As oil refiners cope with the energy transition, the debt they have added to their balance sheets to weather the COVID-19 pandemic may force some to choose between debt reduction and dividend payments if the petroleum market recovery lags expectations.
High-yield members of the group, including PBF Energy Inc., CVR Energy Inc. and Delek US Holdings Inc., have already suspended dividends in order to preserve cash. But during third-quarter earnings calls, executives at investment-grade HollyFrontier Corp., Valero Energy Corp., Phillips 66 and Marathon Petroleum Corp. reiterated their commitment to return cash to shareholders despite the pandemic.
"The only thing that's going to stabilize ratings is the demand response," S&P Global Ratings senior director Michael Grande said in a Nov. 19 interview. "When COVID hit, we were predicting by this time during the year, things would be better, and they're not. … I wish I could be more emphatic about our belief that things are going to be better next year."
U.S. fourth-quarter product demand is averaging 18.7 million barrels per day, below the year-ago level of 20.5 million b/d, S&P Global Platts Analytics estimates. The analysts expect the overhang in U.S. product inventories — which have fallen from 15% above normal in April but continue to weigh on petroleum prices — will continue to diminish in the first half of 2021. While gasoline demand should begin to recover in March, it will reach only about 90% of the 2019 level of 9.31 million b/d.
"Overall, we see an improving environment, yet believe there needs to be more market rebalancing," Morgan Stanley said in a Dec. 15 research report, noting there could be a near-term risk to demand and margins by the recent resurgence of coronavirus cases in the U.S. "There also needs to be more refinery closures (we estimate a further 1.5 million b/d to 2 million b/d for a total of 4 million b/d to 4.5 million b/d in a conservative post-COVID demand scenario)."
According to Platts Analytics estimates, 4.7 million b/d of U.S. refining capacity will be offline in January 2021, up from 4.57 million b/d in December.
High grade or high yield?
Grande said he is "more cautiously optimistic than confident" about a petroleum market recovery. While some oil refiners retain their investment-grade credit ratings for now, they risk downgrades if the market does not improve quickly enough, he said.
Investment-grade companies have issued more than two-thirds of the $14.80 billion of debt that the seven largest U.S. refiners added to their balance sheets. With refining margins in the gutter and debt accumulating on balance sheets, leverage ratios have soared.
More diversified members of the group have offset some of the severe pandemic-driven losses of their refining segments with more stable earnings streams, but "this doesn't really work if the refiners are never profitable again," Grande said. "[Phillips 66 Partners LP] is cash flow positive because Phillips 66 pays them to use their assets for their refining business, which is cash flow negative."
According to a Dec. 11 analysis by investment bank Tudor Pickering Holt & Co., Phillips 66 is the only member of the group capable of paying down its incremental debt using free cash flow after dividends from 2021 through 2023. Marathon Petroleum can pay back around three-quarters of its incremental debt if it cuts its dividend by 50%, they concluded, adding the company plans to pay down some debt with proceeds from the sale of its convenience store business. Executives are still weighing how much debt to repay, but they plan to return a substantial amount to shareholders. Most of Valero's free cash flow goes to pay its dividend, so the company can only afford to repay 9% of the $5.46 billion of incremental debt it issued this year. The analysts predict PBF, which has issued more than $3 billion in incremental debt, will be free cash flow negative through 2023.
"Liquidity should be sufficient to carry [PBF] through 2021, but the absence of a recovery in the second half of 2021 could lead to significantly tighter liquidity thereafter," Fitch Ratings analysts warned Nov. 16, noting that PBF's revolving credit facility matures in 2023.
Refiners face a "tough choice, given the importance of both maintaining the dividend as well as repairing the balance sheet," Tudor Pickering Holt analyst Matt Blair said in a Dec. 11 email. "As long as the general trend is improving, I think refiners will try to hold onto the dividend and wait a bit to repay debt."
For now, it appears that the debt the investment-grade refiners are carrying into 2021 has not spooked bond investors.
"Refining looks like a tough business to be in for quite some time to come, but bondholders clearly see some levers the [investment-grade companies] can pull in the interim," said LCD director John Atkins. "They are giving the space the benefit of the doubt."
Biofuel blending costs march higher
U.S. refiners with high-complexity facilities are better placed to handle low margins and can survive a slow multiyear demand recovery, analysts agree. But biofuel markets pose another near-term challenge.
"Refineries that focus on costs, local markets, and integration with petrochemicals or transformation into bio-refineries will be well-placed to survive," S&P Global Platts Analytics said in a special report titled "2020 Review and 2021 Outlook."
As demand recovered from a second-quarter bottom, refiners' discipline has kept refinery utilization in the mid- to high-70% range for the back half of 2020, which has been supportive of margins, but not enough to avoid the shuttering of about 900,000 b/d of North American refining capacity. Looking ahead, U.S. biofuel policy threatens to increase costs, which might bring more closures.
"We expect an uptick in U.S. biofuel use in 2021 as ... fewer refineries are relieved of their blending requirements through hardship exemptions," said Corey Lavinsky, a biofuels analyst at Platts Analytics.
Under federal law, finalized 2021 renewable fuel volume obligations, or RVOs, were due by Nov. 30, but the U.S. EPA has not yet proposed them. "That brings additional uncertainty into the market," he said. "Refiners do not know how much blending will be required to meet their renewable volume obligations. This usually results in an increase in RIN prices."
RINs are credits that refiners or other obligated parties must purchase if they are unable to meet RVOs.
Biofuel demand growth and regulatory uncertainty have prompted some companies to invest in producing the lower-carbon fuels.
Credit Suisse analysts said Dec. 17 they expect projects announced by Valero, Marathon Petroleum, Phillips 66, CVR Energy and HollyFrontier to begin operating over the next six months to four years, which will both add to their non-refining earnings stream and reduce their RINs exposure.
HollyFrontier already meets 50% of its RVOs by blending within its system. And upon completion of its renewable diesel projects at its Cheyenne, Wyo., and Artesia, N.M., refineries in early 2021 it will be "RIN neutral" internally and does not expect to purchase RINs. Tudor Pickering Holt analysts noted all of HollyFrontier's incremental debt funds its renewable diesel plans.
But rising RIN costs will remain an expense for the sector into 2021, as observers expect the incoming Biden administration to further biofuel blending for transportation fuels.
Janet McGurty is a reporter for S&P Global Platts. S&P Global Market Intelligence and S&P Global Platts are owned by S&P Global Inc. LCD is an offering of S&P Global Market Intelligence.
This S&P Global Market Intelligence news article may contain information about credit ratings issued by S&P Global Ratings. Descriptions in this news article were not prepared by S&P Global Ratings.