Why Shell’s downstream weakness bodes ill for the global economy

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Markets generally obsess over the direction of crude oil’s price. Yet the value of the black stuff only really reveals itself in the refining process. Few of us can do much with a barrel of crude. But turn that into petrol or jet fuel and then we are really going places. Transport accounts for well over half of the consumption of oil. Refining helps produce industrial chemicals as well.

As such, the relative spread between refined product prices and the value of crude oil inputs (refining margin) can indicate the health of global economic activity. The latest data point this week wasn’t exactly inspiring.

Shell’s trading update on Monday didn’t contain a vast amount to surprise energy market wonks, ahead of its full-year earnings in about three weeks’ time. Demand has been sluggish for oil.

But the insights into its downstream divisions were more noteworthy: in its chemicals and (refined) products division, it expects another quarter in the red following a loss in the third quarter of $329mn. The oil group anticipates a refining margin of $10 a barrel, a tenth lower than the consensus of analysts on Visible Alpha.

Part of the problem involves its chemicals unit. Shell thinks that its chemicals margin, a measure of profitability, will go up in the final quarter from the last period. The expectation of more losses, however, suggests demand must remain subdued. Taken altogether, the outlook for Shell’s downstream units hints that demand for refined products overall is weaker than expected.

Shell has also made noises about selling its Singapore refinery and chemical plants. The oil major now anticipates a writedown on these of up to $2bn.

Sluggishness in refining at Shell chimes with what other oil producers are seeing. During October and November the amount of oil processed by refineries had slipped towards four-year seasonal lows, according to data from Rystad Energy. Even though airlines talked up the pick-up in passenger travel last year, in the last couple of months of 2023 jet fuel demand tailed off significantly.

Weakening market demand could this year coincide with a glut of new downstream capacity coming online. Eighteen new refineries (or expansions) are scheduled to start up in 2024, including Nigeria’s very large 650,000 barrels-a-day Dangote refinery, points out Jefferies.

That pace of expansion won’t continue: even oil majors have limited appetite for new multi-decade assets given the uncertainties over fossil fuel demand. But refining businesses, which benefit from cheaper feedstock, usually act as a counterbalance to upstream production when the oil price dips. Weakness there bodes ill for the integrated oil companies — and for the global economy.

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