margins in the third quarter will provide much-needed relief for European oil refiners, Fitch Ratings says. But the increase is unlikely to prove permanent due to continued overcapacity and intense competition from overseas refiners. Refining margins rose to their highest level since at least the start of 2013 in the third quarter because product prices fell more slowly than crude oil prices.

The effect was exacerbated by scheduled and unscheduled outages and some capacity reduction. The lower price of Urals compared to Brent crude resulted in better performance for central and eastern European refiners that have access to Russian oil. The margin improvement will mainly be reflected in the financial results of companies with higher exposure to the refining sector, such as Polski Koncern Naftowy and Turkiye Petrol Rafinerileri.

But stronger results from the downstream business of integrated oil and gas companies such as OMV, MOL and Repsol will mitigate pressure on upstream business results from a declining oil price. Margins remained strong in early October as oil prices continued to fall, perhaps indicating that overall performance in 2014 will be better than in 2013, as 4Q13 margins were particularly poor.

Nevertheless, the European refining sector's underlying problems remain and we therefore expect refining margins to fall again as oil prices stabilise and competition brings down the price of refined products. Further capacity reductions will probably be needed to restore the supply-demand balance. Competition from Middle Eastern, Russian and US refineries, which generally have access to cheaper feedstock and lower energy costs, remains strong. In the medium term US refiners' competitive advantage could be reduced if the spread between Brent and WTI shrinks further.

The spread fell to less than USD3/bbl in late September from over USD8/bbl through most of 2014. A lifting of the US oil exports ban or higher exports of Canadian crude could act as a catalyst for lower exports of US refined products to Europe, which would help European refiners' margins, but we do not expect a reversal of the US ban any time soon.
Source: Fitch Ratings