Marathon Shows Refining is Still Reeling (MRO, TSO, VLO)

Marathon Oil (NYSE:MRO) stock is indicated lower this morning in pre-open trading following release of the company’s interim update for the second quarter.  Shares of Tesoro Corp. (NYSE: TSO) and Valero Corp. (NYSE: VLO) have been under pressure on an almost daily basis that would currently give you the feeling that energy prices this high are impossible for these players whether they rise or fall.

Marathon’s production is expected to reach 372,000 boe/d, slightly above previous guidance, but slightly below the year ago production of 375,000 boe/d. Estimates for sold barrels is off by 22,000 boe/day. Production is expected to be 20% below earlier guidance in Marathon’s oil sands operations, but climbing prices for bitumen cover that up pretty well.Price realizations for oil and natural gas are up, but the company expects a $250 million after-tax write-down on its derivative hedges for synthetic oil sales.

But refining margins are the really bad news. Marathon expects second quarter refined products sales to be lower than last year by about 4%. Gross margins drop nearly 80% y-o-y, from $0.3925 in 2007 to $0.0850 this year. Derivative instrument losses on refined products adds another $190 million worth of bad news.

Then there’s Tesoro Corp. (NYSE:TSO), which hit a 52-week low yesterday. Tesoro issued second quarter guidance in June, aiming for a 10% reduction in their inventory by the end of the second quarter. The company hopes to reduce demands for working capital by reducing inventory. Hedges will cost the company $125 million in the quarter, and higher than expected energy costs will increase expenses by $0.30-$0.50/b. The news from Marathon didn’t help Tesoro, although its stock is up marginally after a nightmare Wednesday.

Finally, there’s Valero Corp. (NYSE:VLO). Yesterday the company announced a quarterly cash dividend of $0.15 per share. This morning, the stock is trading down again at levels challenging its 52-week low. Valero has not issued an interim update on its operations yet, but don’t expect any good news if and when it does.

As bad as things were for refiners last quarter, they’re only going to get worse this quarter. Watch EIA crude and refined products inventory reports. Commercial crude inventories are below the lower boundary of the average range for this time of year. Inventory management is the single best weapon refiners have for managing operational costs and cash flow. There aren’t many other arrows in their quivers.

Paul Ausick
July 10, 2008