Refiners in for More Trouble? (VLO, TSO, MRO, HES)

This week’s report from the Energy Information Administration noted that “strong supply availability from refiners now running at low utilizations in both Europe and the U.S. is likely to moderate gasoline price increases this summer.” That statement may be true, but even if it is, refiners could still be squeezed before the leaves begin to fall next September.  This has continued implications for Valero Energy Corp. (NYSE: VLO), Tesoro Corp. (NYSE: TSO), Marathon Oil Corporation (NYSE: MRO), Hess Corporation (NYSE: HES) and others.

Crude oil stocks, though they have fallen for the past couple of weeks, are still well above their average range. Refinery utilization is around 82%. Gasoline stocks are also falling, and have reached the bottom of their average range. Distillate stocks continue to be well above  average.

OPEC’s difficulties in keeping some of its members from cheating on quotas is contributing to the high levels of crude oil stocks. The rising price for crude is just too tempting for Iran and Venezuela to resist. Russia, though not a member of OPEC, is trying to produce more crude to take advantage of higher prices.

What that means for refiners is that crude prices should be falling, making it easier for companies like Valero Energy Corp. (NYSE:VLO) and Tesoro Corp. (NYSE:TSO) to earn healthy profits. But crude prices are rising, and the reason is almost certainly “speculation” by options traders.

If you believe that the global economy is improving, then demand for oil will increase, and so will the price of that oil because oil is getting scarce. That scarcity component is one of the causes of last summer’s record high prices.

The low pump prices we’ve seen since the end of last year have ignored the scarcity component of crude prices because there was plenty of crude available to meet the lower demand driven by the weak economy. But now futures traders are seeing the current price for crude exceeding the futures price (a phenomenon known as backwardation), and that means that crude prices could well continue to rise, leading to pressure on refiners’ margins.

There is, of course, spare production capacity, but at what price will OPEC turn the spigot on again? The cartel has said on many occasions that it wants a price of $70-$80/barrel? But it will certainly take more if it can get it.

Higher prices for crude will raise pump prices, costing consumers more, and then they will have to choose between driving and something else, like eating. The last time they had to make that choice was last summer, and they chose to eat.

Refiners are not likely to feel the pinch until next quarter. If they are drawing down their stocks now, they are refining crude that cost them far less than today’s price, and they’re selling the gasoline at today’s much higher margins. That won’t last, however, as eventually the cheap crude will run out and they’ll be using the higher priced stuff they’re buying today.

American consumers started to rebel when pump prices got over $3.00 per gallon. If the recent price gains continue, that day is coming again before the end of the summer.

Paul Ausick
May 22, 2009