Supply Glut Ahead for Oil Refiners
March 02, 2009
Spring cleaning came early for oil refiners.
Faced with weak demand, refiners moved up seasonal maintenance, shutting units for work and reducing production of gasoline, diesel, and other fuels. The supply cutbacks, coupled with low crude oil prices, boosted refiners' returns from the units that remained in service, but this dynamic is nearing an end.
Refiners are bringing some shuttered units back to service, as maintenance wraps up. Gasoline output rose 2% in the latest week to 8.9 million barrels a day, the second-highest weekly gasoline output ever recorded in February. As refiners begin to gulp up oil, crude prices are likely to rise, while growing volume of gasoline and diesel being spit out may drive refined product prices down, further squeezing refiners' profits.
Independent refiners, which must buy crude oil and make profit from producing fuel, will be harder hit than integrated oil companies, who produce their own crude and refine it.
"The recovery in crude prices into a weak demand environment and higher refining utilization will negatively affect refining margins," Deutsche Bank oil analyst Paul Sankey said in a report. Sankey has a negative outlook on the refining industry.
Refiners weathered long periods of low margins and enjoyed occasional times of higher margins in the 1980s and 1990s. In periods of higher returns, independent refiners with significant cash reserves, exposure to niche markets, and the ability to run many types of crude will have the advantage.
After refiners shut units for maintenance work in late 2008 and early this year, crude oil inventories at the Cushing, Okla., hub swelled, lowering the price of benchmark West Texas Intermediate crude.
As a result, the discount fell for crudes that are normally cheaper than WTI. Refiners like Valero Energy Corp. (VLO), which normally run the cheapest grades of viscous, sludgy heavy, sour crude found that there was little incentive to run these products and instead favored lighter, sweeter grades of crude.
Without the discount, refiners like Sunoco Inc. (SUN), which lack the capability to process more challenging grades of oil, faced a more level playing field with competitors that can use cheaper crude.
However, WTI inventories have fallen in the latest week, and the benchmark crude price is returning. As a result, companies like Valero are bringing units used for processing heavy crude back to service.
And as the discount for normally-cheap crudes returns, companies like Valero, Frontier Oil Corp. (FTO) and Holly Corp. (HOC) will regain the advantage from processing this hard-to-manage type of oil.
"Smart engineers in those plants are looking at this stuff every day, and optimizing their crude slate as a function of the crude price and product prices," said Dave Hackett, a consultant with Stillwater and Associates in Irvine, Calif.
As individual plants begin to take advantage of these crudes, companies like Valero and Frontier are likely to pull ahead.
Refiners have increasingly stressed the importance of prudent cash management in the past six months, and most independent refiners have slashed spending. The largest U.S. refiner, Valero, cut its outlook for 2009 capital spending three times. Tesoro Corp. created a list of tiny incremental projects that it can complete with small amounts of cash.
By keeping larger cash reserves, these companies aim to stay afloat in a highly seasonal business and during a period of weak profits.
"You're not going to see anything like the profits you have seen when refiners were running full-out, and getting the full profit," said Mark Sadheigan, an oil analyst with Fitch Ratings in Chicago.
Houston-based Frontier announced this week that it has maintained a strong cash position, which analysts agree will help the small refiner maintain its units and perform at full rates to take advantage of profitable periods.
Refiners that have canceled or delayed projects have also reduced their potential execution risk, according to Chi Chow, an analyst with Denver-based Tristone Capital Co. Refiners like Holly Corp., which have maintained an aggressive schedule of projects, face more potential for delays, Chow said.
Still, Holly has maintained free cash and should be able to handle project cost increases or delays, said Ann Kohler, an analyst with New York-based investment bank Caris & Co. Kohler included Holly on a list of companies with strong balance sheets and the ability to run cheap crudes.
"If you're going to lose money for half the year, you're going to need to have a balance sheet that's going to sustain you through periods of lower earnings," said Kohler.
Source: Dow Jones Newswires
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