By OGJ editors
HOUSTON, Mar. 24 -- With more capacity cuts looming and financial metrics still under strain, the North American refining industry remains a credit risk, reports Fitch Ratings.
Although Fitch analysts see “glimmers of improvement,” global product markets remain oversupplied because of a weak recovery in demand and capacity expansions completed or expected worldwide.
“From a credit perspective, the question of who makes capacity cuts to balance the market remains a key issue,” write analysts Mark C. Sadeghian, Sean T. Sexton, and Adam M. Miller, in the Fitch Ratings Chicago office.
Capacity expansions include 180,000 b/d by Marathon Oil Corp. at Garyville, Ind., 580,000 b/d by Reliance Industries Ltd. at Jamnagar, India, and 160,000 b/d by the Fujian joint venture at Guangzhou, China.
In the US, recent closures include the 210,000 b/d Valero refinery at Delaware City, Del., the 155,000 b/d Sunoco refinery at Eagle Point, NJ, and the 17,000 b/d Western Refining facility at Bloomfield, NM.
The Fitch analysts note that other refining capacity cuts are under consideration in the US and have been implemented elsewhere. Also, several expansion projects have been canceled or deferred.
“Fitch anticipates that further significant reductions will be needed both to accommodate these new high-efficiency capacity additions and to offset the market’s ongoing demand weakness,” they write.
Capacity cuts will reduce fixed operating costs for the companies that make them but might not improve credit ratings much. The reductions generally increase debt per barrel of refining capacity because, under current market conditions, they provide limited proceeds from steps such as inventory liquidation and conversion to petroleum storage, the analysts explain.
Sales of refineries provide greater proceeds but don’t solve the capacity problem because buyers usually keep the facilities in operation.
Integrated companies announcing plans to shed capacity probably won’t sell refineries or convert them to other uses until prices improve, the analysts add.
Fundamentals weak
Refiners responded “vigorously and early” to the recent slump in product demand and narrowing of margins by trimming capital expenditures and operating costs, cutting shareholder distributions, and enhancing liquidity in a variety of ways.
“However, at this point Fitch believes there is relatively little left to cut in the event of another drop in demand or further erosion in industry fundamentals, beyond the more drastic steps of shuttering additional capacity,” the analysts say.
They note that crack spreads—a gauge of refining profitability based on the difference between crude costs and product values—recently have improved. And the difference in value between light and heavy oils, important to the profitability of high-complexity refineries, has increased after collapsing last year.
But with global capacity still excessive and US product demand set to drop for the third straight year, the fundamentals of refining economics remain weak.
The Fitch analysts expect independent refiners to continue to suffer this year from negative free cash flow—cash flow from operations minus capital expenditures and maintenance costs minus dividends.
Also elevating risk for refiners are regulatory pressures to transition to “emissions-friendly fuels,” including pending regulation of greenhouse gases.
Credit quality of the refining industry would benefit from more aggressive rationalization of capacity or acceleration of the economic recovery.
It would deteriorate further from a “double-dip” recession or greatly higher crude prices, “especially if crude oil were to become unmoored from market fundamentals due to its use as a hedge against inflation or a collapsing dollar,” the analysts say.
Photo from ExxonMobil Corp.
Photos from Repsol SA.
