In a recent note, CS Euro Refining analysts highlight Russia’s drive to modernise its refining system by tweaking taxation structures and the impact on refined product balances. We see a further cut in Export Duties from 42% to 30%, which can result in lower Russia refinery runs, notably for simpler refiners. This modernisation drive had additional disincentives built in for heavier fuels, leading to a 25% fall in Fuel Oil (FO) exports from Russia in CY16, and may result in a further 20% fall in CY17. Russia is the largest exporter of FO in the world; this lower supply in turn helps margins. We noted earlier that supply shortages were leading to stronger FO margins, which is beneficial for simpler Indian refiners. HPCL and IOCL output slates have ~10% FO and current strength in FO cracks adds $0.6/bbl to GRM (12/9% to annualised EPS). Further FO margin increase may be unlikely given: (1) demand is in structural decline, (2) ease of production caps margins. Nevertheless, FO strength in the near term can benefit HPCL/IOCL while the contracting diesel-FO spreads can hurt complex refiners.
Asia margins fall from peaks
CS 6-2-3-1 margins have seen a modest fall in the past two weeks, but still remain $2/bbl ahead of 9M CY16 averages, and we expect margin strength to sustain through the winter months. Fuel Oil margins in particular have outperformed expectations, and are trending up $8.0-8.5/bbl stronger than long-term averages. We had noted earlier that FO margin strength was due to supply-side issues at both Russia and Venezuela—the world’s top two exporters of the product. Further FO output cuts in Russia can lead to stronger FO margins in 2017 as well.
Simpler refiners to benefit: IOCL/HPCL
HPCL and IOCL output slates have 10% Fuel Oil and current strength in FO cracks adds $0.6/bbl to GRM (12/9% to annualised EPS). We view further FO margin increases as unlikely because: (1) demand is in structural decline—and moves toward implementing the IMO directives on sulphur content in FO (by 2020) can exacerbate the decline, and (2) ease of production caps product margins. Nevertheless, we see FO strength benefiting IOCL/HPCL earnings in the near term.