Skinny and sweet: U.S. refiner earnings depend on the oil diet

NEW YORK - 26 April 2018: Smaller independent refiners with less complex facilities are surging in the stock market of late, as investors expect strong earnings growth thanks to the recent fall in price of their primary cost - light, sweet crude oil coming out of West Texas.

Over the last 20 years, the nation’s biggest refiners spent billions building units capable of turning heavy, sour crude into gasoline, diesel fuel and other products.

But the U.S. shale revolution has boosted crude production to a record 10.5 million barrels per day, upending the global oil market by adding millions of barrels of very light crude to the supply mix. A majority of that new production is light, sweet West Texas crude.

Recent trends have turbocharged this shift: full pipelines in West Texas, where light U.S. oil originates from, have depressed prices for Midland, Texas, crude WTC-WTM to more than three-year lows. On the other hand, OPEC production cuts and supply issues among big producers of heavy crude like Venezuela and Mexico have raised the cost of heavy, sour oil.

That gives an advantage to some independent refiners equipped for lighter crude, which is less complicated to process. Investors have been buying up independents with less complex refineries like Delek US Holdings Inc (DK.N) and HollyFrontier Corp (HFC.N), as they could benefit from low Permian prices for several quarters to come.

“To have your major feedstock be in such abundant supply is unequivocally a positive for U.S. refining,” said Matthew Blair, a Denver-based refinery analyst with Tudor Pickering & Holt.

“The benefits of that are going to be unevenly spread through the group.”

To be sure, shares of most refiners have been rallying, as refining margins CL321-1=R recently hit a five-month high and U.S. gasoline demand is near record levels. Results are likely to show strong profits across the sector, beginning with Valero Energy Corp (VLO.N) on Thursday.

However, over the last three months, as Permian crude has slumped, Delek shares have soared, returning more than 30 percent, with HollyFrontier close behind at 25 percent, besting all other independent refiners. The two are also ranked highest among U.S. refining companies in the Thomson Reuters earnings revisions model, which looks at analyst revisions for earnings and revenue and recommendation changes.

“Light” grades are distinguished based on what is known as API gravity - a measurement of density. A majority of U.S. shale crude output growth is at the top of the scale with API gravity above 40 degrees.

More complex U.S. refineries are configured to run on grades of crude with an API gravity of around 31-33 degrees. Most refineries cannot simply take in only lighter crude, because it would affect operational efficiency.

“In order to process more shale from here on, refiners will need access to more heavy crude too,” Morgan Stanley analysts said in a note last week.

About 70 percent of Delek’s crude slate is based on Permian crude, according to a March company presentation. The company did not respond to a request for comment.

HollyFrontier is less reliant on the Permian - it accounts for 35 percent of its crude slate, said Craig Biery, director of investor relations.

However, its imports of heavy crude have exclusively been discounted Canadian oil in the six months through January, according to U.S. Energy Information Administration data. The company has existing pipeline commitments for that oil, so it can take full advantage of those discounts, said Barclays analyst Paul Cheng.

Valero, Marathon Petroleum Corp (MPC.N) and Andeavor (ANDV.N), three of the largest independent refiners, have had more downward earnings revisions over the last 30 days than other independent refiners, according to Thomson Reuters data. Those refiners, with multiple facilities on the Gulf Coast, rely more on imports from Latin America.

For the six months through January, Valero imported 6 million to 7 million barrels a month, and only 10 to 15 percent is from Canada, according to the EIA, with the bulk from Mexico, Venezuela or other Latin American nations.

The spread between international benchmark Brent crude and U.S. crude WTCLc1-LCOc1, a proxy for import costs, has surged to more than $6 a barrel - the biggest premium seen all year.

Valero has only about 25 percent of its crude slate directly linked to U.S. crude, and its exposure to Midland is even smaller, Cheng said. A March investor presentation says sweet crude makes up an average of 17-37 percent of its Gulf refineries. The company declined comment.