Bleak Outlook for Independent U.S. Oil Refiners

Our outlook for independent refiners in the U.S. remains bearish. After experiencing a very favorable macro environment over the last few years, the independent refining companies have been under pressure since the start of the second half of 2007 due to continued margin contraction, resulting from unusually high feedstock costs (peak-cycle oil prices) and relatively modest product demand.

The subsequent bottoming-out of oil prices has been beneficial to feedstock costs, and as a result refining margins started the year in robust condition, thereby bringing a much-needed reprieve to the refiners. However, this recovery is unlikely to be sustained for much longer as the ongoing long-term fundamental changes to the industry suggest future struggles.

The major factors that could have a sobering influence on refining profitability include weakening demand for petroleum products in major markets, commissioning of new refineries and conversion projects, and a decline in the price differentials (also known as spreads) between the ‘light sweet’ and ‘heavy sour’ variety of crude oils.

At the forefront of this weak outlook is the shifting balance in global supply and demand, with capacity additions outpacing incremental demand. The global refinery sector has been in the midst of several projects, especially in West Asia, China and India. Led by Reliance's 580,000 Bbl/d Jamnagar facility in India, over a million barrels of new refining capacity is expected to come on line in 2009.

At the same time, global demand for almost all fuel products (except gasoline) remains in a downtrend, precipitated by the economic slowdown. Current distillates and jet fuel demand remains significantly below year-earlier levels, while U.S. demand for motor fuels have been crushed by the recession.

With the likelihood of economic recovery in 2009 being remote, refiners will have to continue to adjust production to meet lower demand levels. As such, processing rates at refineries around the world is expected to remain below average, at least in the second and third quarters of 2009.

Refiners who have the capacity to process the cheaper heavy/sour grades of crude oil to make refined products would further boost their margin capture rates. Bloated stockpiles of light/sweet crude oil (current crude oil inventories in the U.S. are at multi-year highs), coupled with growing demand for heavy/sour grades as a result of new and expanding complex refining capacity has significantly narrowed these spreads.

We currently have a Sell rating on both our refinery stocks, Tesoro Corporation (TSO) and Valero Energy Corporation (VLO).

Comments

[A Barrel Full:]

My question would be is this not all priced in?

Everyone knows that refining is a tough business at the moment. However there are a number of issues that will impact the relative performance of the players.

Scale, complexity and closeness to customers are key in this business. If inefficient players are forced out of business, a great likelihood with the current market conditions, tightening specs and future carbon costs, then the remainder will enjoy better conditions a few years down the line.

Jun 26 08:46 AM

[Ferdinand E...:]

I published a book on oil a couple of centuries ago, and refiners were in trouble then. Since then every time I check, refiners are singing the blues. That they are in trouble now is easy to understand, because with the demand for oil products down due to the macroeconomic downturn, the independents have no choice but to see a slice of their business go to the refineries owned by the large oil companies - who among other things have a competitive advantage in the financing of new technology.

And that's just the beginning, because more of the refining ( and petrochemicals) industry will end up in the Middle East.

Jun 26 08:51 AM

[Shaggieman:]

Ferd... Better to refine it locally since the blends are so different depending on where your at. That's besides the dangers of transporting gasoline. Caboom!

Jun 26 01:00 PM

[blackjack:]

Likely demise of poorly located/inefficient refiners, existing viable ones cutting back resulting in shortages and eco-uptick in 2010 mean stardom for those buying cash-in-bank, already retrofitted rfnrs today selling at $4-5PEs...A Tidal certainty: the lowest ebb marks the start of flush flow.....get in now!...vlo and tso best buys..

Jun 27 12:22 PM

[blackjack:]

...right on!..


On Jun 26 08:46 AM A Barrel Full wrote:

> My question would be is this not all priced in?
>
> Everyone knows that refining is a tough business at the moment. However
> there are a number of issues that will impact the relative performance
> of the players.
>
> Scale, complexity and closeness to customers are key in this business.
> If inefficient players are forced out of business, a great likelihood
> with the current market conditions, tightening specs and future carbon
> costs, then the remainder will enjoy better conditions a few years
> down the line.

Jun 27 12:23 PM

[Henry Buttal:]

My assumption is that the independents will be squeezed, especially with the carbon costs coming into play because
a) they don't have extensively diversified lines of business like the majors
b) the forthcoming swings in price will exacerbate their situation
c) they have insufficiently greased the palms of the current administration

Jun 27 11:41 PM

[JeffDB:]

According to the Bloomberg article below, the Waxman-Markey climate bill will hurt the U.S. refineries by imposing 10cents more per gallon in taxes on them than on the foreign refineries.

Big Oil’s Answer to Carbon Law May Be Fuel Imports
www.bloomberg.com/apps...

June 26 (Bloomberg) -- America’s biggest oil companies will probably cope with U.S. carbon legislation by closing fuel plants, cutting capital spending and increasing imports.

...refiners would have to buy allowances for carbon dioxide spewed from their plants and from vehicles when motorists burn their fuel. Imports would need permits only for the latter, which ConocoPhillips Chief Executive Officer Jim Mulva said would create a competitive imbalance.

“It will lead to the opportunity for foreign sources to bring in transportation fuels at a lower cost, which will have an adverse impact to our industry, potential shutdown of refineries and investment and, ultimately, employment,” Mulva said...

The same amount of gasoline that would have $1 in carbon costs imposed if it were domestic would have 10 cents less added if it were imported, according to energy consulting firm Wood Mackenzie in Houston.

The equivalent of one in six U.S. refineries probably would close by 2020 as the cost of carbon allowances erases profits, according to the American Petroleum Institute...

Jun 28 01:00 AM