Is the Crude Price Rebound a Boon or Bane for Refiners?
The whole world waits with bated breath to see the curve being flattened. An all-out effort is being made in every sphere to wipe out the novel coronavirus from the face of the earth. However, the road to recovery seems a long, bumpy ride. In fact, this rapidly-spreading virus spared no sector under the sun, especially the energy space wherein the Oil and Gas - Refining & Marketing industry is facing a slew of challenges.
The Zacks Oil and Gas - Refining & Marketing industry consists of companies involved in selling refined petroleum products (including heating oil, gasoline, residual oil, etc.) and a plethora of non-energy materials (like asphalt, road salt, clay and gypsum). Some companies also operate refined products terminals, storage facilities and transportation services. The primary activity of these firms entails buying crude/other feedstocks and processing the same into a wide variety of refined products.
Industry Underperforms Sector and S&P 500
The Zacks Oil and Gas - Refining & Marketing industry has lagged both the broader Zacks Oil - Energy Sector and the Zacks S&P 500 composite in the year-to-date period.
The industry has declined 41.6% since the beginning of the year against the S&P 500’s gain of 0.4%. The same is wider than the broader sector’s decrease of 35.7%. Moreover, the industry currently ranks at the bottom 26% of the Zacks Industry Rank.
Refining & Marketing Industry in a Shambles
The coronavirus chaos sent most energy companies into a tizzy with dwindling oil prices.On a worrying note, with major cities on lockdown and travel bans in place, global inventories swelled and product demand remains depressed. In particular, usage of distillates, such as aviation fuel continues to be weak with air travel being seriously curtailed. Gasoline consumption is also hit hard with millions of individuals confined to homes, resulting in sparse traffic on the road.
However, the world’s major oil producers extended the record output curbs through the end of July in a bid to tackle a global supply glut and keep prices afloat. Member countries of the OPEC+ group, a coalition between OPEC countries under kingpin Saudi Arabia and non-members led by Russia, recently decided via a video conference to carry on with their historic cuts in oil output for another month as they battle a surplus crude, globally, due to coronavirus-induced demand destruction.
The alliance, looking to shore up prices, started to withhold production by almost 10 million barrels per day —highest in history — from May 1. Per the original plan, the initial reduction would have lasted for a couple of months. Beginning July, the production cap would have been relaxed to 8 million barrels per day through the remainder of this year. However, Riyadh and Moscow agreed to retain the current level of ramp-down until this month-end. The producer group took a call to keep the existing checks, which helped lift the price of a barrel of crude from the sub-zero depth to around $40 now.
But as we know, the traditional fuels refining operation — where crude is turned into products ranging from gasoline and diesel to jet fuel and asphalt — is heavily dependent on commodity price fluctuations. In other words, crude acts as the primary input for refiners. The actions of Saudi Arabia, Russia and the rest of the OPEC+ group suggest that refiners will remain oppressed for an extended time with oil prices beating the recovery in fuel prices.
The refiners’ main concern arising from demand deficit for its major products has been low utilization rates. Crude inputs by refiners dropped nearly 25% below normal levels in both April and May. Moreover, the consequent recovery has been rather sluggish due to excess fuel supply that stemmed as demand waned. The nosediving crude prices that accompanied the demand disruption could have bloated refining margins on a usual basis. However, a plunge in product usage over the same period meant that refiners had to drastically compress their utilization rates, resulting in lower revenues and cash flows. And now, the sharp rebound in oil prices further jeopardized the industry by squeezing its margins. Thus, we can say that although slashed production is like a life-saving drug for the wider petroleum industry, it is a pricking peeve for refiners.
The Future Course
Just like all other energy subsectors, refining and marketing segment suffered a huge setback from the coronavirus crisis, which shrank demand for jet fuel and gasoline.
However, in June, it seemed that the crude’s worst losses were in the rearview mirror with signs of gradual rebalancing. But with the recent second-wave resurgence in the number infected cases, refined fuels’ demand woes continue to loom on for the merchant refining segment. With superfluous inventory already in abundance, any further scarcity of demand will imply more misfortune for refiners.
While refinery runs increased over the past few weeks, utilization in the United States falls short of the usual capacity usage at this time of the year. Downstream operators including Valero Energy VLO, Marathon Petroleum MPC and Phillips 66 PSX have drastically trimmed processing capacity to cope with the demand erosion caused by efforts to break the chain. Demand has still not picked up the pace whereby the operators can think of restarting their refinery work.
With refining margins unlikely to improve anytime soon, analysts downgraded their forecasts for downstream companies and related support plays, inducing negative estimate revisions. A look at the following stocks will further clear the picture:
HollyFrontier Corporation HFC: HollyFrontier is one of the largest independent refiners and marketers of petroleum products in the United States. Currently carrying a Rank #3 (Hold), this company has seen the Zacks Consensus Estimate for 2020 widen from a loss of 19 cents per share to 42 cents over the past 30 days.
Delek US Holdings, Inc. DK: The company is an independent refiner, transporter and marketer of petroleum products. The company’s operations are organized into three reportable segments: Refining, Logistics and Retail. This Zacks #3 Ranked firm has seen the Zacks Consensus Estimate for 2020 widen from a loss of $1.45 per share to $1.67 over the past 30 days.
Marathon Petroleum Corporation: This leading independent refiner, transporter and marketer of petroleum products with a Zacks Rank of 3 at present has seen the Zacks Consensus Estimate for 2020 widen from a loss of $2.09 to of $2.26 over the past 30 days.
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