Oil refiners are heading into earnings season on a strong run. The pandemic is easing in much of the world, leading to higher demand for gasoline and aviation fuel. The natural gas shortage that’s causing gas prices to rise around the world is causing some gas-users to switch to oil products for generating electricity, further boosting demand. And those trends are boosting the bottom line: Refiners are likely to post their first quarter of solidly positive earnings since the pandemic started.
(ticker: PSX) is leading the pack, up 23%.
(VLO) has risen 19%,
(HFC) is up 13%, and
(MPC) is up 11%.
“It makes for a good short-term view,” said Citigroup analyst Prashant Rao in an interview.
But the medium and longer term isn’t as rosy for refiners. There are at least three negative trends that could slow their rebound, and even send the stocks in reverse.
The most immediate danger is that high prices for oil products will start to erode demand for those products. High oil prices could cause people to use less of it, or government policies meant to curb high costs could force changes in behavior.
“Right now there’s a very, very positive environment,” Rao said. “But there’s some fears around what happens later in the winter.”
Another problem is that a quirk in the market that has historically helped U.S. refiners isn’t helping them quite as much anymore. There has been a spread between the international price of crude oil and the U.S. price for several years. The international price, Brent, has traded at higher levels than the U.S. one, West Texas Intermediate, or WTI. That’s because there was an oversupply of U.S. oil. U.S. refiners were able to buy U.S. crude at low prices and process it into products that they sent overseas, making a wider margin than their international competitors.
But U.S. producers have been pumping out less oil this year because they’re more focused on fixing their balance sheets than drilling new wells. The spread between Brent and WTI is now about $3, versus $6 two years ago.
The third challenge is potentially an even more consequential and long-lasting one. More refineries are being built around the world, at a rate that is outpacing demand for oil products, Rao said. The pandemic may have slowed oil demand, but it didn’t slow refinery projects enough. So even as refiners work to get back to their prior operating levels, new competitors are getting close to opening.
“Because you lost a year of oil demand, you had too many refiners in the world,” he said. “And now there’s new refineries in the Middle East and China coming on top of that. You’re going to have excess capacity for multiple years is what it looks like.”
Refining capacity is likely to outpace demand by 1 million to 2 million barrels a day in the next two to three years, Rao said. As in any industry, too much capacity hurts prices, and the analyst expects refiner profitability to “take a step down from where it was before the pandemic.”
Rao still likes some names. In particular, Valero still has particularly profitable operations, and is among the furthest along in transitioning to renewable fuels, including renewable diesel. In the next two to three years, about a quarter of its cash flows are likely to come from non-petroleum sources, he said.
Write to Avi Salzman at firstname.lastname@example.org
Read More: Oil Refiners Have Gotten a Boost from the Power Crunch. It Won’t Last.