Positive signs returning to U.S. refining sector

Aug. 16, 1999
Positive indicators are proliferating for the downstream side of the petroleum business, belatedly catching up to the good news that oil and gas producers have been experiencing in recent months.

Positive indicators are proliferating for the downstream side of the petroleum business, belatedly catching up to the good news that oil and gas producers have been experiencing in recent months.

U.S. third quarter refining margins are, on average, 27% higher than those in the second quarter, outside the West Coast, according to Bear Stearns. On the West Coast, a series of refinery outages and resulting product shortages have pushed margins 70% higher this quarter vs. the previous quarter.

Strong products demand and the downtime for a number of refineries have caused utilization rates to rocket to record levels. During July, U.S. refinery utilization averaged 99.1%, the highest level ever recorded for this season. As some problems have been resolved on the West Coast, refinery utilization in that region has rebounded to 93.1%, up seven percentage points from June. But refineries in the Midwest and on the Gulf Coast last month were running evern harder, at over 100% of nameplate capacity.

The sharply higher refinery utilization is contributing to a massive drawdown in stocks, a reflection of rebounding global demand and the tightening constraints OPEC has put on oil supplies. U.S. crude inventories are 5% below year-ago levels, or the equivalent of 0.3 days of supply lower. That's good news for a sector bedeviled by surplus stocks for more than a year, the primary cause of the recent oil price slump.

Much of the market robustness centers on strong demand for gasoline in the U.S., spawned in large part by the continued strong economy and dry weather-which both spur more driving-and U.S. consumers' persistent craze for gas-guzzling sport utility vehicles and pick-up trucks. Gasoline demand in the U.S. for first half 1999 was up 1.5% from 1998, which in turn was up 3% from the prior year.

As a result, gasoline stocks currently are more than 9 milion bbl below year-ago levels, sliding 4.6 million bbl in July alone. But that puts gasoline stocks pretty much at what can be considered normal levels.

While gasoline remains the bright spot of the downstream sector, prospects are little less sanguine for distillate. That's to be expected this time of year, but things now are a little worse than usual, in large part because of the persistent overhang of stocks that dates back to last year. Even at that, distillate demand in the U.S. in June fell by 5.3%, largely on the strength of a steep 16.5% drop in heating oil demand. But distillate transportation fuel rose 4.5% for the year to date, while heating oil demand fell by 5.4%.

Distillate stocks remain stubbornly high, at 38.8 days of supply, a half-day higher than the same time a year ago. Still, there has been some progress on this front. Distillate stocks are currently 3.7% below year-ago levels, despite a stockbuild of 8.3 million bbl in July. And heating oil inventories, while persisting well above 1997 levels, have fallen by about 5 million bbl in the past year.

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Bear Stearns also took at look at regional refining margins. Leading the pack is the cloistered West Coast market, where refining margins were hanging at a remarkably high $14-18/bbl in the past month and currently are pegged at $16.81/bbl. The culprit here is a string of refinery outages resulting in product shortages coupled with the stringent gasoline specifications mandated by the California Air Resources Board (CARB). While crude costs were rising by 12% in July, CARB gasoline prices shot up by 20%.

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Refining margins in the U.S. Midwest climbed to$3.64/bbl in July before slipping back to August levels of about $3/bbl. Margins for gasoline and distillate there both edged back from mid-July highs, but the gross margin for gasoline remains strong at $4.07/bbl, while the respective margin for distillate remains weak at $1.11/bbl.

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Things were a bit more volatile on the East Coast in recent weeks, as overall refining margins have fallen in recent weeks but still remain above second quarter levels averaging $2.94/bbl. In the past 4 weeks, East Coast gasoline margins have jumped 9% to $4.32/bbl. Distillate margins have swung even more wildly, plummeting to only $0.18/bbl recently after strengthening to $1.58/bbl at the end of the second quarter. Things look to get worse for East Coast distillates, as a soaring refinery utilization rate there (99%), in response to high gasoline margins, puts more distillate on the market, thus squeezing distillate margins still further.

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Gulf Coast refining margins have shown sharp improvement since the second quarter, with margins up 54%, or $1.18/bbl, from the end of June. The margin for gasoline alone has improved to $4.51/bbl, coming on the heels of a 14% increase in gasoline prices and the highest level since June 1998. Here again, distillate is faring poorly, with margins languishing at $1.10/bbl-even if that is 57% above second-quarter levels.

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A normal winter will pull down the distillate stocks to more acceptable levels, carrying through the downstream market strength through the fourth quarter and into first quarter 2000. But if some of the heat doesn't come off of oil prices soon, then the margins could start to get squeezed again as reduced gasoline demand coupled with higher feedstock costs starts to squeeze refining margins again. The betting here is that much of the crude oil price strength has been talked up by the market-still surprised at OPEC cohesion-and that oil prices are likely to moderate back in proportion with actual physical fundamentals.

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So U.S. refiners may have something to smile about again heading into the new millennium (or just into 2000, for you math purists).