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Refineries Delight In Americans On The Road Again

Posted: Feb 10, 2009 13:04 PM by Eugene Bukoveczky

Tickers in this Article: SUN, VLO, COP, BP

Despite reporting better than expected results for the final quarter of 2008, management at Sunoco (NYSE:SUN), one of the nation's largest refiners, states expectation of a "challenging" market for refined products in 2009, as the weak economy continues to dampen demand for gasoline.

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Analysts appear to agree with Sunoco's assessment and forecast significantly lower earnings for 2009. Compared with the $6.63 per share Sunoco earned in 2008, analysts generally predict that the company's earnings to fall to the $3.66 range this year. (For more on analyst expectations, be sure to read Analyst Forecasts Spell Disaster for Some Stocks.)

However, recent evidence suggest that such pessimism may be a bit dramatic.

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Last Year's Spike, This Year's Glut
Last year's oil price spike was not good for the refinery industry. As crude oil prices soared, margins were squeezed. The concurrent spike in gasoline prices caused consumers to ease back on the gas pedal, which resulted in the first decline in total U.S. gasoline consumption in 17 years. While the price of gasoline has since tumbled, the recession has prevented demand from fully recovering. Thus, inventory levels remain high. At the end of January, gasoline supplies stood at a 44-week high.

Production Cuts Boost Prices
Since bottoming at 87 cents per gallon in mid-December, wholesale gasoline prices have managed to stage a remarkable 42% rally, despite sluggish demand and supply excess. In large part, the price rally can be attributed to the impressive feat of self-regulation by the industry, which has involved scaling back production pending a resurgence of demand.

Currently, at least seven U.S. refiners have announced production cutbacks. Valero Energy (NYSE:VLO), the largest U.S. refiner, has idled as much as 30% of its gasoline production. Meanwhile, number two player ConocoPhillips (NYSE:COP)has taken about 15% of its refining capacity offline. However, the one notable standout remains BP (NYSE:BP). After sustaining significant hurricane and accident-related damage to its Gulf Coast refineries, the company boosted its refining capacity to 91% during the fourth quarter.

So far, the strategy of reducing production appears to have paid off by helping push refining margins back into positive territory. Thus, production remains economically viable.

Signs Of Recovery
Another positive development for the refinery industry has been the recent evidence of restored U.S. consumer demand for gasoline. Despite the recent uptick in pump prices, U.S. motorists appear to be returning to the roads.

On a year-over-year basis, national gasoline consumption is off by only one-half of one percentage point. Furthermore, the latest figures from the U.S. Energy Department suggest that demand is making a comeback. Total consumption for the week ended January 30 increased 4.2% over the previous week. If this trend continues, refiners could stand to regain some of the revenues that were lost due to the previous cutbacks in production.

The Final Word
Simply put, Americans appear to be driving again. Although it is unlikely that margins will return to the levels of 2006 and 2007, the worst may be over for refineries. (To learn more about stocks in this sector, be sure to check out our Oil and Gas Industry Primer.)

By Eugene Bukoveczky

Eugene Bukoveczky is a freelance writer and investment researcher. He holds a CFA designation and has spent several decades working in the investment business in places like Toronto, New York, London and Dubai. He currently resides in Nova Scotia, where, when not writing, he devotes his time to chopping wood, growing his own vegetables, riding his bike to the store, and thinking about other ways to reduce his carbon footprint.

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