US Midcontinent refiners are not in as bad shape as the recent drop in share prices and margins makes them out to be following the Seaway pipeline reversal announcement, analysts and market watchers said Thursday.
The unusually wide WTI-Brent spread that discounted WTI-priced crude purchases was already deemed unsustainable, though it has collapsed earlier than expected, they said. Some production from Canada and new US shale plays is expected to remain landlocked in the Midwest due to pipeline constraints, underpinning margins there.
"Crudes, e.g. some of the Bakken, Niobrara or Utica production, that cannot get to Cushing via pipeline will still trade at a $10-12/bbl discount vs LLS i.e. a $7-9/bbl discount to WTI based on rail logistics costs," said Credit Suisse analysts in a report Thursday.
"As management teams watch next year's profits shrink, we believe there is still more than enough free cash flow to support a decent yield...there is longer term upside," said the analysts, while cutting earnings forecasts for US independent refiners by 42%. "With EPS in freefall one year earlier than expected and macro uncertainty in Europe remaining center stage, share price appreciation could take some time, even if value remains."
In the meantime, "the market spoke yesterday," in the words of one industry source, who pointed out the sharp drops in the share prices of several WTI-related refiners: CVR Energy (down 16% on Wednesday and another 4.6% on Thursday to $17.53), Western Refining (down 13.5% and then another 9.8% to $12.10), HollyFrontier (down 10% and then another 3.5% to $23.93) and Delek (down 7% and then another 11.1% to $12.15).
The tighter spreads mean "from a profitability perspective, Midcontinent refiners relative to the third quarter results that we saw, they're certainly down," said Doug Aron, executive vice president and CFO with HollyFrontier, in an interview.
The company's refineries include: Artesia, New Mexico (100,000 b/d); Tulsa, Oklahoma (125,000 b/d); Woods Cross, Utah (31,000 b/d); El Dorado, Kansas (135,000 b/d); and Cheyenne, Wyoming (52,000 b/d).
HollyFrontier's share price was above $32 on November 8, when it posted record third-quarter earnings as the company's first quarter as a combined entity of Holly and Frontier coincided with strong refining margins due in part to the wide WTI/Brent spread.
"Medium-term, until that Seaway reversal gets to their full 350,000 b/d and really until even another pipeline project is announced...we still think there's more supply" destined for the Midcontinent between the Bakken Shale, Canadian oil sands production and the Permian Basin, said Aron. He cited expectations of 50,000-100,000 b/d of new production from each of those areas each year for the next several years. "Plus the Niobrara [Shale]...and a couple of the newer developing plays like Wolfberry and the Wattenberg and some others," he added.
"We think that we will certainly continue to see some differential between WTI and Brent. We never would have guessed that it would have gotten as wide as it did...but we also don't think that it's going to go away overnight," said Aron. "At $10 WTI-Brent spreads and the current gasoline and distillate margins we still have plenty of incentive to run our refineries full," he said.
The NYMEX WTI-ICE Brent spread ended the day Thursday at $9.29/b.
The Seaway "sale has occurred, and the mid-con refining stocks 're-calibrated' accordingly," said Deutsche Bank analysts in a report. They said until the WTI/Brent spread and margins stabilize, refiners "face a relative headwind after such strong performance."
"This group is lightly held (high proportion of hedge fund ownership) and the year is near a close; it may be a tough end for refining stocks," said Deutsche Bank.
