Moody’s Investors Service has changed the outlook to stable from negative on the North American and EMEA (Europe, the Middle East, and Africa) regions refining and marketing (R&M) businesses. This outlook reflects Moody’s expectation for the fundamental business conditions over the next 12-18 months.
According to Moody’s most recent outlook, the R&M business’ earnings before interest, tax, depreciation, and amortization will rise 2-4% in 2017 and a further 1-3% in 2018. This represents a period of modest growth that follows a very lackluster 2016, when high inventories and utilization rates had narrowed margins dramatically.
While these disadvantages linger today, crack spreads—a crucial factor in the refiners’ profitability—will average at or above 2016 levels into early 2018, as seasonal demand for gasoline rises and distillate demand improves with increasing drilling and manufacturing activity, Moody’s said.
Gasoline demand
Moody’s still expects very high gasoline demand in 2017-18 after a record 2016, despite sporadic modest declines.
Gasoline demand within the Organization for Economic Cooperation and Development “faces long-term secular decline as vehicle fuel efficiency improves and biofuel use increases,” Moody’s said. “Still, lower gasoline costs have changed near-term driving habits, especially in North America, with sales rising for less fuel-efficient vehicles.”
According to Moody’s outlook, gasoline demand will stabilize before the peak 2017 summer driving season, following 5-7% declines in early 2017 amid bad weather and rising fuel prices. US miles driven will rise by 1-2% in 2017, while gasoline demand will decline by 2-3%—not enough to worsen crack spreads beyond the unusually weak levels of 2016.
Product inventories, RINs
US refined product inventories remain high, limiting refining margins in 2017, but production cuts and continuing high demand for gasoline and improving demand for diesel could help reduce inventories, especially in late 2017 and into 2018.
“Production could slow among refineries that produced at 90% of capacity or higher in 2016, in some cases to perform postponed maintenance. High oil inventories will also support crack spreads through 2018, though not at levels much higher than in 2016,” Moody’s said.
Meanwhile, the cost of complying with US renewable fuel standards (RFS) has decreased since the new US administration came into office.
“Prices have dropped for renewable identification numbers (RINs)—federal credits related to RFS compliance that US refiners can earn, buy or sell—dramatically easing their strain on refining margins. Trading prices of $1/RIN in the summer of 2016 have fallen to 35-50¢/RIN since then, benefiting merchant refiners such as Valero Energy and CVR Refining,” Moody’s said.
Regional refiners
Fewer advantageous crude options will continue to hurt refiners on the US East Coast, while US West Coast refiners such as Tesoro Corp. will benefit from a tight product supply-demand balance in their market.
Still, near-term profits will improve for East Coast refiners such as PBF Holding, with less competition from European imports. Tight crack spreads will discourage brisk production at Europe’s generally less efficient, smaller and less complex refining operations, which also face increased competition from Middle East capacity expansions, Moody’s said.
US Midcontinent refiners close to shale production, such as HollyFrontier, will benefit from a potential partial reemergence of discounted crude prices, given their proximity to the region’s quickly increasing production.
The large, complex US Gulf Coast refineries, representing more than half of US capacity, will continue to benefit from favorable light, heavy, and sour crude differentials, especially against Canadian crudes requiring more complex processing.
Risks to the outlook
However, a sudden drop in demand, or demand that does not keep up at least with incremental refinery production, would increase the industry’s risk.
“We would likely change our outlook to negative if the peak US driving season fails to support crack spreads, inflating gasoline inventories again,” Moody’s said.
“Weaker demand for gasoline and distillates in China, India, the US, or the Middle East would depress North American crack spreads, and West Texas Intermediate crude prices rising above prices for Brent from Europe would directly hit profitability for North American independent refiners.”
On the other side, Moody’s would consider a positive outlook if the US and Asian diesel and distillates markets surged, and if increased gasoline demand led to stronger crack spreads.
