Oil prices pared gains on Monday, despite the weekend announcement by OPEC and its allies, known as OPEC+, that historic production cuts of 9.6 million barrels per day across the group would continue through July as the coronavirus pandemic continues to weigh on demand.
The move spurred hopeful talk of a recovery for oil prices, which are down about 30% year-to-date after a 56% recovery for international benchmark Brent crude in the month of May. But data from refineries across several regions shows weak margins, or "crack spreads" — the difference between the price of crude that refiners buy versus the price that the market is paying for the refined products.
Higher crude costs without increased returns for the products refineries are selling suggests demand growth isn't in line with the growth in prices, and could force refineries to buy lower crude volumes, translating into lower crude prices.
"One word of caution is if we look at the rally we've seen in crude oil prices, it's been amazing, but the big uncertainty is if you look at refinery margins, they are very weak across the board across all regions," Warren Patterson, head of commodities strategy at ING. "And what that suggests is that maybe demand isn't recovering as quickly as many had anticipated, or at least it's not keeping up with the move higher that we've seen in crude oil prices."
The crack spread for refined products in the U.S. was at $9 last week, compared to $21 at the same time last year, Reuters reported, citing Refinitiv Eikon data. Margins for European diesel reached a record low of $2.90 per barrel last week.
"Very poor refining margins and the recent sharp decline in U.S. crude bases now comfort us in our sequentially bearish outlook," analysts at Goldman Sachs wrote this week. They see Brent pulling back to $35 per barrel in the coming weeks, compared to spot prices at $43.
And soon to pressure refineries further is Saudi Aramco's announcement over the weekend that it's raising official selling prices (OSPs) for all of its customers in July, and for some the highest increases in twenty years.
Saudi selling prices will spike next month by $5 to $7 per barrel just for Asian buyers, for instance — "again further hitting refining margins," Patterson said.
What refineries need is for the demand side to match up with the steady revival of crude prices, expected to gradually improve as economies reopen and lift their lockdowns meant to stem the spread of the coronavirus.
"Refiners are facing weak cracks (margins) at the moment and the current pick-up in crude prices will only make them worse," said Edward Bell, commodity analyst at Dubai-based bank Emirates NBD.
"If there isn't an improvement in refining margins, based on demand improving across the barrel then we would expect to see refiners pushing back on volumes and that feed back into lower crude prices."
Demand has been picking up in some key hubs but is still well short of pre-pandemic levels, with inventories across many markets still high.
China, for one, saw a massive rebound in crude imports in May with a record 11.3 million barrels per day, an increase of 13% from April.
But analysts question whether that's real consumption or just opportunistic buying from Chinese refiners taking advantage of cheaper crude. "My view is that it is the latter," said ING's Patterson. "They've taken advantage of the lower prices we've seen in the last couple of months in order to stock up on oil."
For Ehsan Khoman at Japanese bank MUFG, part of China's buying "does signal opportunistic purchasing to capitalize on cheaper crude costs" as China build up its strategic reserves.
But to see such a rebound coming from China — the first country where Covid-19 was first detected — "the sheer velocity of the snap back offers reasons for optimism surrounding demand recovery trends in developed economies and other emerging markets," Khoman said.
"The sharp revival of Chinese oil consumption is a welcome marker for the global economy in the second half of this year."
MUFG sees Brent crude picking up to $46 per barrel at the end of this year and $49.20 in the first quarter of 2021, joining several forecasters who see oil reaching $50 a barrel in the early months of next year.
Still, "it's still all about the demand recovery," Rystad's Head of Oil Markets Bjornar Tonhaugen wrote in a note Monday. "OPEC+ must be cautious not to become too greedy with respect to crude price increases and hurt refinery economics too quickly, since the recovery in products demand and prices at the end of the day will call the shots in this recovery."