The price of petrol has risen in recent months and general fuel demand looks likely to recover more strongly next year. But the companies that refine crude oil to make that fuel are not doing well. The outlook for US refineries does indeed look quite bleak.
That’s a conclusion from a new report by Citigroup analyst Prashant Rao, who downgraded several stocks in the sector amid a series of negative trends.
A major problem is that companies around the world are building more refineries, but demand is not rising as quickly. That is generally a bad sign for refineries and could be a precursor to weak margins. By the end of 2024, capacity expansions could exceed refinery closures or conversions by 1.1 million barrels per day, and demand growth is unlikely to fill that gap, Rao expects.
The second problem for US refineries is that they have lost some of their geographic advantage. For years, oil produced in the US has been traded for less money than oil produced elsewhere. West Texas Intermediate crude oil, the US benchmark, typically traded for a few dollars less than Brent crude oil, the international benchmark. Part of that has to do with the difficulty of transporting U.S. crude — pipeline capacity has grown slowly in some key areas. Crude oil can build up in hubs and storage tanks and drive prices down.
But oil inventories are dwindling as producers have cut back on new projects and WTI is trading at a smaller discount to Brent. US refiners like wide spreads because they can buy oil cheaply and sell products abroad at higher margins. Now that advantage is disappearing and Rao expects the trend to continue. WTI traded less than $4 on Brent on Thursday, down from more than $7 in 2018.
In general, investors have reduced the amount they are willing to pay for refineries, Rao writes. Their valuations for the stock based on their mid-cycle gains are 20% lower than in 2019, he estimates.
Partly on the basis of that revaluation, Rao thinks that various refineries are now less attractive investments. He relegated
Delek US Holdings
(ticker: DK) to sell from neutral, and
(PSX) to Buy Neutral. On Thursday, Delek was down 2.6%, the CVR was down 3.1% and Phillips 66 was down 1.9%.
In the longer term, Rao believes that refinery stocks will need other properties to make them attractive. He loves
(VLO), for example because it has a promising low-carbon energy business. Recently, the company has been earning money from renewable diesel, among other things. Valero lost 0.8% on Thursday.
Rao also upgraded
(MPC) because he believes the company has made progress in reducing costs and improving return on capital. Nevertheless, he lowered his price target for the stock to $67. It traded 0.5% to $58.35 on Thursday.
Write to Avi Salzman at firstname.lastname@example.org