Get 40% Off
🤯 This Tech Portfolio is up 29% YTD! Join Now to Get April’s Top PicksGet The Picks – Just 99 USD

Skinny and sweet: U.S. refiner earnings depend on the oil diet

Published 04/26/2018, 03:48 AM
Updated 04/26/2018, 03:48 AM
© Reuters. FILE PHOTO: A crude oil train sits parked outside the Philadelphia Energy Solutions refinery in south Philadelphia

© Reuters. FILE PHOTO: A crude oil train sits parked outside the Philadelphia Energy Solutions refinery in south Philadelphia

By Devika Krishna Kumar

NEW YORK (Reuters) - Smaller independent refiners with less complex facilities are surging in the stock market of late, as investors expect strong earnings growth thanks to the recent fall in price of their primary cost - light, sweet crude oil coming out of West Texas.

Over the last 20 years, the nation's biggest refiners spent billions building units capable of turning heavy, sour crude into gasoline, diesel fuel and other products.

But the U.S. shale revolution has boosted crude production to a record 10.5 million barrels per day, upending the global oil market by adding millions of barrels of very light crude to the supply mix. A majority of that new production is light, sweet West Texas crude.

Recent trends have turbocharged this shift: full pipelines in West Texas, where light U.S. oil originates from, have depressed prices for Midland, Texas, crude to more than three-year lows. On the other hand, OPEC production cuts and supply issues among big producers of heavy crude like Venezuela and Mexico have raised the cost of heavy, sour oil.

(Graphic: Crude oil grades go differing ways - https://tmsnrt.rs/2vKuIX2)

That gives an advantage to some independent refiners equipped for lighter crude, which is less complicated to process. Investors have been buying up independents with less complex refineries like Delek US Holdings Inc (N:DK) and HollyFrontier Corp (N:HFC), as they could benefit from low Permian prices for several quarters to come.

"To have your major feedstock be in such abundant supply is unequivocally a positive for U.S. refining," said Matthew Blair, a Denver-based refinery analyst with Tudor Pickering & Holt.

"The benefits of that are going to be unevenly spread through the group."

To be sure, shares of most refiners have been rallying, as refining margins recently hit a five-month high and U.S. gasoline demand is near record levels. Results are likely to show strong profits across the sector, beginning with Valero Energy Corp (N:VLO) on Thursday.

However, over the last three months, as Permian crude has slumped, Delek shares have soared, returning more than 30 percent, with HollyFrontier close behind at 25 percent, besting all other independent refiners. The two are also ranked highest among U.S. refining companies in the Thomson Reuters earnings revisions model, which looks at analyst revisions for earnings and revenue and recommendation changes.

CARRY THAT WEIGHT

"Light" grades are distinguished based on what is known as API gravity - a measurement of density. A majority of U.S. shale crude output growth is at the top of the scale with API gravity above 40 degrees.

More complex U.S. refineries are configured to run on grades of crude with an API gravity of around 31-33 degrees. Most refineries cannot simply take in only lighter crude, because it would affect operational efficiency.

"In order to process more shale from here on, refiners will need access to more heavy crude too," Morgan Stanley (NYSE:MS) analysts said in a note last week.

About 70 percent of Delek's crude slate is based on Permian crude, according to a March company presentation. The company did not respond to a request for comment.

HollyFrontier is less reliant on the Permian - it accounts for 35 percent of its crude slate, said Craig Biery, director of investor relations.

However, its imports of heavy crude have exclusively been discounted Canadian oil in the six months through January, according to U.S. Energy Information Administration data. The company has existing pipeline commitments for that oil, so it can take full advantage of those discounts, said Barclays (LON:BARC) analyst Paul Cheng.

Valero, Marathon Petroleum Corp (N:MPC) and Andeavor (N:ANDV), three of the largest independent refiners, have had more downward earnings revisions over the last 30 days than other independent refiners, according to Thomson Reuters data. Those refiners, with multiple facilities on the Gulf Coast, rely more on imports from Latin America.

For the six months through January, Valero imported 6 million to 7 million barrels a month, and only 10 to 15 percent is from Canada, according to the EIA, with the bulk from Mexico, Venezuela or other Latin American nations.

The spread between international benchmark Brent crude and U.S. crude , a proxy for import costs, has surged to more than $6 a barrel - the biggest premium seen all year.

© Reuters. FILE PHOTO: A crude oil train sits parked outside the Philadelphia Energy Solutions refinery in south Philadelphia

Valero has only about 25 percent of its crude slate directly linked to U.S. crude, and its exposure to Midland is even smaller, Cheng said. A March investor presentation says sweet crude makes up an average of 17-37 percent of its Gulf refineries. The company declined comment.

Latest comments

Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2024 - Fusion Media Limited. All Rights Reserved.