OREANDA-NEWS. The historically high European refining industry margins that cushioned the first-quarter results of BP and Total are likely to weaken later in the year, Fitch Ratings says. Healthy fuel demand in recent months exceeded market expectations and supported margins, but this was partly driven by temporary factors including opportunistic trading. Overcapacity and strong competition from refiners in oil producing countries may put pressure on European margins later this year.

European refining margins started to recover in July 2014 after Brent began its fall from USD112/bbl. In 1Q15 the north-west European refining margin averaged USD7.6/bbl, up from USD4.1/bbl in 1Q14 and from USD5.9/bbl in 4Q14.

The boost in margins resulted from a combination of factors. Prices for oil products, such as diesel and gasoline, went down more slowly than crude, which supported margins in 2H14. Higher demand for refined products in Europe in late 2014 and early 2015 and the lower cost of crude for refineries' own consumption also contributed. There were some temporary effects including a cold winter in the US that pushed up demand, unexpected refinery outages in the Americas, and opportunistic buying to capitalise on lower product prices that added momentum to margins.

Fundamental challenges such as overcapacity and strong competition remain and are likely to put pressure on European refining margins in 2H15. Oil inventories in the US in April 2015 reached an all-time high and Brent-WTI spreads continue to favour US refiners. This may lead to higher oil-product exports from the US to Europe later this year as the US refiners will aim to offload large inventories. We expect an increase in exports to Europe from the Middle East this year as new refineries ramp up production. Russian refiners may also increase their exports due to poor domestic prices caused by the weak rouble and changes in taxation.

Strong refining results partially offset lower upstream profits for BP and Total in the first quarter and this trend is likely to be repeated across the industry, with earnings of integrated players declining more slowly than those of pure upstream producers. However, other factors, such as the ability to reduce upstream lifting costs and to keep capex under control, will be more important for supporting the current ratings of integrated majors.