Refiners and Oil Prices, Conundrum and Quagmire (VLO, MRO, TSO, WNR, XOM, CVX)

There has been a never-ending battle between rapidly changing energy prices and the effect on margins at refineries.  Since the beginning of the year, the best-performing crude oil refiner has been Western Refining Inc. (NYSE:WNR).  With a market cap of $885 million, it is also the smallest of the large refiners among competitors Valero Energy Corp. (NYSE:VLO), Marathon Oil Corp. (NYSE:MRO), Tesoro Corp. (NYSE:TSO), and Frontier Oil Corp. (NYSE:FTO).

Western’s share price has risen more than 60% since January, while the best the others can do is around 20%, with Valero actually dropping by nearly 10%. Valero’s purchase of the assets of failed ethanol maker VeraSun did not boost its shares. As if anyone really expected that to happen.

The increase in the refiners’ share prices has almost everything to do with the rise in crude oil prices. Or does it? Rising crude prices, provided they don’t rise too high too fast, usually benefit refiners that can market their refined products at higher prices and generally higher margins.

However, in today’s slow economy, demand for gasoline has been dropping steadily, forcing refiners to turn to distillates and other refined products in a search for profits. For a while, European demand for diesel fuel kept the party going, but that demand has now cooled.  Exxon Mobil Corp. (NYSE: XOM) has joined in the ranks of companies looking for reduced demand in oil ahead.

For a look into what may be in store for refiners, let’s ponder what Chevron Corp. (NYSE:CVX) had to say about refining in its interim update for the first quarter of 2009. Barrels/day of crude processed is flat with the fourth quarter of 2008, but up about 4% compared with the first quarter of 2008. Chevron’s refining margins rose on the US West Coast, but fell on the Gulf Coast.

Chevron’s marketing margins in the US were down substantially. In the fourth quarter of 2008, margins on the West Coast were at $9.11/barrel. In the first two months of the first quarter of 2009, the margin was $0.01/barrel, and the expecteded margin for the full first quarter is just $0.83/barrel. The Houston margin for Eastern gasoline is down nearly 40%.

Western’s gross refining margins for all of 2008 were about $4/barrel less than in 2007, and the first quarter of any year is typically a low-profit quarter for refining and marketing. Marathon’s refining margins for the 2008 fourth quarter were about 75% lower than the previous quarter. And while crude prices did gain some during the first quarter of this year, the prices are not substantially better than they were in December 2008.

Reduced gasoline consumption in the US, seasonal declines, and likely hits to marketing margins could lead to a tough first quarter for refiners.  The real debate may be on whether this dilemma is a quarterly issue or a much longer-term issue.

Paul Ausick
April 13, 2009