Russian refineries runs likely to suffer on poor margins

Despite the end of the autumn turnarounds, which are drawing to a close in November, processing rates will likely remain depressed in December due to a combination of poor margins, low uptake of products due to persistent rail delays and the upcoming increase in excise taxes and various tariffs.

A more unfavorable way of calculating compensations under the damping mechanism, which covers refineries for the difference between higher export and lower domestic prices, will also add to the negative factors, sources said.

"According to oil majors, the margin is too low and is not covering costs; they don't want to generate losses," a market source said, adding that price levels inside Russia were too low.

The average profitability of the production of 92 RON gasoline in the Russian oil refining industry is near zero, and the production of the higher-octane 95 RON is loss-making, Petromarket, a prominent Russian consultancy reported in November, citing the gasoline export ban among the reasons for this situation. Only diesel production remains profitable, the analysts admitted.

According to S&P Global Commodity Insights analysis, Russia's refinery runs had already sunk to a two-year low of 5.14 million b/d in October as throughput was slashed from high levels in the summer. Commodity Insights forecasts last projected Russian crude runs to average around 5.4 million b/d through the fourth quarter of 2024, supported by plants returning from maintenance.

Russian refined product exports have showed signs of stalling activity in November, with the country exporting 1.2 million b/d of oil products in the month to date, down from around 1.3 million b/d in October, according to S&P Global Commodities at Sea data. Refined product shipments averaged 1.5 million b/d in Q4 2023, despite the imposition of both gasoline and diesel imports for several months.

Russia enforced a gasoline export ban in March, initially due to last for six months but extended until year-end. Attempts to lift the ban earlier than planned encountered protests among independent retailers, who complained that lifting the ban would push spot prices higher and affect already slim margins. Retail prices are closely monitored by the authorities and are not expected to rise above inflation.

According to other analysts, including Igor Yushkov, a senior analyst with the National Energy Security Fund and a specialist at the Russian government's Financial University, gasoline sales, rather than production, are likely to generate losses.

Rail delays continue to hinder deliveries, operations

Retailers have also complained about ongoing rail delays, which result in longer delivery times and force them to buy additional volumes to avoid shortages. Refineries, on the other hand, cannot load products in a timely manner and are faced with rising inventories, which force them to reduce production.

Rising taxes and tariffs will further exacerbate logistical issues. From December, railway tariffs are expected to rise by 13.8%. Pipeline tariffs for shipping crude oil and products will also increase in January, when much higher excise taxes will come into force after Russia upped them twice from the original levels.

If refineries cannot pass on those costs to the consumer, they will likely curtail output.

Export-oriented refineries have also faced difficulties. The Tuapse refinery on the Black Sea, which only exports feedstocks such as naphtha, middle distillates and fuel oil, has halted on several occasions this year for economic reasons, according to sources.

The Tuapse refinery was among the sites to have been repeatedly targeted by Ukrainian drone strikes earlier in the year, which left key units damaged and added financial strain. Attacks that reached their height around May/June were seen as a form of economic warfare, denting export revenue and adding to maintenance costs across some of Russia's largest refineries.

Attacks have more recently focused on fuel depots close to the Russia-Ukraine border, however, and analysts suggest that focus has shifted from critical refining units.

Analysts have said that Ukrainian-produced drones could still focus on fuel depots, but said broader refining attacks could be curbed amid stronger cooperation from Ukraine's allies. "Some fire attacks might continue, but not at the previous scale," said Sergey Vakulenko, an industry analyst and former Gazprom Neft head of strategy.

High interest rates to hurt upgrades

Another factor affecting, if not refinery production, at least modernization plans, has been the high interest rate, which was set at 21% in September by the Central Bank after several consecutive hikes.

The currently export-oriented small Ilsky refinery near the Black Sea, which plans to launch a gasoline complex next year and start supplying the domestic market, asked earlier this month for state support for its modernization, partly due to the high interest rates.

The high key interest rate makes construction projects on borrowed funds at Russian refineries unprofitable, Tamara Kandelaki, chairman of the Committee on Economics at the Oil Refiners and Petrochemical Association, said.

The government is reportedly considering extending fiscal allowances for refinery modernization programs beyond 2026 to stimulate activity but has not yet formalized measures. Recently, local media reported that the finance ministry had proposed to defer refinery upgrades "to a later period".

More than 20 Russian refineries, including Ilsky, signed an agreement with the government in 2021-22 committing to build or upgrade 30 deep processing units, which would help increase gasoline output by 4 million mt/year and diesel by 25 million mt/year.

Smaller refineries, like Slavyansk, have postponed the initially set completion dates due to the impact of Western sanctions on technology. Following Russia's invasion of Ukraine, both the US and EU announced sanctions that target the development and upkeep of Russian refineries, as well as their massive upgrade projects. For the moment, larger refineries have not made any public announcements about their upgrade plans, but previously set timelines appear to be slipping.

"There is a sense in delaying modernization projects in the Russian refining industry now," Yushkov said.

According to Alexander Kotov, head of consulting at NEFT Research, a Moscow-based think tank, the upgrade projects "that are at an advanced stage of implementation will be completed, but instead of borrowed funds, the companies will have to invest their own capital." However new investments to increase the depth of processing are "no longer on the agenda," Kotov said.

Author: Elza Turner, Kelly Norways, Vladislav Vorotnikov

Edotor: Jonathan Fox

S&P Global, 21 nov 2024