With a tailwind provided by federal tax reform in the U.S., analysts say macroeconomic factors will continue to drive some U.S. refining equities to outperform the broader market, but experts debate the extent to which those factors will continue to boost corporate earnings.
In a March 20 report, Barclays analysts noted that since 2009, U.S. refiners have ranked sixth in performance out of approximately 130 top-performing subindustries, leaving some long-term investors concerned about volatility and overvalued shares.
But the analysts argued that macroeconomic trends favor earnings and cash flow growth at U.S. refiners "at least through 2021."
U.S. refining equities have varied widely in their performance versus the broader market, with Andeavor, formed from Tesoro Corp.'s acquisition of Western Refining Inc., outperforming all U.S. refining equities.
Barclays noted that while "fairly well understood and accepted by investors," the benefits of low Canadian heavy crude oil prices, which the analysts expect to last through the second half of 2019, and impending marine fuel sulfur standards are not fully priced into U.S. refining equities.
"We believe [HollyFrontier Corp.] and [Marathon Petroleum Corp.] are best positioned due to their substantial direct pipeline access to [West Canadian Select crude oil]," the analysts wrote.
In the short run, the analysts wrote there is not as much consensus around macroeconomic drivers.
Among them, the analysts wrote that the Brent-WTI crude oil differential may have reached its narrowest point in the cycle and should begin to widen in the coming weeks to reach between $5 and $6 before year-end and average $7 in 2020 to 2021.
When the market prices domestic crude with a delivery point at Cushing, Okla., at a discount to the Brent crude produced in the North Sea, it benefits U.S. refiners, who achieve wider margins through their access to cheaper crude and global petroleum product markets.
The analysts also expect margins to improve in the near term as U.S. gasoline and distillate inventories begin trending lower, driven by the transition toward gasoline grades for the summer driving season.
Speaking at the American Fuel and Petrochemical Manufacturers annual meeting in New Orleans on March 13, Wood Mackenzie vice president of refining, chemicals and oil markets Alan Gelder cautioned that not all U.S. refiners are in a position to benefit from these trends.
"The key message is there is no such thing as a single refining margin: It depends on where you are … what you're processing," Gelder said. "[The relative profitability of refiners] doesn't change very much. If you get yourself into the top quartile, year on year, you stay there. If you're in the bottom quartile, … once a dog it's always a dog, unless you're going to spend a lot of money. In between it oscillates depending on the light-heavy [crude oil] spreads, the [crack] spreads."
Gelder said while as a group U.S. refiners are in a strong position relative to the rest of the world, "there's a wide disparity driven by location and … crude [oil] advantage."
The federal government divides the U.S. oil and petroleum market into petroleum administration for defense districts, or PADDs.
Gelder said that refiners located in PADDs 2, 4 and 5 make the most money given their position in the market, while those in PADDs 1 and 3 are more challenged.
The bulk of the U.S. refining capacity is concentrated along the Gulf Coast.
Gelder argued those refineries do not benefit as much from the widening WTI-Brent spreads as much as inland refineries.
"What we need to see is actually a WTI waterborne [price] quote emerge," Gelder explained. "The trouble with [Cushing, Okla.] for a global reference [price] is Oklahoma isn't remotely near the coast. And it's all for the challenges around the infrastructure of getting Cushing barrels down to the coast and off on the water [that] not all of this Brent-WTI differential will be captured," Gelder said.