Exceptionally High US Refining Margins to Reverse Next Year
Fitch Ratings expects US refiners’ crack spreads to fall in 2023 from record setting levels, resulting in an approximate 40% decline in median sector EBITDA and median leverage increasing to slightly over 2.0x. Weaker than expected global economic growth next year and sharply higher inventories due to other oil product market factors are key downside risks to our EBITDA forecasts. We expect US refiners’ ratings to remain stable even with weaker-than-expected profitability absent large, debt-funded acquisitions or shareholder friendly activities that exceed companies’ financial policies.
Our ratings case projections assume US refining crack spreads fall by 30%-50% next year from unsustainably high current levels, driven by refiner output mix adjustments, increasing Chinese exports, global refining capacity additions and weaker global economic growth. US crack spreads drifted lower from spring 2022 through late summer, reversing course in September when spreads for middle distillates widened to 3.0x–4.0x the level of gasoline, based on US Gulf Coast (USGC) benchmarks.
We expect the global refining industry will likely shift near-term production towards middle distillates to capitalize on high crack spreads for diesel and jet fuel driven by inventory shortages at key international hubs. Crack spreads should gradually move closer to normalized levels next year as a result; however, a rapid increase in middle distillate inventories to historical averages is unlikely given the size of the current gap. Most US refineries are designed to maximize gasoline output. However, middle distillates comprise a material 30%–40% of production for many US refineries and this share can typically be adjusted up by several percentage points if necessary.
Recently enacted Chinese fuel export quotas should boost current, low global middle distillate inventories. China exported 48 million barrels of diesel equivalents in the LTM ended September 2022, down from 159 million barrels in 2019, largely driven by pandemic-related refining capacity utilization declines. Positively, middle distillate exports jumped in September 2022, and recent policy shifts easing COVID restrictions could further support a rebound.
Price-induced demand destruction and a global recession could also pressure crack spreads. Fitch cut its 2023 world GDP forecast by 1.0pp to 1.7% in September. We expect the eurozone and UK to enter recession later this year and a mild US recession in mid-2023. Key downside risks to our forecast include the European gas market remaining imbalanced and greater than expected stress on US and European labor markets from higher inflation and interest rates.
Not all risks point to lower crack spreads. For instance, a European ban on Russian oil product imports expected on Feb. 5, 2023 could boost global refining crack spreads if sanctions on sea charters, high freight rates or other logistical problems keep Russian supplies from finding alternative markets. Russian supply of oil products to Europe decreased by 0.5 million barrels per day (mmb/d) between February and August 2022, but still remains large – around 1 mmb/d. Although not our base case, faster Chinese economic growth, possibly due to easing COVID restrictions, could also boost demand for oil and oil products and keep exports below average.
Lower crack spreads could have an outsized impact on profitability given the high operating leverage within refiners’ business models. Fitch does not set uniform global refining margin assumptions. Rather, we incorporate the near-term margin expectations for a particular issuer and assume they converge to midcycle levels over the four to five-year projection horizon.
Fitch’s US refining company ratings incorporate a through-the-cycle approach and rating changes from current, Stable Outlooks are unlikely absent a more severe recession in 2023, sharply higher inventories or a material change in companies’ business profiles or financial policies, such as large-scale M&A or large share buybacks. Most issuers are building cash with excess profits, presumably to preserve liquidity ahead of a likely decline in cash flows towards normalized levels. However, M&A and share buybacks are the most common capital use within our coverage, after building cash.
Source: Fitch Ratings