Strong refining environment of 2000-01 has re-emerged

Dec. 16, 2002
US refining margin spikes and upside earnings/share surprises have surfaced, reminding Merrill Lynch analyst Andrew Fairbanks of the strong refining environment of 2000-01.

By OGJ editors

HOUSTON, Dec. 16 -- US refining margin spikes and upside earnings/share surprises have surfaced, reminding Merrill Lynch analyst Andrew Fairbanks of the strong refining environment of 2000-01.

"We continue to believe that the US downstream has seen the worse for this cycle," Fairbanks said in a Dec. 6 research note. Regarding concerns about increasing gasoline imports into the US, he said refining stocks already have incorporated that.

"In addition, we believe that although refining margins have receded from their recent 10-year seasonal highs as expected, they are not poised to collapse back to the breakeven levels witnesses during much of the first half of this year," Fairbanks said.

The overall industry inventory is much tighter now than it has been any time during the past year. Gasoline and distillate inventors stand at 20 million bbl below normal for this time of year vs. a 20 million bbl overhand in May.

"As such, we believe that even if supply increases from higher imports, the US can withstand even 10 million bbl of imports in excess of what can be absorbed by demand without margins falling back to below average levels," Fairbanks said.

He anticipates that gasoline imports, although high this year, should be fully absorbed in similar quantities next year with only modest demand growth.

Earnings/share surprises
The fourth quarter of this year is the first quarter in more than a year in which consensus estimates are moving up instead of down, Fairbanks said of analysts' earnings/share estimates for refiners.

"We expect this process will continue into 2003 as the industry continues its recovery back to the tight conditions prevalent during much of 2000 and 2001," he said.

A gradual tightening in US product inventories has been occurring since mid summer, he said.

"We think that as expectations for the refiners' earnings improve, the stocks will move up in tandem. Critical factors for stronger results will be wider sour (and) heavy crude oil discounts and better growth in overall product demand next year," Fairbanks added.

Assuming a modest rebound in global growth in 2003, he anticipates that the US downstream sector "will see a solid rebound next year, despite a rough ride in 2002."

Margin spikes
Fairbanks said refining margins rose to 10-year seasonal highs in all major US regions as product inventories moved into tight conditions in late October and November.

"We regard the strong Oct.-Nov. margin environment as the first major margin spike since (the) Sept, 11, 2002 period. We expect more to come in 2003," he said. "Recall that our view is: the US refining market will be characterized by an increasing frequency of significant margin spikes going forward as the industry is pushed to its effective capacity limit by growing demand."