It’s no secret the oil refining margins have been dropping like a rock for the past few quarters. When pump prices began to approach a US-wide average of about $4/gallon, US drivers started changing their habits.The latest numbers indicate miles driven dropped by 12.2 billion miles, almost 5%, in June. That translates into millions of gallons of gasoline that were either not refined or were not sold. This decrease has hit refiners hard.

The award for largest drop in value goes to Western Refining (NYSE:WNR), down nearly 84% from a 52-week high of $55.72 to close yesterday at $9.23. Next on the list are two refiners that are majority-owned by Isreali parents: Alon USA Energy Inc (NYSE:ALJ) fell by almost 72%, from a high of $41.25 to $10.49; and Delek US Holdings (NYSE:DK) dropped by 69%, from $28.34 to $8.64. Tesoro (NYSE:TSO) fell by 64%, from $65.98 to $18.43, and Valero (NYSE:VLO) fell by nearly 50%, from $75.75 to $34.79.

We could include the refining and marketing operations of majorintegrated companies like Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX),and ConocoPhillips (NYSE:COP), which have also lost a ton of money inthe past year, but we’re saving integrated oil companies untiltomorrow’s installment.

Every one of these independent refiners faces the same problem: highcrude oil prices are compressing profit margins because the full costof the crude can’t be passed on at the pump. Consumers have been votingwith their feet. US gasoline consumption has dropped in every one ofthe last 12 months, and the year-over-year drop in consumption amountsto 2.5%. The US Energy Information Administration (EIA) attributes"almost all" of the drop in consumption to higher prices for crude.

And the situation won’t improve. The EIA projects declines in USpetroleum consumption through the end of 2009. So, what are therefiners doing to deal with this situation? They’re either trying tosell some of their refineries or they’re trying to figure out a way toride out the tide of high crude prices. As the price of crude hasfallen over the past few weeks, refining stocks have recovered a bitbut all are still quite near 52-week lows.

Selling refineries seems like a non-starter. Who’s gonna buy? Anotherrefiner? Private equity? A possibility is a national oil company likeSaudi Aramco, which has plenty of capital and is currently building amassive refinery in Saudi Arabia to export refined products. When theseexports begin to hit the spot markets, gasoline prices will rise againand local refineries will benefit because they’ll be able to sellrefined products at the higher spot price.

But there is no evidence for that scenario. What’s real is thatrefiners are in for several more tough quarters. And if US driverscontinue the trend of driving less, we could actually be witnessingtrue demand destruction, not just demand erosion.

Paul Ausick
August 14, 2008

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