Refiners Shouldn't Fear Oil Exports Yet

Even prior to the news last week that the government would allow exports of very ultralight oil or condensates, investors in the refiners had to consider the potential for future exports of oil as a major risk. Based on the news, Marathon Petroleum , HollyFrontier Corp , and Phillips 66 dropped for several days. The stocks had already traded relatively flat for a long time after peaking back in early 2013.

One has to wonder if the threat of exporting oil and the lowering of beneficial pricing differentials was already priced into the stocks. The Brookings Institution estimated that up to 700,000 barrels of ultralight oil could be exported starting next year. Does the drop in the above refining stocks provide a buying opportunity for these stocks, especially if the impact of relaxing the export restrictions isn't as severe as feared?

Differential fears
Refiners like Marathon Petroleum and HollyFrontier continue to benefit from selling refined products like gasoline at global prices based off the price of the higher Brent oil and buying the feedstock at domestic prices where differentials for West Texas Intermediate, or WTI, are currently $7. The company expects the following outlook for crude spreads:

Source: Marathon

Any reduction in these spreads will hurt earnings, especially between Brent, WTI, and Louisiana Light Sweet, or LLS. One important thing to understand about refiners is that profits are constantly shifting. Marathon Petroleum has seen wide swings in operating income per barrel of crude throughput over the last 15 years. The spread was fractionally profitable back in 1999, 2002, and 2009 while reaching above $10/bbl in both 2006 and 2012. The market shifts back and forth with the recent $5/bbl being roughly the average over that time period.

Another key point is that the refiners don't just refine crude oil. Marathon Petroleum has interests in a pipeline system of 8,300 miles, owns convenience stores and tons of infrastructure including refining systems with approximate capacity of 1.7 MMbbl/d and numerous terminals and tank farms. The amazing part is that the company has limited debt and a rock-solid balance sheet.

HollyFrontier leads the group with net cash of over $750 million providing the company with ultimate financial flexibility. The refiner operates five refineries with combined crude oil processing capacity of approximately 443,000 barrels per day, and is the most tied directly into refining.

In addition to refining, Phillips 66 operates a chemical segment that produces ethylene, propylene, and other olefin products that benefit from the low natural gas prices. As well, it has limited net debt of less than $1 billion.

Top oil producer
According to a Bank of America report, the U.S. became the world's largest producer of crude oil and liquids by producing 11 million barrels per day during the first quarter. The country passed both Russia and Saudi Arabia, but the production still isn't enough to push down global oil prices considering the geopolitical issues in other top crude producing countries like Iraq and Libya, and the U.S. still uses far more oil than it produces.

Investors need to consider that as oil production continues to grow the country will have economic reasons to export resources that can't be used or properly refined within our borders. At the same time, the infrastructure issues encountered by strong production growth will likely constrain regional prices. With the U.S. still importing 7.5 million barrels a day in the first quarter, the government will no doubt delay any meaningful oil exports unless the market forces it via wide spreads between domestic prices and Brent crude prices.

Bottom line
The recent slump in refiners appears vastly overdone considering the domestic oil supply continues to grow and the prospects for exporting all crude oil are far from assured. With strong balance sheets, low price to earnings ratios, and a supply/demand scenario not likely to change anytime soon, the refiners are worth a look on the dip.

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