Oil refineries struggle with low net profits

[Courtesy of each company]

The South Korean oil refining industry’s strong operating profits contrast sharply with its reduced net earnings as the crude oil inventory book value surges.

According to regulatory filings on Thursday, the combined net profit of major players—SK innovation Co., GS Caltex Corp., S-Oil Corp., and HD Hyundai Oilbank Co.—totaled 399.4 billion won ($292.2 million), a mere 22 percent of the robust 1.8 trillion won operating profit.

SK innovation reported an operating profit of 624.7 billion won, but incurred a net loss of 92.7 billion won, in the first quarter of 2024. Similarly, GS Caltex, S-Oil, and HD Hyundai Oilbank recorded operating profits of 416.6 billion won, 454.1 billion won, and 305.2 billion won respectively, with net profits of 220.2 billion won, 166.2 billion won, and 105.7 billion won respectively.

Even with the smallest difference between operating profit and net profit among the four major companies, GS Caltex’s net profit ratio was a mere 53 percent. The average net profit ratio for major South Korean corporations—Samsung Electronics Co., SK hynix Inc., Hyundai Motor Co., and LG Electronics Inc.—was notably higher at 88 percent.

The decline in net profit within the oil refining sector is primarily attributed to currency fluctuations, and the dollar’s strength in particular. The industry’s heavy reliance on imported crude oil exposes it to significant exchange rate risks.

If the won weakens against the dollar from the time of signing the crude oil import contract to the time of payment, the foreign exchange losses will increase accordingly. “With the won weakening by nearly 100 won recently compared to the end of last year, foreign exchange losses of about 150 billion won occurred in the first quarter of this year alone,” an industry insider said.

Corporate taxes are also impacted by inflated operating profits. When international oil prices rise, refinery-held crude oil‘s book value increases, triggering potential tax liabilities. For each $10 increase in oil prices, refineries face a notional profit of about 250 billion won, leading to additional tax burdens of around 625 billion won when calculated using the 21 percent corporate tax rate for taxable standards exceeding 200 billion won. However, such inventory valuation gains could translate into losses during periods of oil price downturns.

The refining margin, a key measure of profitability, is another indicator that is on a downward trajectory. The refining margin, calculated by subtracting the cost of production from the final price of petroleum products, fell to $6.2 in the first week of May 2024, down 59 percent from $15.1 in the first week of February. The break-even point for oil refiners is considered to be the $5 level.

“In the past, when the petroleum market was rapidly expanding, it was common for refining margins to rise along with oil prices due to hoarding. Now, the trend of oil prices and refining margins are out of sync, meaning the increase in operating profit due to high oil prices is an illusionary effect that only exists on the books,” a second industry insider said.

The oil market is expected to contract as electric vehicles and renewable energy become more widely used. According to the International Energy Agency’s (IEA) 2023 projection, oil demand from the road transport sector will peak in 2025, while the scale of the reduction in oil demand from EVs is expected to increase from 700,000 barrels per day in 2022 to more than 5 million barrels per day in 2030.

Against this backdrop, securing investment for new businesses to prepare for the decarbonization era is also an emerging but major challenge for refiners. S-Oil initiated the construction of its new Ulsan petrochemical plant under the Shaheen Project in 2023. With an expected investment of 9.26 trillion won and an investment of 1.5 trillion won from its parent company, Saudi Arabian state oil company Aramco, the plant is expected to be operational by 2026.