Surprising Strength in Refining Benefits Big Oil

Includes: COP, CVX, MRO, RDS.A, TOT, XOM
by: Kurt Wulff

An exciting reversal in the profit outlook for oil refining benefits buy-recommended major oil companies Royal Dutch Shell (NYSE:RDS.A), ExxonMobil (NYSE:XOM), Total (NYSE:TOT), ConocoPhillips (NYSE:COP) and Chevron (NYSE:CVX). Futures prices for the New York Harbor 3-2-1 crack spread, the most widely quoted proxy for refining profits, point to an average margin 60% higher for 2011 compared to 2008-2009. Futures have adjusted sharply in just the past few weeks perhaps in response to surprises in economic activity and winter weather.

Since downstream profits track the crack, we will likely be raising our cash flow estimates within the week. Investor enthusiasm for downstream can be volatile to the upside as it was in 2007. Considering the peak stock market action for Marathon (NYSE:MRO) four years ago, it looks like management of the buy-recommended medium-sized producer/refiner may have timed the forthcoming spinoff brilliantly. Investors may have stock in the new Marathon Petroleum Company at mid-year during the heart of a promising gasoline season.

Meanwhile, crude oil price continues its upward trend while natural gas shows signs of a turn. Futures price for the next six years currently at $94 a barrel is above the 40-week average of $88 Six-year natural gas at $5.33 a million btu remains below the 40-week average of $5.56. Yet, we are encouraged that one-year natural gas futures at $4.78 are above the 40-week average at $4.66, signalling an uptrend by that measure.

Large cap oil and gas stocks are concentrated by value 64% on crude oil, 22% on natural gas and 14% on downstream. The largest global refiners, XOM and RDS, have 18% and 21% of NPV in downstream, respectively. Yet, advances and declines in refining profits have an impact on overall earnings out of proportion to their contribution to value. Should earnings from refining be surprising on the upside, stock price may surprise, too.

Originally published on January 25, 2011.