Cenovus Energy Trails Peers as Refining Riches Shrink

Energy companies with refineries such as Cenovus Energy Inc. (CVE) were the darlings of Canada’s oil patch a year ago. Now they’re out of favor with some investors as a 15 percent rise in crude prices squeezes refining profits.

Increasing shipments of oil by rail and new pipeline capacity are boosting supply to the U.S. Gulf Coast, easing a glut of crude oil and lifting prices and refinery costs for Canadian companies with U.S. Midwest facilities such as Cenovus.

“The margins aren’t what they were” for companies with refining divisions, John Stephenson, a portfolio manager at First Asset Investment Management Inc. who owns shares in Cenovus, said in a phone interview on Oct. 28. “In general, I prefer the names that aren’t as integrated right now,” he said, including Canadian Natural Resources Ltd. (CNQ)

Cenovus, an energy producer that owns stakes in refineries that process oil into products such as gasoline, is the third-worst energy stock this year among companies with a market value of more than C$2 billion ($1.9 billion), according to data compiled by Bloomberg. The Calgary-based company has declined 6 percent, compared with an 8.4 percent gain on Canada’s S&P/TSX Energy Index.

Canadian Natural, the nation’s largest producer of heavy oil which doesn’t own a refinery, has returned 17 percent this year.

Weaker Profitability

Cenovus is forecasting 2014 will bring weaker profitability for its refining unit, which had a 75 percent drop in third-quarter operating cash flow, Cenovus Chief Executive Officer Brian Ferguson said Oct. 24 in a telephone interview after the company reported results. One reason is that prices are no longer being suppressed by a glut of oil in a key oil-storage hub in Oklahoma.

“You’ve had a big increase in pipeline takeaway capacity out of Cushing down to the southern tier of the U.S.,” Ferguson said.

Cenovus said its drop in refinery returns was due to higher feedstock costs and lower crack spreads, a measurement of the difference between the prices of crude and products derived from it such as gasoline, diesel and jet fuel. The company owns half of two U.S. refineries operated by Houston-based Phillips 66: one in Roxana, Illinois, and the other in Borger, Texas.

Cenovus reported a 28 percent increase in third-quarter profit to C$370 million on Oct. 24, helped by rising production and unrealized hedging gains. Revenue increased 17 percent to C$5.08 billion.

Slimmer Returns

Husky Energy Inc. (HSE), another Canadian producer with U.S. refineries, is forecasting that slimmer returns from its division that includes refining and upgrading of crude into higher-value products will continue for the rest of this year, Chief Financial Officer Alister Cowan said on an Oct. 24 conference call.

Net income in the unit fell 76 percent to C$89 million in the third quarter from a year earlier, Husky said the same day. The downstream division accounted for 17 percent of total profit for the period, compared with 70 percent a year earlier.

Husky, which has gained 1.5 percent this year, owns a refinery in Lima, Ohio, and has a stake in BP Plc’s Toledo, Ohio refinery.

Narrowing Spreads

Rising North American oil prices are narrowing the spread between the international Brent benchmark that’s used to set gasoline and diesel prices. West Texas Intermediate, the U.S. benchmark, climbed 15 percent to $105.81 a barrel in the third quarter from a year earlier, while Brent increased 0.2 percent to $109.65 and Canadian heavy oil rose 8.3 percent to $83.10 a barrel.

The U.S. margin on processing crude oil into fuels such as diesel and gasoline fell 43 percent to an average of $17.54 a barrel in the quarter from a year earlier.

Cenovus, which has plans to more than quadruple oil-sands output in the next decade, chooses an integrated model to shield itself from commodity price swings, Brett Harris, a company spokesman, said by phone yesterday.

“Because we own both upstream and downstream assets, that gives us the best opportunity to achieve the secure cash flow we need to fund those growth plans,” Harris said.

“Husky’s focused integration strategy helps to mitigate market volatility by capturing world pricing for our heavy oil and Western Canada production,” Kim Guttormson, a spokeswoman for Husky, said in an e-mailed statement yesterday.

Refining Earnings

Suncor Energy Inc. (SU), Canada’s largest producer by market value, is poised to report C$309 million in after-tax refining and marketing operating earnings in the third quarter, Greg Pardy, an analyst at RBC Capital Markets in Toronto, said in an Oct. 25 note. Suncor, which is scheduled to release results after the close of trading in North America today, reported record downstream earnings of C$708 million a year earlier.

Imperial Oil Ltd. (IMO) is poised to report C$166 million in after-tax downstream earnings tomorrow, Pardy said in a separate Oct. 25 note. Canada’s second-largest producer by market value brought in C$536 million in the unit a year earlier.

Imperial has gained 7.6 percent this year, while Suncor is up 16 percent.

Integrated energy companies can often make up for lower refining profits with bigger returns on production. Cenovus and Husky have underperformed partly because of expectations for slower oil production growth in the so-called upstream division amid higher prices, Sam La Bell, an analyst at Veritas Investment Research in Toronto, said yesterday by phone.

‘Upstream Volume’

“The biggest returns come from upstream volume growth,” La Bell said, noting Cenovus is also suffering from costs tied to credits in the U.S. biofuel blending program known as Renewable Identification Numbers, or RINs.

“The argument that pure-play producers will be favored by investors since they can capture better prices in a high oil price market is flawed,” Sneh Seetal, a spokeswoman for Suncor, said yesterday by e-mail. Suncor can “capture value” in its upstream or marketing and refining divisions depending on market dynamics, Seetal said, noting the company has historically captured on average 93 percent of the global oil price thanks to the integrated model.

Pius Rolheiser, an Imperial Oil spokesman, said by phone yesterday the company has no comment and will provide information about third-quarter refining results tomorrow.

While integrated stocks are currently out of favor, now may be the time to buy them as refining profits are poised to rise next year as U.S. oil prices have fallen in recent weeks relative to Brent, Todd Kepler, an analyst at Cormark Securities Inc. in Calgary, said in a phone interview on Oct. 28.

‘Looking Forward’

“The market should start looking forward,” Kepler said.

There’s a risk that wider refining margins won’t last, said Jennifer Stevenson, vice-president and portfolio manager at GCIC Ltd. in Calgary, who owns shares in Suncor.

Though oil supply costs have eased in recent weeks as refineries go offline for maintenance and reduce demand, those facilities are scheduled to return this quarter and drive up WTI prices again, trimming profitability for refineries, Stevenson said in an e-mail on Oct. 28.

“I haven’t been adding to the Canadian integrateds as this is a headwind for them going forward,” Stevenson said.

To contact the reporter on this story: Rebecca Penty in Calgary at rpenty@bloomberg.net

To contact the editors responsible for this story: Susan Warren at susanwarren@bloomberg.net; David Scanlan at dscanlan@bloomberg.net

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