Crude oil prices are off more than 20% from their high of $87.15 on May 3rd. The major contributor to that slide are serious concerns over sovereign debt primarily in the European Union. The nearly $1 trillion EU bailout fund temporarily put some confidence back in global markets, but the stringent cost-cutting measures that accompany the fund threaten to stifle growth in the European economy.
And while the possibility that Europe’s weakness will spill over into the global economy as well, the falling price of energy, especially crude oil, holds out some hope for the refining business. US refiners Valero Energy Corp. (NYSE:VLO), Marathon Oil Corp. (NYSE:MRO), Tesoro Corp. (NYSE:TSO), Frontier Oil Corp. (NYSE:FTO), Hess Corp. (NYSE:HES), Sunoco Inc. (NYSE:SUN), and Western Refining Inc. (NYSE:WNR) could see some substantial boosts to margins during the second quarter.
Refiners use a last-in-first-out (LIFO) inventory accounting system, so crude purchased at $70/b today is “used” before higher priced oil purchased last week. Because crude prices move faster than pump prices, refiners have a window of opportunity where their selling price significantly exceeds their cost of goods.
Today’s early report from the US Energy Information Administration notes that refinery utilization is now at 87.9%, pretty close to the four-week average utilization rate of 88.2%. The rate has grown steadily from the beginning of the year, when it was under 80%. Refinery inputs were up 4.7% compared with a year ago, and supplied product was up 4.8%. Distillate production, which include diesel fuel, is up 12.3 %. Distillates are especially important to refiners because the margins on distillates is almost always higher than on gasoline.
As the summer driving season approaches, crude oil imports are rising again and total stocks are still above five-year averages. If crude prices stay low or fall even further, imports will grow as refiners keep their tanks topped up to maintain their LIFO margin advantage.
The wild card in this scenario, though, is likely to be OPEC. Several of the cartel’s oil ministers were saying just last month that OPEC would consider increasing production if the price of crude rose above $90/b and stayed there for some unspecified length of time. The opposite side of that coin is that OPEC may decide to lower production if prices fall below $70/b and appear to be sticking there.
The Saudi Arabian finance minister told an interviewer that he did not think oil would fall below $62/b. The Saudis and other Middle East producers depend on income from crude oil to fund almost all their governments’ spending. OPEC usually spins their story to say that a price below $70/b is too low to fund investment and grow capacity. Right.
One thing OPEC, and the Saudis in particular, are firm about and that is the role of speculation in the market for crude. When prices soar, speculators get the blame. Now that prices are falling, the Qatar oil minister is saying that the drop is “psychological” and has no relationship to market fundamentals. Worries over the crisis in Europe and news stories about a widening contagion are fueling the fall in crude prices. The Kuwaiti oil minister has also suggested that if oil falls below $65/b OPEC could call an emergency meeting before their next scheduled meeting in October. That, of course, will send prices up, based on speculation that OPEC will cut production. But that’s good speculation, at least as far as OPEC is concerned.
Crude prices are down near $68/b this morning, and every refiner’s share price is off. Marathon is off less because it just announced that it is selling a refinery and other downstream assets in Minnesota for a reported $800 million to two private equity firms. Valero has sold its Delaware refinery and Sunoco has sold two of its refineries this year.
The only way refiners get a positive bump to share prices is by selling off refineries. If crude prices stay low, that may change.
-Paul Ausick
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