Oil refiners squeezed by price spreads

Investor’s Digest of Canada, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

– Edited from an article by Peter Pham


As strange as it might now seem, big oil these days  could use a tiger, or two, in its tank.

That’s because integrated oil companies are struggling with  low refining margins as their net profits continue to plunge, notwithstanding healthy demand for petroleum.

The integrated oils are also posting disappointing downstream earnings, despite robust exploration and strong crude oil output.

Admittedly,  independent refiners such as Valero Energy Corp. (VLO-NYSE, $41.24) of San Antonio, Texas continue to benefit from the strong price spread of distillates over heavy crude.

And although Valero’s net income for its most recent quarter was almost 54 per cent lower year over year, it still came in at a healthy US$312 million, or $0.58 a share.

Margin eroded

But the spread over sweet crude, such as Brent oil, has eroded, as shown by the weak results of Dallas-based HollyFrontier Corp. (HFC-NYSE, $44.88),  another independent refiner.

For the three months ended Sept. 30, for example, Holly’s net income plunged 86.3 per cent to US$82.3 million, or $0.41 a share — far below analysts’ expectations.

Holly’s margins on inland refined products continued to be squeezed by a tightening of the price differential between Brent crude oil and West Texas Intermediate, says Mike Jennings, its president and CEO. Holly also took a hit from higher prices for crude itself.

But HollyFrontier and Valero haven’t been the only petroleum plays to suffer.

Chevron Corp. (CVX-NYSE, $120.09), one of the biggest oil and gas outfits in the world, also recently pumped up weaker-than-expected earnings.

Indeed, because of lower margins on sales of refined products, Chevron’s profit on its downstream operations tumbled 45 per cent to US$380 million for the three months ended Sept. 30. The company also took a hit from higher operating expenses.

Income slips 5.7 per cent

Not surprisingly, Chevron’s total earnings were down as well, sliding 5.7 per cent to US$5 billion. But total revenue was slightly higher, inching up to US$58.5 billion from $58 billion for the similar period in 2012.

Despite relatively low inventories of distillates in the U.S., crack levels for distillates have recently fallen, putting into doubt the ability of companies’ downstream operations to produce profits based on current margins.

In the U.S., the heating oil crack, a measure of distillate refining margins, has collapsed over the past three months, hitting levels not seen since early this year.

The gap is calculated by subtracting the value of heating oil from the main input fuel in the distillation process, which is crude oil. Moreover, because heating oil is usually quoted in dollars per gallon, it needs to be converted to generate a spread level in dollars per barrel.

Although a crack can be measured using either Brent crude or West Texas Intermediate,  Brent, for refining purposes, is considered a more precise global benchmark.

And even though October is  typically a seasonal high for the distillate cracks, the spread has fallen since hitting a peak in July.

The levels of distillate margins will now depend on colder-than- expected weather in the northern hemisphere, or an uptick in overall economic activity.

But there have been signs that an uptick may be coming. In the U.S., for example, data from the Institute for Supply Management turned out to be stronger than expected. And in China, the Purchasing Managers Index showed an improvement in that country’s manufacturing sector.

Still, without continued improvement, refining margins are likely to remain under pressure. Indeed, given the weakness of the 2013 hurricane season, as well as  strong production of crude oil, product margins are likely to remain weak, making it difficult for refiners to gain traction.

Investor’s Digest of Canada, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

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