Gasoline Oversupply Is A Short-Term Issue For Refiners

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Includes: BP, PSX, UGA
by: Orthodox Investor

Summary

Gasoline stocks are rising.

Fears about cuts in production from refiners are pushing the oil prices down.

Gasoline futures are also showing signs of weakness.

Crude oil prices have been falling in the recent weeks. This is usually good news for the refiners because cheaper oil results in wider margins for these companies. However, this time the things are getting tricky. The most recent slump in oil prices is coming from the fears that the refiners might start to decrease their production as the gasoline inventories are going up. There are fears that the refined products market will face the issue of oversupply. The situation regarding the oversupply in the crude market and aggressive measures from OPEC has not changed. In fact, the global demand for oil and supply dynamics are showing that the equilibrium will be reached during 2017.

A closer look at the supply and inventory levels of refined products also shows that the situation is not as grave as depicted by the fall in price. The gasoline prices are certainly falling and the inventories are again rising slowly, but the inventory levels have not reached or crossed the historical levels. In fact, the current inventory levels are lower than the February 2016 levels. The diagram shows the historical levels of gasoline. The diagram was taken from EIA website.

Click to enlarge

Weekly stock of gasoline on 22 July 2016 was 241,452 barrels. An interactive chart and the historical levels can be seen here. In February this year, these stocks crossed 256,000 barrels. This was the highest they have ever been in the last 25 years. Before this, the highest levels were in 1991 when the stocks crossed 251,000 barrels mark. We saw crude oil prices go below $30 in February when these stocks were at their highest levels. However, this was not the only reason for the fall in price, a number of other factors were also present. There were still fears about the supply glut and weak demand.

The trend in the crude price since February shows that there is some correlation between the gasoline stocks and the oil prices. As these stocks started to fall after reaching their record levels, the oil prices started to rise. Again, this was not the only factor. Hope of increased demand in summer and some supply outages contributed towards the strong rally we saw in oil prices. Nevertheless, there are strong indications that the traders have been keeping a keen eye on this trend. It can be seen from the diagram that the inventory levels are again going up, which has triggered another fall in oil prices.

This makes things tricky for the refiners. Usually, a fall in oil price means that the consumers will demand more refined products. However, the gasoline futures are also showing signs of weakness due to the fears of oversupply. This means that the refiners now have to seriously consider reducing the production in order to maintain their margins. Oil majors are also feeling the pressure as their refining segments are now starting to come back to normal and the refining margins are becoming narrower. BP plc (NYSE:BP) announced that its refining margin reached to the lowest level in the last six years in its most recent quarter. Declining demand, rising inventories and the recovering crude price might have played a part.

While these factors are a cause of concern for the refiners, I do not think this is a big threat in the long term. The profitability might take a small hit in the short term, but the long term prospects of refiners are bright. These businesses have a history of taking appropriate measures to tackle short term issues like these. The inventory levels are still well below the recent highs and there is no need to panic.

Things are slowly coming back to normal. Refiners do not enjoy high refining margins - cyclicality in the oil prices allows them to take advantage of cheaper feedstock prices. However, as the cycle starts its upward trend, the refining margins come back to normal and the refiners continue to make money. I see things coming back to normality over the next few months. My favorite pick in the refining sector is Phillips66 (NYSE:PSX). The company has a diversified business model and the midstream assets protect is against the volatility in oil prices, to some extent.

Another key characteristic of this stock is that it is still trading at relatively lower multiples (P/E of just above 11) and an attractive dividend yield. These characteristics make it a value stock which should be held for the long term (Please read my detailed article about PSX here). As the supply glut ends, the prices of gasoline to the end user will also increase which will result in higher margins for refiners. So, there is nothing too critical for refiners and this issue is short term in nature.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.