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 July 27, 2015
Oil Producers' Ugly Duckling Refineries Just Turned Into Swans

 Oil companies' least-loved business over the past five years is proving to be their lifeline.

Margins from refineries in northwest Europe rose fivefold last quarter to the highest since at least 2003, data from Total SA show. In the preceding quarter, the share of profit from processing crude and chemicals at Royal Dutch Shell Plc and BP Plc was four times higher than the same period a year earlier.

The turnaround follows last year's end to an oil boom that tripled the cost of crude for processing since 2009 and spurred a focus on drilling instead of refining. A decade-long doubling of refining capacity in China also swamped European efforts to rein in supply. Crude's slump in the past year has reversed the dynamic, curbing refining costs and raising demand for fuels.

"Refining has become a boon in these times from being a burden over the years," Iain Armstrong, an oil analyst at fund manager Brewin Dolphin Ltd., said July 22 in London. "The companies will look to make the most of this dramatic change while it lasts."

Shell and BP are scheduled to release second-quarter earnings at the end of the month. Results at their downstream businesses, which include trading as well as refining, are likely to show they also benefited from a market structure called contango, where future prices are higher than those for immediate delivery. That allows their traders to profit by storing cheap oil now to sell for more later.

Brent crude, the global benchmark, fell 1.2 percent to $54.62 a barrel on the London-based ICE Futures Europe exchange on Friday.

Trading Gains

Last quarter, BP made about $350 million more than normal from trading, Chief Financial Officer Brian Gilvary said on an earnings conference call on April 28. That figure represented 13 percent of adjusted profit for the period.

"In the first quarter there were a lot of trading numbers contributing," Richard Griffith, an oil analyst at brokerage Canaccord Genuity Ltd. in London, said by phone on July 21.

Earnings from trading and refining in the first quarter surprised analysts, with producers beating market estimates by an average of 51 percent, according to data compiled by Bloomberg. Even with help from those two areas, the 42 percent slide in the average price for Brent crude in the second quarter from the same period a year earlier is hurting companies.

Shell's adjusted net income will drop 44 percent to $3.4 billion, according to the average of nine analyst estimates compiled by Bloomberg. Exxon Mobil Corp.'s will fall 49 percent to $4.5 billion and BP's by half to $1.8 billion, estimates show. BP will announce results July 28, Total the next day and Shell on July 30. Exxon and Chevron Corp. follow on July 31.

Shareholder Returns

Shell's B shares, its most traded stock, have sunk 26 percent in London since oil prices began their descent in June last year. BP's stock is down 20 percent. Shell's total shareholder return -- the change in share prices plus dividends and buybacks -- is a negative 22 percent since the beginning of June 2014, while BP's is down 14 percent, compared with a 3.1 percent return for the FTSE 350 index.

"Refiners are benefiting from a double whammy of lower crude oil prices and strong demand"

Cuts in European refinery capacity to come may soften the blow for earnings at the integrated oil companies by supporting margins, or the profit from turning a barrel of crude into fuels.

European refiners will probably halt 700,000 barrels a day of capacity, on top of the 240,000 barrels they cut during the five-year surge in oil prices, according to Oswald Clint, an analyst at Sanford C. Bernstein Ltd. The combined figures represent about 4 percent of total European capacity as of the end of last year. Northwest European refining margins grew to $54.10 a metric ton last quarter from $10.90 a year earlier, according to data from Total, Europe's biggest fuel producer.

Refining Share

In the first quarter, processing crude and producing chemicals contributed 80 percent of Shell's adjusted net income, up from 22 percent a year earlier. For BP, it expanded to 73 percent of the total from 18 percent previously.

Shell sold its Geelong plant and gasoline stations in Australia in February last year after offloading its Stanlow plant in the U.K. to India's Essar Group in 2011. BP completed the sale of its Carson refinery in California and related assets to Tesoro Corp. in June 2013, following a deal to pass on its Texas City refinery concluded in February of that year.

The capacity cuts have helped the companies fight back after the Asian refining expansion squeezed the market for processors in Europe, where high costs combined with stagnant demand to crush refining revenue.

Lower crude prices since June 2014 and stronger growth in some economies helped push up European oil-product demand by 4.4 percent in the first three months of this year from a year earlier, the International Energy Agency said this month.

"Refiners are benefiting from a double whammy of lower crude oil prices and strong demand," Hamza Khan, head of commodity strategy in Amsterdam at ING Bank NV, said July 20. "As long as the oil price remains depressed and economies strengthen, refinery margins will exceed expectations."