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Execution drives Q2 US merchant refiner earnings as sector rakes in billions


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Execution drives Q2 US merchant refiner earnings as sector rakes in billions

During the second quarter, analysts had broadly expected U.S. merchant refiners to benefit from domestic crude oil discounts and improved crack spreads. Those expectations materialized as eight of the largest U.S. refiners grew second-quarter adjusted earnings year over year by a collective $2.40 billion, but some companies were unable to take full advantage of the tailwinds currently behind the industry.

During the first half of the year, growing domestic crude oil production and pipeline bottlenecks pushed domestic crude oil prices lower, providing U.S. refiners with cheaper feedstock amid rising gasoline and distillate prices.

From the first quarter to the second quarter, that average discount of West Texas Intermediate to Brent crude oil widened to average 64.6% higher at $7.10 per barrel, and reached $11.69/bbl during the second quarter.

At the same time, the Midland crude oil discount to WTI blew out from an average of 14 cents/bbl during the first quarter to $8.02/bbl in the second quarter.

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Meanwhile, heating oil and RBOB gasoline futures climbed 8.1% and 13.2% higher, respectively, to average $2.15 per gallon and $2.11/gal.

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Phillips 66 and Andeavor beat Wall Street expectations by the widest margin. Both companies reported improved refining margin per barrel and higher refinery utilization, but Phillips 66 said its refining fleet achieved 100% utilization of capacity.

Marathon Petroleum Corp., which expects to close on its acquisition of Andeavor on Oct. 1, also cited improved crack spreads and wider crude oil differentials.

Despite an April 19 fire at its Texas City refinery, Valero Energy Corp. narrowly beat expectations as it benefitted from domestic crude oil discounts relative to Brent and higher distillate margins.

Meanwhile, HollyFrontier Corp. blamed the March Woods Cross refinery fire for increasing costs and reducing refinery throughput, hindering its ability to capture widening margins. CVR Energy Inc. also cited increased operating expenses and lower crude oil throughput as it missed analyst estimates by a wide margin.

Delek US Holdings Inc. narrowly missed estimates as analysts blamed low margin capture at some of their facilities. However, analysts noted widening crude oil differentials could provide a tailwind in the third quarter.

"So far in Q3, the lagged [Midland-to-Cushing] differential is just under $12 [per barrel], well above [Delek's] realized Q2 differential of just $3/bbl. This factor alone could represent a [roughly] $170 [million] tailwind in Q3, although of course there are plenty of other moving parts including lower gasoline cracks and brutal [West Texas Intermediate] backwardation," Tudor Pickering Holt & Co. analysts wrote in an Aug. 8 note.

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Most refining equities outperformed the broader market the day they released earnings, with Marathon and Valero standing out on a percentage basis. Of the three stocks that missed analyst expectations, only Delek outperformed the broader market.

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During conference calls discussing results, executives told analysts they expect a favorable business environment looking ahead as crude oil pipeline bottlenecks persist and the industry anticipates looming marine fuel sulfur regulations.

"Whether we can repeat a $1.3 billion quarter or not, I can't forecast that for you today, but I do think refining is going to do well coming into the third quarter," Phillips 66 Chairman and CEO Greg Garland said July 27.

Executives outlined different strategies for managing the expected windfall of cash, but broadly said they would maintain the capital allocation strategies they had previously outlined.

Valero executives declined to commit to an increase in their dividend, citing the cyclical nature of the refining business.

Phillips 66 executives suggested they would pay down some of the debt the company issued to help fund some of the $3.28 billion in stock it repurchased from Berkshire Hathaway Inc. in February.

HollyFrontier executives said they would build cash reserves as they explore acquisition targets, while Marathon Petroleum executives expect its pending acquisition of Andeavor will produce even more cash to fund future share repurchases.