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The demand for refined products is dropping globally due to COVID-19, leading to run cuts at refineries; shut-downs are inevitable as utilization rates at some units drop to 60%
Recent developments involving OPEC and COVID-19 have caused a
historic downturn in global oil prices and national economies. This
downturn is remarkable not only for its speed but also how it is
causing different parts of the energy industry to react
simultaneously, particularly the downstream sector.
Usually drops in oil prices are excellent news for downstream
companies since they benefit greatly from reduced input costs.
However, this current downturn is affecting both the commodity
supply and demand sides and therefore negating that expected
upside. Indeed, oil prices dropped owing to lingering oversupply
but more importantly because of severe drops in the demand for
products derived from that oil, such as gasoline, diesel and jet
fuel.
As a result, while historically low oil prices would usually
increase refinery activity, we are now seeing units become heavily
under-utilized (perhaps even shutting down completely), leading to
drops in costs for the equipment and labor needed to build
them.
The Downstream Capital Cost Index (DCCI) tracks refinery
construction costs around the world, and in response to the
historic downturn of the past few weeks we performed cost analyses
under three distinct scenarios. The "Rivalry" base case assumes,
among other conditions, that new, global COVID-19 cases will peak
by mid-second quarter 2020 and that Brent crude prices will
generally be in the $10-$30/bbl range for the rest of 2020, rising
to $30-$40/bbl in 2021 as demand growth returns.
Even though the presence of a base case inherently implies we
have modeled a lower scenario, the foundational assumptions are
still very bearish and indeed we project that the DCCI will fall 6%
and 1% in 2020 and 2021 respectively from its Q4 2019 value of 203
as a result of recent developments (figure 1).
Figure 1: DCCI values through the end of 2023
Turning now to the individual markets of the DCCI, we have
summarized their state below and full assessments are in the latest
report.
Construction labor: A prolonged period of low oil prices,
lasting two or more quarters, would lead to a greater chance of
decreased employment and wages in the downstream sector.
Equipment: Not all equipment sectors will be affected equally
since the oil and gas sector's share of the overall market varies.
However, lower demand will lead to deferment of several downstream
projects which will adversely affect suppliers, especially
specialized equipment manufacturers.
Steel: Buyers have been shifting to spot purchases as it is
preferable to buy just-in-time as opposed to stockpiling supply in
an environment where prices could be cheaper in the future.
Engineering and project management (EPM): Smaller lump-sum
contracts are expected in the short-term and more cost controls are
expected in all regions of the world.
Electrical and instrumentation: Even a short-term drop in oil
prices, lasting one quarter or less, would contribute to slowing
demand for building materials in the energy sector.
Civil and construction: The downstream civil and construction
material market is expected to experience a price decline
immediately following the oil price collapse in early March
2020.
Jeff Otten is a Principal Research Analyst working
within the Costs and Technology team at IHS Markit. Pritesh Patel is an Executive Director for Upstream Energy
at IHS Markit.
