Refiners have been beaten up and declining since late
February, but the downtrend has shown signs of a pause in recent
weeks. The sector has been pressured by a meaningful drop in
crack spreads (profit margins) in part linked to a narrowing of
the Brent/WTI spread. The supply/demand conditions in the
oil market seemed to tighten as highlighted by a sharp drop in
U.S. inventories and pick up in refinery activity.
The crack spread or margins are a key price
Refiners have differing input costs depending on their ability
to source and crack differing grades of crude oil. As the graphic
displays, the stock price of refiners tends to follow the
direction of crack spreads or their margins. The 3:2:1
crack is overlaid against the average price of Valero (
), Western Refining (
), and Tesoro (
). The 3:2:1 crack calculates the profits of converting
three barrels of crude oil into two barrels of gasoline and one
barrel of heating oil.
The graphic displays a generic view of margins using WTI crude
oil for an input. In reality, refiner profits are subject
to the differing pricing of inputs. There are light
and heavy crude mixes and different prices among light and heavy
crudes. The Brent/WTI spread is an example of
differing prices for light crude oil. These differentials can
Refiner processing slowing:
After surging to a peak of 16.237 million barrels a day (mbd)
in the middle of July, refiner input eased to 15.611 mbd as of
. The Energy Information Agency is looking for refinery
inputs to average 14.9 mbd in in Q3 and Q4 of 2013. This
reduction in usage may cut some of the tightness in the domestic
oil market, and take some of the bid out of WTI. Refinery
utilization declined 1.5% to 89.4% in the week of August 9
and fell below 90% for the first time since the week end June 14
Tightness in the oil market expected to end:
U.S. crude oil inventories have fallen sharply, 37 mln
barrels, between May 24
and August 9. Inventory levels have dropped from being
well above the five year range to working within the five year
range. Seasonally, inventories are likely to drop through
September, but then gradually build going into late
spring. A build in crude stocks may reduce concerns
over tightness in the energy market and help bolster refiner
The days supply of crude oil is 22.7 down from 23.4. The
days supply has been below a year ago for the past six weeks
after a long period of exceeding a year ago.
In addition to inventory patterns, the WTI futures price curve
shows a discount or backward structure. September 2014 WTI
futures were trading around $94.90 at writing and trading at over
an $11 discount to September 2013 WTI futures. The 3:2:1
crack on the CME is expected to rise from $14.53 to $22.73
between the September 2013 and September 2014 period. In
other words, crack margins are expected to improve.
The outlook for strong North American crude oil production
remains intact and infrastructure is being build to handle the
EPA biofuel blending wall less negative:
The cost of credits to comply with the renewable fuel mandate
has been a negative for refiner profit growth. The cost of
a credit soared in the first part of 2013, but it looks like the
EPA is willing to relax the mandate. The industry has been
complaining and the cost is flowing into the price of a gallon of
gasoline - hitting the consumer.
The 2013 standard was revised down and the EPA is showing
flexibility on 2014. There is an expectation that the mandate of
biofuel will be a percentage of consumption.
The price of credits remain elevated, but have recently
declined from the peak. The bleeding of profits linked to
EPA regulations may be stopped, but the issue is a source of
uncertainty and remains a headwind to profits (without the
mandate and need to purchase credits, profits would be
higher). VLO recently said its cost to comply with the
regulation would range between $600 to $800 mln in 2013.
The table displays the valuation picture for a select group of
refiners. The valuation in the sector is tight with forward
PE ratios ranging between 8.5 and 9.2 with an average of 8.9.
Based on this measure, WNR is most expensive and PSX and VLO are
the cheapest. Likewise, the price to tangible book
value ranges between 1.4 and 3.8 with an average of 2.1.
WNR is also most richly priced by this metric, while VLO is
the most inexpensive.
Price to cash flow is also present. The range of values
rests between 4.5 and 6.6 with an average of 5.7. VLO is
cheapest, while TSO is most expensive.
The earnings picture is downbeat:
Earnings estimate revisions are trending lower for the sector.
Every stock in the table is expected to see profits per share
fall in 2013. The picture is more mixed for 2014. TSO, VLO,
and MPC are projected to post growth, while WNR, HFC, and PSX are
expected see contraction.
All the stocks in the table are a Zacks Rank #3 (Hold) with
the exception of VLO which is a Zacks Rank #5 (Strong
Sell). Earnings estimate revisions are unfavorable
and analysts will want to see some type of expansion in crack
margins before getting more bullish with their estimates.
As the graphic above showed, the price of refiners will be
sensitive and driven by the change in crack margins with a
widening needed to improve the outlook for higher stock
Technical factors are mixed:
There are a few charts in the refinery sector which may be
worth monitoring. PSX has consolidated between about $55
and $70 in recent months. Chartists may view this formation
as a triangle pattern. Usually this pattern signals a
continuation of the trend upward, but a breakout will help set
In contrast to PSX, TSO looks to be forming a large head and
shoulders top. A close below the neckline around $50
will provide confirmation of a trend change. A rally over
$58 would question and/or destroy the pattern and paint a more
VLO, HFC, and MPC have shown some variation of trading in or
trying to break out of a broad downward sloping channel.
However, a small channel off the recent low is also
The chart of MPC is displayed, above, as a
representative. MPC looks vulnerable to a move toward the
lower end of the major channel before trying another leg higher.
It is on the cusp of breaking below the minor channel.
The refinery sector is in a funk. Earnings estimates are
falling, valuations reflect cautions, and the EPA regulations are
creating a headwind to profits. However, if futures markets
are correct in their pricing, crack margins may be able to
improve into 2014.
It is interesting that VLO has the cheapest valuation based on
the 12 month foward PE ratio and price to tangible book value,
but is a Zacks Rank #5 (Strong Sell) due to its poor trend in
earnings estimate revisions.
Technically, more work in the sector needs to be done to prove
prices are ready to work higher. A breakout above the
downward channels or above the triangle formation in PSX would
suggest an improved outlook.
The technical condition of the sector is consistent with the
Zacks Rank. Most of the sector is a Zacks Rank #3 (Hold) with the
exception of VLO which is a Zacks Rank #5 (Strong Sell).
Those interested in an energy play may want to check out
Murphy Oil (
). It just announced a spin off its retail marketing
business and is a Zacks Rank #2 (Buy). It has stronger
momentum in earnings estimates revisions.
The bull story for pure refiners is trying to develop and the
outlook for the refining sector looks "cracked" for the timing
HOLLYFRONTIER (HFC): Free Stock Analysis
MARATHON PETROL (MPC): Free Stock Analysis
MURPHY OIL (MUR): Free Stock Analysis Report
PHILLIPS 66 (PSX): Free Stock Analysis Report
TESORO CORP (TSO): Free Stock Analysis Report
VALERO ENERGY (VLO): Free Stock Analysis
WESTERN REFING (WNR): Free Stock Analysis
SPDR-EGY SELS (XLE): ETF Research Reports
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