COVID-19 and the oil price collapse: Impacts on refining and downstream businesses

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April 2020

John Corrigan - Partner, Strategy&, PwC US
Michaela Greenan - Principal, Energy Sector, PwC US

Refining has often offset oil price declines in the crude markets, with margins and volumes typically growing as crude prices have fallen. But this time is different.

Today, while crude oil prices are falling due to oversupply, there is also a rapid decline in demand — both domestically and internationally. This plummeting demand comes in the wake of the response to COVID-19, which has shuttered large parts of the economy, including a slowdown in all kinds of business and personal travel, especially commuting by car. Some analysts estimate that gasoline demand could be slashed by 50% during the months most impacted by the COVID-19 outbreak.

This depleted demand is already creating inventory problems in both the distribution network and at the refineries. This has led to dramatic drops in the crack spread (pricing difference between a barrel of crude oil and the petroleum products refined from it), with many markets experiencing negative crack spreads. The EIA Daily prices report for April 13, 2020, shows the WTI/USGC 3:2:1 crack spread at -0.084.

As spreads invert and inventories begin to top out across the fuels distribution and retail network, refinery shut-ins will be required, with output necessarily shunted to the export markets. One silver lining is the diesel market, which is experiencing relatively less-severe demand declines (closer to 20%). Businesses and supply chains in that sector remain open for essential services, as well as for industrial and retail businesses that are less exposed to the economic effects of the COVID-19 pandemic.

What now?

As downstream businesses look for ways to respond to these challenges, what should companies focus on now? In the short term, how can you reduce the negative effects of the current COVID-19 impacts and the oversupply of both crude and products? Depending on a company’s position across the value chain, downstream companies will need to address the following areas:

  • Take care of people and assets. Operations safety and continuity are a challenge under the COVID-19 rules. Developing and implementing COVID-19 protocols, schedules and contingency plans will be critical to protect employees and ensure asset integrity.

  • Support customers. You need customers today and will need them tomorrow. Communicate and collaborate with customers to weather the storm. This could mean delayed payment terms, pricing flexibility, and put- and call-options, among other things. As companies seek to shore up their supply chains and distribution channels, one option gaining popularity across industries involves establishing a forum to discuss issues and get support for accessing the CARES Act and other services to help navigate the crisis. 

  • Quickly assess and closely manage inventories and storage positions. Look for trouble spots throughout the controllable value chain. Where do you have — or want — inventory? How can you manage price exposure, and what is your strategy to manage levels as prices continue to move around?

  • Search globally for market outlets. Are there markets in less affected regions that can take cargoes of products in the short term (e.g., Latin America or Africa)?

  • Consider refinery shutdowns. While a last resort, companies will need to understand both the profitability and the market options for each plant. Then they will have to prioritize production to those refineries that can operate most profitably and have greater flexibility for moving volumes.

  • Despite the slowdown, prepare for a recovery. In situations that require shutdowns or shut-ins, consider using the extra time for turnaround and maintenance activities when the initial recovery begins and inventories slowly work down over time.
  • Revisit the capital projects portfolio. Which projects can you defer or cancel to preserve capital, and which projects should you accelerate or bundle if you have to shut-back or shut-in a refinery?

Taking the long view

Longer term, there will be additional challenges and opportunities for the downstream sector to emerge as better companies. As the virus outbreak subsides and the world’s economies begin to rebound, having a strategy and plan will be key for a company to emerge as unscathed as possible — ideally, stronger and more resilient.

Looking forward, companies should develop strategies and plans that consider the following:

  • Manage the resumption of demand. Inventories will be nearly full as we emerge from various stages of lockdown. Managing the pricing and drawdown of inventories will be critical for two reasons. First, lowering product inventories downstream of the refineries will allow those refineries that were shut-in or shut-back to resume production. Second, retailers and jobbers will likely be motivated to restore volumes and market share with low-priced products that may be below inventory costs.

  • Consider establishing a broader set of markets. Exploring new markets now may provide more flexibility in the case of future pandemics, adding a layer of resilience that’s currently lacking. Diversification of markets and channels can both reduce risk and improve the realization of value from assets.

  • Look for ways to optimize commercial opportunities. Leveraging assets to access arbitrage opportunities across the value chain can help offset declining volumes and lower crack spreads.

  • Enhance emergency protocols based on lessons learned during this event. What worked well? Where were the challenges or failures? To make sure those hard-earned lessons are not lost, rewrite an emergency protocol playbook of best practices. 

  • Continue to build customer relationships. Times of crisis often bring people together, and it’s no different between organizations and their customers. Build on the rapport created when collaborating with customers to solve problems and resolve issues during the crisis. Maintain that esprit de corps with customers after the crisis to develop deeper, tighter and more trusted relationships. 

These are just a few of the opportunities to enhance outcomes as we emerge from this crisis. As the world and the industry emerge from this double whammy of COVID-19 and the oil price collapse, now is a good time for companies to look at the downstream landscape and assess current strategies through the perspective of how the industry will emerge. 

Will the industry trends that existed before the crisis continue or accelerate? Will there be a round of industry consolidation that changes the competitive dynamics in different regions? Will opportunities present themselves during the crisis that could position companies for these scenarios? 

Indeed, this period of volatility raises numerous questions — some that the industry has never encountered. Finding answers now will offer clarity and confidence going forward.

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