As Korea's four refiners released record first-quarter results this year, S-Oil posted the highest operating margin. That was thanks to S-Oil's accounting method, which amplifies profit in periods of rising oil prices. However, in a downturn, its profit can shrink more than rivals'.
According to the refining industry on the 14th, the combined first-quarter operating profit of Korea's four refiners was 5.9635 trillion won, a 7,254% surge from 811 billion won in the first quarter of last year.
This was the result of an inventory effect as petroleum product prices soared amid the Middle East crisis. Using crude bought when prices were low to make petroleum products such as jet fuel and gasoline, then selling them at higher prices, increases profit. Because there is a time gap between crude purchases and product sales, it is also called the "lagging effect (Lagging effect)."
In particular, S-Oil posted first-quarter revenue of 8.9427 trillion won and operating profit of 1.2311 trillion won, achieving an operating margin of 13.8%. S-Oil's first-quarter operating margin is higher than other refiners such as GS Caltex (12.6%), HD Hyundai Oilbank (12.1%), and SK Energy (10.7%).
The refining industry cites S-Oil's use of first in, first out (FIFO) to calculate the cost of inventories as the main reason for its highest operating margin. The concept is that inputs are made in the order the materials and supplies were purchased. In a period of rising oil prices, it is calculated that crude bought cheaply is first put into production, so materials and supplies costs are set relatively low.
When International Financial Reporting Standards (IFRS) were adopted in 2011, corporations had to choose an inventory valuation method between FIFO and the weighted-average method. S-Oil adopted FIFO, following its major shareholder Aramco.
By contrast, other refiners use the weighted-average method. It determines materials and supplies costs by averaging recent crude purchase prices. When oil prices rise, materials and supplies costs come out higher than under FIFO.
For example, assume international oil prices were $50 per barrel two months ago, $100 a month ago, and $150 this month, and a refiner buys 100 barrels each month. The refiners are refining and producing using 200 barrels of crude purchased from two months ago to the recent month.
In this case, the materials and supplies cost for a refiner using FIFO is $15,000 ($50×100 barrels + $100×100 barrels). By contrast, for a refiner using the weighted-average method, the materials and supplies cost is $20,000 (($50×100 barrels + $100×100 barrels + $150×100 barrels)×(200 barrels/300 barrels)).
Conversely, in a period of falling oil prices, S-Oil, which uses FIFO, can see a larger profit decline. In the first quarter of 2022, when international oil prices swung sharply, S-Oil's operating margin was 14.2%, but it posted an operating loss in the fourth quarter, with a change of minus (-) 15.7 percentage points (p). Over the same period, the changes were larger than at SK Innovation (-13.7 p), GS Caltex (-9.9 p), and HD Hyundai Oilbank (-9.6 p).
Accountant Park Dong-heum said, "When you use FIFO, results tend to swing more during periods of oil price volatility."