By Ryan M. Couture and John R. Auers
Back in February, we took a look at how refiners and integrated majors fared in 2015, the first full year since oil prices cratered. In fact, while that year was very difficult for the upstream segment of the petroleum industry, it was quite good for refiners, with refinery margins and company earnings hitting records by some measures. But 2016 hasn’t been as kind, and borrowing the title from Bananarama’s 1980’s hit, it has actually been a “Cruel Summer.” This is despite continued strong demand for gasoline in the U.S., which is well above both last year’s strong numbers and the “all-time record” demand set in 2007. Unfortunately, supply growth has been even stronger, as refiners sowed the seeds for this year’s downturn by cranking up rates, resulting in margin crushing inventory builds. This has shown up in the recent financial results, which we will review in this week’s blog, along with what might be expected in the coming months.
“Things I can’t understand”
The big story in early 2016 was the decline in crude prices to lows not seen since the early 2000s. Average crude oil prices for many of the common grades sat at or below $35/bbl for Q1. While on the surface this should be great news for refiners (after all, low prices mean declining feedstock costs and growing demand), refining margins fell well below the record levels refiners enjoyed during the summer of 2015 and continued to languish even as spring moved into the summer driving season.
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Those record margins last year resulted largely from surging demand following the fall of crude prices in late-2014. This in turn prompted refiners to put the “pedal to the metal” and run all-out, deferring maintenance and keeping utilization high. While demand continued to be strong in 2016 and has reached record levels for gasoline, refiners’ production rates have been higher. This has caused product inventories to build throughout the second half of 2015 and accelerate in 2016.
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Despite the high stock levels, refiners have continued (until recently) to run at near record rates. This was not isolated to the U.S. either, as international refiners continued to pile up product storage volumes as well. Initially, the higher run rates did cause crude inventory growth to reverse, and helped push crude prices up from their lows in the first part of 2016. Ultimately, though, the market realized that it was simply a movement of inventory surpluses from the crude side to the product side, and the crude rally that we saw earlier in the summer has ended. What’s worse, with fall approaching, marking the end to the peak summer driving season, working through these inventories will pose an even greater challenge.
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As we enter into the third quarter, U.S. inventories of gasoline remain at the record levels first reached in February, while distillate stocks remained at or above the historic 5-year range, as shown in the figures below. Refineries have paid lip service to making run cuts, but so far crude throughput has stayed near record levels, as everybody is waiting for the “other guy” to go first. Many seem confident that when the next refinery maintenance season comes around, stocks will be reduced. There is also the chance that unplanned outages could help tame the inventory builds. In the last week there have been several of these, notably the fire at the gasoline and diesel producing H-Oil unit at the Motiva Convent refinery last Friday, and flooding related impacts at other Louisiana plants. With the hurricane season still in the early stages, weather could play an even bigger role in USGC utilization over the next few months. But with inventory levels as high as they are, and demand likely to cool, it will likely take a series of these type of events to move the market in a bullish direction.
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“You’re not the only one”
Amid the low oil prices, producers have been doing their best to control the losses and wait for a price recovery. Independent refiners have enjoyed the bump in demand that low prices have brought, supporting higher margins and incentivizing throughput. For the integrated majors, though, coming off years focused primarily on upstream, their recent profits have been weighted heavily towards any profit the downstream (and chemicals) divisions can muster. The hope is that those profits can offset the upstream losses. This year has been no different than last, as seen in the figure below.
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The integrated majors (ExxonMobil, Chevron, Shell and BP) all reported upstream losses for Q1, with only ExxonMobil reporting upstream profits in Q2. This has made ExxonMobil the only one to have upstream profits thus far in the first half of 2016, albeit only by about $200 million, a relatively small sum compared to the billions usually generated. Overall, upstream performed slightly better in Q2, but it will take some unforecasted price improvements later in the year for the sector to return to the black.
Contrasting this to the major’s downstream sectors, and all have generated a reasonable profit. Given the current inventory situation as we head into the fall and winter, a historically a low margin period, the trajectory for 2016 will be lower than 2015 was. That said, given the even poorer refining margins this year, downstream will still carry the majors into 2017 just as it did into 2016.
“Trying to smile”
All of the major independent refiners (P66, Valero, Marathon, PBF and Tesoro) were down year on year in the first quarter, as the specter of inventory levels and the seasonally low winter margins settled in. While the financials were much stronger in the second quarter, as margins improved and companies didn’t have to contend with the lower cost of market write-downs due to the crude price drop in the first quarter, the first half of 2016 leaves them well behind their 2015 trajectory as seen in the figure below.
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Among the independents, there were several things that echoed loudly. Utilization was up, even during the traditional spring turnaround season. Tesoro reported Q1/Q2 utilization of 89% and 92%. Valero reported 96% utilization in Q1, while P66 reported 94% Q1 and 100% Q2 utilization. With these kinds of numbers, it is no wonder inventories have not fallen. Lower crude differentials impacted profitability across the board. P66, Marathon and Valero echoed the importance of continued product exports to balance product demand. Marathon announced 325 MBPD of exports, predominantly to Latin America, while Valero had nearly 400 MBPD. P66, with a comparatively small 125 MBPD of exports highlighted the importance of continued demand in Asia and Europe as well as Latin America. The increasing dependency on these markets, especially in Latin America, for product outlets, highlights a potential weak point were demand to fall.
“My friends are away”
The aforementioned inventory overhang has impacted refining margins in 2016. The reported refining margins for the first half of 2016 have thus far been some of the weakest in the past several years. While it was expected the sky-high West Coast margins in 2015 (due to the Torrance FCC outage for most of the year, and into early 2016) would come down with the restart, lower margins were reported across the board. These correspond with our own internal margin calculations, which show PADD 1 refiners feeling the greatest pressure.
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Looking at the international margins, the situation is not much different, with global margins sagging under the inventory overhang.
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gRIN and Bear It
While all refiners have grumbled, the independent refiners have continued to maintain a vocal opposition to the RFS program. With the latest RFS requirements for 2016 and beyond (talked about here), the cost of compliance for those refiners has begun to rise. PBF Energy’s Tom O’Malley was particularly outspoken about the need for reform, saying the program was fundamentally broken, and at the very least the liability for compliance should be with the gasoline blender, with transparent costs similar to California’s system. RIN prices have continued to rise, and depending on the outcome of the final 2017 regulations, could become an even more significant challenge and cost.
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“Now you’re gone”
The first two quarters of 2016 have been much more “cruel” to refiners than 2015. As we head into the second half of the year with record inventories and traditionally lower demand, the weaker margins are unlikely to dramatically improve. Continued strong demand and economic improvement not only in the U.S. but in key export markets will be critical to ensuring that margins stay strong and inventories stay in check. What decisions (or likely, indecisions) that OPEC makes could have some say in whether the crude prices and subsequent differentials rise, helping some regional refiners improve their margins, as long as higher prices don’t chew into demand. Any improvement in prices will be integral for the majors, who have become increasingly dependent on their upstream sectors and are now struggling to stay in the black. For both the independents and the majors, the outcome of the 2017 RFS regulations could make or break them as RIN prices continue to slowly climb.
Despite the “cruel, cruel” market refiners face now, Turner, Mason & Company continues to believe U.S. refiners are well positioned to maintain their leadership position in the world product markets. But the competitive environment is constantly evolving, driven by changing crude supply and product demand patterns, construction of new plants, closures of others, new government regulations and any number of other factors. We continually monitor these developments and make adjustments to our industry models to reflect the changes. This analysis is used in our biannual Crude and Refined Products Outlook that was published in July. Included in The Outlook are projections of crude and refined products demand and prices, as well as an analysis of RINs and impacts of potential policy decisions. For more information on our products or on specific consulting engagements we may be able to assist with, please visit our website or give us an email or call.