Oil Market Report April, 2016

This month Portland was lucky enough to speak at Canada’s annual Fuel Marketers’ conference in Montreal (www.cipma.org) and the topic was (you’ve guessed it) oil prices! Unsurprisingly, the global nature of oil means that Canada’s downstream industry (“downstream” being anything to do with refined oil, whilst “upstream” is all things crude oil related) is being buffeted by the same trends of over-supply, cooling global demand and tension in the Middle East, as anywhere else in the World. In fact it was difficult not to be struck by just how many similarities there are between the Canadian Fuel Market and its British counter-part.

In pricing terms the Canadian downstream sector – like Britain – is an import market. That is to say that even though it has its own crude oil, supplying an extensive local market, the price of the fuel is still based on an external price index – in this case New York Harbour (NYH). This means that the starting point for all Canadian fuel is the published NYH price for gasoline, diesel etc, just as the UK is priced off the Rotterdam market. The Canada-UK parallel continues in the methodology used to calculate “landed” costs. In the same way that the cost of fuel in England is based on the Rotterdam price plus the (often notional) cost of shipping, the Toronto Rack Price is made up of the NYH price plus the cost of pipe or rail freight to bring the product into Canada. Likewise, fuel prices in Canada’s Maritime Provinces are based on NYH plus coastal shipping costs, which is very similar to Scotland, where prices in Grangemouth, Aberdeen and Inverness are based on Rotterdam plus the cost of the small coastal ships that supply those ports. Clearly such a pricing methodology completely ignores the salient fact that both the Eastern Canadian Seaboard and Scotland have their own refineries. But no matter, because in the downstream world, alternative economics rule OK and refineries will never sell below the regional index price (ie, NYH and Rotterdam) plus the cost of freight.

The structure and current outlook of the respective Canadian and UK oil industries is another area where valid comparisons can be made. The woes of the exploration sector in each country are well known and job losses plus project cancellations continue to be the order of the day. But cheap indigenous crude is boosting domestic refineries and in both geographies, refining is enjoying a rare and notable renaissance. What a different picture this is to the last 10 years or so, where creaking assets across Canada seemed to be in terminal decline due to expensive crude feedstocks, unsustainable margins and competition from more sophisticated refineries in the USA. This situation was a virtual replica of the UK (and Europe), where rudimentary refineries built in the 1950’s continually lost market share to more complex refining assets in the Middle and Far East.

Fast forward to the present day and what remains of the refining industries in Canada and the UK seem to be in relatively rude health. Between 2000 and 2015, significant surplus capacity was stripped out of the industry through a string of refinery closures (Oakville, Montreal, Dartmouth in Canada and Thames, Tees, Milford Haven in Britain) and those left standing are now enjoying greatly reduced feedstock costs (as a result of rock bottom crude prices). Moreover, the remaining refineries are also enjoying the time lag factor between falling crude prices and falling product prices. In short, whilst crude and refined products have both fallen greatly in value, crude has fallen a lot more (than products) and this has allowed refineries to “hang on” to margin for longer. The result; 2015 refinery margins in Canada increased by 28% and in the UK, by 24%.

This good news continues to filter down through the downstream supply-chain, where marketing margins (made up of commercial and retail sales) are up by about 12% in both countries. And it is independent companies in both geographies that are benefitting most from this particular upward trend – rather than the major oil companies. Unlike refining where a handful of oil majors doggedly held on through the lean years, the touchy-feely side of the business (ie, things that involve customers) was jettisoned by “Big Oil” long ago. In fact just prior to this month’s conference, Esso had announced that it was to fully remove itself from owning petrol stations in Canada, meaning it would now have no assets beyond the refinery gate. This is a trend that the British market knows all too well (not to mention mainland Europe and Australia) and is indicative of where the majors see value in the oil markets. Dealing with each other on a “super-power” basis is fine, but engaging with “normal” customers is no longer for them.

The trends that shape the oil business are no different in Canada than in the UK or any other country with a mature petroleum infrastructure. Current low oil prices have generated a complete re-evaluation of the “exploration only” model that has been so loved by the major oil companies over recent years. In turn, ageing refineries are now enjoying a new lease of life, although fears remain that the rays of sunshine will be as short-lived as a Newfoundland or British summer. And finally down at the coal-face, the independents – without major assets in either upstream or downstream – are fighting it out for market superiority in a sector previously dominated by much larger players. So after a long day at a conference and an even longer night at the bar – surrounded by a plethora of Canadian voices with that North American cum Scots cum Lancastrian accent (with a bit of French thrown in for good measure) – it would be easy to forget where you are in the world. But actually it doesn’t matter, because when it comes to oil, the language and the issues are all the same.