By John Auers and Ryan Couture
With Super Bowl 50 putting the finishing touches on the 2015/16 season this past Sunday, we now know who rules the roost in the NFL. Our congratulations go out to those surprising Denver Broncos, Peyton Manning, their dominating defense and all their fans. Our condolences also go out to the fans of the Panthers and all of the teams that fell by the wayside before Sunday’s finale. Similarly, with earnings reports coming in, we also are finding out who the winners were in the petroleum industry in 2015. From a sector standpoint, the independent refiners certainly dominated the playoff brackets, as strong product demand, incentivized by low prices, led to healthy margins. These same low prices inflicted damage on the upstream sector, who fared even worse than our hometown Cowboys (though not by much) over the past year. Companies operating in the midstream sphere also have been hurt by the lower price environment, while integrated companies are a bit of a mixed bag. Just as in the NFL, where some divisions were much stronger than others (see NFC North and West vs. NFC East and AFC South), so too did geographic placement matter regarding the performance of refiners, with those having facilities in the West and parts of the Midwest doing better than their Eastern counterparts. But the past is in the rearview mirror and Vegas is already setting odds on who will win Super Bowl 51 in Houston. In the same way, the petroleum industry, centered in that very same city, is preparing for an unknown future. Certainly refiners are the favorites to continue their strong performance, while producers will have to find ways to weather what may well be a “lower for longer” crude price environment (and with no high first round draft choices as consolation). In today’s blog, we take a look at the 2015 “season,” focusing on the independent refiners and integrated majors, and provide some thoughts on the seasons to come in the petroleum industry.
Defense Dominates the Super Bowl; Low Prices Dominate the “Oil” Bowl
While low oil prices clearly are not good for producers, their impact on refiners is much more complex and so far has been very good by most measures. As we have discussed throughout the past year, the impact that low prices have had on product demand has been significant (Sign Blogs 1, 2, 3, 4, 5). With crude prices hovering in the mid-$30s per barrel, and prices at the pump falling below $1.50/gal in many places (sorry, California), consumers have chosen to drive more, spurring gasoline demand and leading to the biggest bump in U.S. consumption since 1976. Distillate demand growth has not been as robust, due in large part to its dependence on overall economic performance, which has been sluggish. This has resulted in some interesting dynamics, with diesel prices falling below gasoline (Diesel Oversupply 1 and 2/ Diesel Doldrums Blogs), and automakers profiting by booming sales of high profit margin trucks, SUV’s and other larger vehicles.
The positive impact low prices have had on demand has led to strong refining margins, not only in the U.S., but across the globe. This has helped to stave off the grim reaper for many European refiners (at least for now), and also buoyed the earnings of Asian refiners significantly. Low energy prices also impact refiners in other ways, with the impacts dependent in many cases on geography. Lower natural gas prices have been very positive for international refiners, while a declining “domestic crude discount” (resulting from decreased U.S. crude production) has actually been negative for domestic refiners. In both cases, these factors have closed the gap between the performance of U.S. refiners and those in developed Europe and Asia, as shown in the figures below. Note Figure 1 margins are based on Platts netback calculations, based on models provided by Turner, Mason. U.S. margins are a weighted average of the U.S. refining system.
Having All the Eggs in One Basket Can be a Good Thing (As Long As it’s a Good Basket)
Just as a focus on defense allowed Denver to overcome an anemic offense, independent refiners focused only on that activity were able to thrive in a 2015 environment which was very difficult for companies focused on other sectors of the petroleum industry. The four largest independents, Valero, Marathon, Phillips 66 and Tesoro have all reported their 2015 earnings, and all four have shown some of the strongest performance in years. In the figure below, we show a graph of earnings for the past five years.
Location, Location, Location
One thing to highlight is that location played a big part in the performance of specific refiners in 2015, as is usually the case. For refiners with exposure to the California market, margins were very high over the past year, as problems at some refineries, particularly the year-long outage of the fluid catalytic cracking unit at ExxonMobil’s Torrance refinery resulted in regional product shortages and high margins. These margins were not only the best in the U.S., but also the world throughout 2015. The two largest independent refiners, Valero and Phillips 66, report their margins and averaging their results for respective regions, you can see the trend over the past several years. The only one of the four large independents who did not benefit from the high West Coast margins was Marathon, which has a predominantly Mid-Continent and Gulf Coast focus.
One thing to note in the above figure is the weaker performance over the last quarter. While the annual numbers show stronger performance in 2015 than in 2014 for three of the four companies (P66 falling short), all four companies showed much lower 4th quarter profit, as they experienced a combination of the domestic crude discount compression we noted earlier, along with the impacts of accounting factors, such as lower of cost or market (LCM) adjustments.
Significant Variance Among Majors
For the integrated majors, though, their results were far less rosy, as seen in Figure 5. All four saw dramatic declines in their overall profit in 2015. Each of the companies has a significant upstream component that has increasingly become the primary breadwinner in most cases. While this resulted in record performances when crude prices stayed above $100 per barrel in the 2011 through 1H 2014 timeframe, this exposure has been a serious drag over the last 18 months as a result of the oil price crash. The most upstream focused majors, BP and Chevron both posted losses in the 4th quarter of 2015. In Chevron’s case, this was their first quarterly loss since 2002, while BP experienced their largest ever annual loss last year.
Being “integrated” though, all four companies have refining assets spread globally, and for the first time in a while refining profits played a significant part in the company’s bottom line. Figure 6 shows how big a part it played in each company’s bottom line. Note that there are other components to a company’s total earnings that were omitted for simplicity in this figure, such as chemicals, marketing, etc.
Looking at the performance of the upstream portion of the integrated companies helps explain why independent upstream companies have slashed budgets and announced tens of thousands of layoffs. The question remains, what will 2016 bring? With some questioning the oversupply situation for both crude and refined products coming to a head, will the industry as a whole be in for a major upset or will refiners continue to thrive while the other sectors struggle? How will Iran’s reintegration into the market impact the prices as we move forward, and what decisions (or indecisions) will come out of the June OPEC meeting? And what will happen to U.S. producers and production if prices remain where they do and what will this mean for refiners? One thing is clear, 2016 should be an interesting year for the oil industry. And we won’t have to wait through seven months of offseason and exhibition games for the excitement to begin as we do for the NFL. In a future blog, we will look closer at the performance of the midstream and upstream and see what portends for them in 2016 and beyond.
We will be releasing our 2016 Crude and Refined Products Outlook later this week, and in it we will discuss in detail our forecast for all of the key factors which will determine the winners of the petroleum Super Bowl in the years to come. Included in The Outlook will be projections of global and regional petroleum supply and demand, a detailed forecast of both crude and product prices, an assessment of regulatory and policy impacts, along with the analysis of other factors which we believe will be important in determining the directions of petroleum markets. Additional details about The Outlook are provided on our company website at turnermason.com. And finally – my prediction for Super Bowl 51 – Pittsburgh 24, Seattle 21.