By OGJ editors
HOUSTON, Jan. 3 -- The US refining sector's profit margins and stock prices are apt to see downward pressure in early 2005 because of strong supply levels and lower demand growth, said investment banker Friedman, Billings, Ramsey & Co. Inc., Arlington, Va.
FBR analyst Jacques Rousseau reported that he sees refining fundamentals for the first quarter as less positive than they were for the first quarters of 2003 and 2004.
"Given the poor refining industry fundamentals throughout 2002, refiners voluntarily reduced their production levels in first quarter 2003 (utilization rates averaged only 87% during this period vs. a historical 90%), leading to a decline in total refined products inventories," he said in a Dec. 29 research note.
Consequently, refining margins returned to above mid-cycle levels during the first quarter of 2003. A similar trend emerged during winter 2003-04 when refining margins dipped below mid-cycle. Dropping margins and a heavy maintenance turnaround schedule during early 2004 caused a steep decline in products inventories, resulting in record refining margins, he said.
"However, despite the current US average refining margin hovering slightly below mid-cycle levels, we expect the positive trend of falling inventories and rising margins witnessed over first quarter 2003 and first quarter 2004 to be more mild in first quarter 2005," Rousseau said.
High product supply
US refined products supply is likely to remain high as the first quarter 2005 turnaround schedule appears to be light.
"The lack of major refinery turnaround activity in both the US and Europe should lead to strong US refining production and possibly to above-average import levels during first quarter 2005," Rousseau said.
Additionally, light product yields from US refineries have increased 2-3% during the past 5 years, so investments in upgrading capabilities and improved technology has increased refinery output of gasoline, diesel, heating oil, and jet fuel, he said.
Rousseau expects that total refined products demand growth will slow following a 2.4% rise during 2004 vs. a historical 5-year average of 1.4%. FBR forecasts a 1.3% demand growth in 2005, partially because sustained high retail gasoline prices negatively affect consumption.
Crude oil differentials remain exceptionally strong, stemming from strong production by members of the Organization of Petroleum Exporting Countries, he said.
"Light-heavy differentials, for example, are currently averaging $6/bbl, significantly higher than $3/bbl witnessed in December 2002 and $2/bbl in December 2003. This higher level for differentials should allow complex refineries to remain profitable even when benchmark refining margins dip to low levels," Rousseau said.
Inventories
Gasoline inventories are expected to continue rising, he said.
"Given our expectations for continued strong production coupled with the low demand growth, gasoline inventories could enter the spring season (second quarter) near a new record high," he said.
Most US refiners continue trading at peak-cycle valuations, he said.
"The sector as a whole is fairly valued, based on our mid-cycle earnings and free cash flow analysis," Rousseau said.
