A positive trading update from a big oil producer enjoying a commodities bull market should not elicit much surprise. The oil price rally has led Shell to increase some of its internal assumptions. That lifted the valuations of upstream, oil-producing assets. But it is considerably less optimistic about refining.
Commodity markets love a supply scare. Scarcity arguments back high prices. Demand, while never ignored, is deemed to have too many moving parts to forecast accurately. That explains why commodity traders, and some oil company executives, have stuck with the shortage thesis this year.
But very high oil prices must eventually hit demand. Consumers do not buy crude oil, but refined (downstream) products such as petrol and diesel. Prices of these have soared more than the crude they depend upon. The path of refining margins, a calculation of the spread between the prices of refined products and crude oil, reveal this.
Relative to the Brent price, one typical refining margin jumped as much as 18 times in the period between April 2020 and June this year. That magnitude of increase sets a record for this century. Only the surge in the three and a half years after January 2002, precipitated by China’s economic boom, can compare. Even that was less than half the percentage increase. In the US, still the world’s biggest oil consumer, signs of flagging petrol demand are apparent. Department of Energy data show that seasonal consumption this year has already slipped below the five year average.
Shell, like ExxonMobil, has upgraded its second-quarter profit outlook partly due to its refining margins. These should nearly triple over the first quarter. Yet Shell clearly does not believe that these will last for long. The Anglo-Dutch oil producer kept quiet about what the super-high margins mean for the valuation of its downstream assets. It still plans to reduce its refineries to six by 2025, down from 13 a year ago.
Meanwhile, its retail business, including the petrol it sells to consumers, was flat in the second quarter over the same period of 2021. That suggests that demand remains as depressed as it was early last year, notes Société Générale.
No wonder oil prices have been walloped. Expect more of these downward lurches as price inflation for all goods and services take its toll on global economies.
