Refiners Enjoying Strong Margins... For Now
BMI View: US refiners are benefitting significantly from the North American tight oil boom. However, we expect improving margins will erode as market forces work to correct the current pricing imbalance between regional and global benchmark crude prices over the medium term.
The ongoing fall in North American crude prices is giving US refiners a much-needed boost to their margins. For example, Phillips 66, the largest US independent refiner, has recently reported a 14% quarter-on-quarter (q-o-q) increase in Q212 profits, with profits from refining rising by 53% over the same period. Valero, widely seen as the industry bellwether, has seen its share price rise by over 30% this year. Western Refining, Holly Frontier, Marathon Petroleum, and Sunoco have all seen their profits and share prices rise significantly as well, with Western Refining posting a 75% gain year-to-date. For some of the international oil companies (IOCs), including Chevron, profits in the refining segment were the only bright spots in an otherwise poor quarter across the board ( see BMI 's Downstream Helps Contain Upstream Predicament, August 1 2012 and Lower Prices Hit Upstream Earnings, July 30 2012).
|Beating The Crowd|
|Refiners' Performance Vs. S&P 500|
BMI has been highlighting the fundamentals which are driving this dynamic for some time, namely the US and Canadian boom in tight oil and oil sands production and the resulting supply glut. Spot prices for some North American crudes have been falling, primarily due to the massive rise in oil production without the necessary increase in infrastructure to bring it all to market. The price of the benchmark West Texas Intermediate (WTI), as well as oil coming from Canada and the Bakken shale plays, has fallen significantly. Other crudes, however, including those priced in Alaska, the Gulf of Mexico (GoM), and Louisiana, have registered much higher prices in line with other seaborne benchmarks such as Brent. These dynamics have created a divergence in prices that was previously unseen in the North American oil market. At the time of writing, the spread between the most expensive and the cheapest North American crudes was US$41.75.
|A Crude Spread|
|North American Spot Crude Prices|
A Rising Tide Lifts Most Boats
The lower prices are benefiting individual refiners, albeit unevenly. Indeed, those with access to the lower cost feedstock are running at record-high levels, capitalising on an opportunity to generate higher margins. According to the EIA, refiners in the Midwest and the Rocky Mountains paid US$11/bbl and US$15/bbl below the US average respectively, in the first half of 2012.
Midwest refiners are processing 8.6% more barrels of crude than the average number of barrels recorded between 2007 through 2011, and those in the Rocky Mountains have increased their crude processing by 4.7%. There has also been growth in Gulf Coast crude oil processing, despite slightly higher feedstock costs. This has been primarily as a result of investment into increased refining capacity, particularly heavier crudes from Canada, Venezuela and Saudi Arabia.
Conversely, East Coast refiners, which are not able to access these cheaper crudes due to geographic constraints, have been facing rising costs and falling margins for some time. Indeed, their costs are on average US$12/bbl above the US average, putting them at a relative disadvantage. These market dynamics have threatened to lead to the closure of some East Coast refineries, although it now appears that only one - Sunoco's Marcus Hook plant - will be closed permanently ( see BMI 's Indian Summer For East Coast Refining, July 9 2012).
A Reversing Trend?
This period of exceptional prices will not last forever. Indeed, we believe that just as the WTI-Brent spread will contract over the next few years as additional oil transportation infrastructure comes online, so too will the price differential between North American crudes ( see BMI 's New Pipeline Infrastructure To Constrict WTI-Brent Spread, July 30 2012). Furthermore, our oil price outlook supports an ongoing rise in prices over the second half of the year, as evidenced by the strong rally in WTI prices since a low on June 28 ( see BMI 's Uptrend In Prices Set To Continue In H2 2012, July 27 2012).
This spread contraction is reflected in our medium term oil price forecasts as well. Although we are predicting slightly lower prices through 2016, we believe that the WTI-Brent spread will shrink steadily, and fall as low as US$4/bbl by 2016.