Refiners are likely to have another good year in 2004, but there are some bumps in the road ahead.
The first bump looms in the second quarter, when margins typically decline in the so-called "shoulder months" between the heating and driving seasons.
Margins are expected to thrive in the next few weeks, as a number of refineries undergo turnarounds in March, notes Jacques Rousseau, senior vice-president with Friedman Billings Ramsey Group Inc., Arlington, Va. That bodes well for refiners' earnings, as margins in recent weeks have exceeded most expectations.
Shoulder dip
However, as supply rises again after turnarounds end and demand declines beginning in April, the first of the shoulder months, inventories will continue to climb, putting downward pressure on margins. This trend is likely to persist into July.
"With total refining product inventories almost exactly at the same level as this calendar week last year (and no major supply disruption issues like Venezuela and Iraq), we expect refining margins in 2004 to follow a similar pattern to 2003 and decine noticeably (20%) in the second quarter vs. the first quarter," Rousseau said in an end-February research note. "While we are cognizant that there is a high level of turnarounds occurring this quarter and concerns that imports are declining due to the newly enacted low-sulfur gasoline standards, year-to-date supply (domestic production plus imports) is 2.4% higher than the same calendar weeks of 2003. We expect this trend to continue as refiners maximize production to take advantage of the currently strong refining margins."
Rousseau also noted that crack spreads have already begun to dip on the Gulf Coast and in the Midwest while remaining strong on the East Coast and especially the West Coast.
Silver cloud's dark lining
Even the good news for refiners expecting a flush year for earnings is tinged with a bit of bad news. Total refined products demand remains strong, about 1.2% higher than it was for the same time a year ago. The bad news is that the robust demand is being driven by unusually strong demand for heating oil and resurgent demand for residual fuel oil. Both of these categories are influenced strongly by high natural gas prices and the recent rounds of arctic weather across the US. In fact, gasoline and diesel demand, which account for 70% of total demand, show only minor improvement for the year to date, Rousseau points out.
All of which suggests that some of the strength underpinning margins is ephemeral.
Gasoline demand to slacken?
To cast a little more gloom around for refiners, Rousseau also sees the threat of rising retail prices squeezing gasoline demand in 2004. With the average self-serve regular gasoline pump price at $1.62/gal at the end of February—the highest since September—last year's surge in gasoline demand isn't likely to repeat this year.
"Historically, when this average retail price has exceeded $1.60/gal, gasoline demand growth has leveled off, according to our calculations," Rousseau said. "In 2004, year to date, this pattern has begun to reemerge, with retail gasoline prices averaging more than $1.58/gal and demand increasing by only 1% vs. 2003, below the 1997-2003 average annual 1.8% growth rate.
"With our expectations that retail gasoline prices will remain high, 2004 gasoline consumption growth in 2004 should be reduced to the 1% level, below the current consensus expectations."
High pump prices
And there is every reason to believe that pump prices not only will remain high this year but will be higher than consensus expectations.
In a new study, New York-based Petroleum Industry Research Foundation Inc., concluded that new gasoline formulations created by government fiat to favor ethanol over methyl tertiary butyl ether are already coming in at a much higher cost than expected.
As refiners in New York began reducing stocks of MTBE-based gasoline in preparation for MTBE bans this year, total gasoline stocks declined, and the differential between New York reformulated gasoline (RFG) and comparable RFG blends elsewhere doubled during May-November 2003 to 18-20¢/gal. This compares with the US Department of Energy's estimate of the long-run difference for switching to ethanol RFG from MTBE RFG being only 1-5¢/gal. Given the added logistical hurdles for transporting ethanol, the effects of any outages are likely to be magnified greatly. And pump prices will zoom. And this is an election year with Big Oil in the crosshairs.
Yes, it will be a good year for refiners. But they might not enjoy much of it.
(Online Mar. 1; author's e-mail: [email protected])
