Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Oil refiners just got a taste of what their counterparts in the business of producing crude have been enduring for well over a year. Of eight large, independent U.S. refining companies that have reported first-quarter earnings so far, seven have missed consensus forecasts, according to figures compiled by Bloomberg.

Winter Grade
Most independent refiners missed consensus EPS forecasts for the first quarter
Source: Bloomberg

(The eighth company, Holly Frontier, isn't even in the chart because it reported a loss instead of the positive number expected.)

It is a far cry from where the group started the year. Unlike most other stocks tethered to oil, these refiners all rose in 2015 (except for Western Refining, which fell a relatively mild 5 percent). Valero Energy, one of the biggest, reported its best annual earnings per share since 2007. Unlike those struggling exploration and production companies, refiners are buyers, not sellers, of crude oil. So as long as demand for things like gasoline and diesel holds up, cheaper crude actually helps the bottom line. And that's what happened.

A Cracking Summer
Benchmark 3:2:1 crack spreads shot up last summer, boosting refining profits per barrel
Source: Bloomberg

As you can see toward the right side of that chart, though, things went south later in 2015 -- and that continued into the first quarter, as the latest results confirmed. All refining stocks are now in the red so far this year, lagging behind their E&P peers (as of Tuesday's close).

Downstream
Refining stocks have underperformed the E&P sector so far this year
Source: Bloomberg

Some refiners suffered unexpected outages in the first quarter, but the real problem was a mild winter hitting demand for diesel and fuel oil and a glut of gasoline that had built up as refineries ran flat out last year.

Yet the sector could be due for a summer rally -- albeit one that may fizzle out soon after.

On the demand side, U.S. gasoline consumption is up again this year. The weekly estimate from the Energy Information Administration looks suspiciously high, with Wednesday's figure showing about an extra 500,000 barrels a day, or almost 6 percent, compared to the same time last year. That said, demand clearly is up to some degree. Americans are taking advantage of lower gasoline prices by driving more miles and buying thirstier vehicles.

Hitting the Road (Again)
U.S. vehicle miles traveled, trailing 12 months
Source: Federal Reserve Bank of St. Louis
Super-Size Me
Sales of light trucks and SUVs have pulled further away from cars since fuel prices began falling in 2014
Source: WARD's Automotive Group, Bloomberg
Note: Figures are for the seasonally-adjusted annualized rate in the U.S.

Gasoline crack spreads, a proxy for refining margins, have staged their usual seasonal rally heading into the summer.

Rising Sun
Gasoline margins have risen heading into U.S. driving season
Source: Bloomberg
Note: Crack spread for reformulated gasoline blend-stock for oxygen blending over WTI crude oil.

On the cost side, stubbornly high oil production from an OPEC in disarray is the very thing that threatens E&P companies, but it can help those refineries on the coast able to process heavier grades of crude. The discounts on these have widened out again due to excess supply, offering the likes of Valero and PBF the opportunity to reap bigger margins.

The Heavy Stuff
Latin America Maya crude oil's discount to WTI is about 4 times wider than a year ago
Source: Bloomberg

This combination should ease the pressure on margins that sank the refiners' first-quarter earnings and help the stocks regain their mojo vis-a-vis the E&P sector in the coming months. The big question is how long that can last.

Gasoline margins are up, but not to the blowout levels of last year. Moreover, we are well into the period between March and June, when gasoline prices tend to peak, based on data going back to 1985.

Refiners are relying on gasoline to keep margins healthy on each barrel of crude they process because margins on distillate are so lousy -- PSX said these fell in the first quarter to their lowest level since 2010. There is a treadmill-to-hell quality about this: The more crude oil you process to take advantage of demand for gasoline, the more distillate you tend to produce, adding to the glut weighing on that market and dragging down your margins overall. Distillate inventories are high globally, but the U.S. stockpile alone illustrates the problem well enough.

Diesel Do Nicely
U.S. distillate stocks
Source: Energy Information Administration

And, the thing is, gasoline isn't exactly in short supply either -- for all the extra demand, stocks actually increased slightly last week. The chart below shows historical U.S. inventories divided by average demand over the following 12 weeks, to give an idea of how much of a buffer gasoline stocks provide. For the coming weeks, let's assume that demand rises to 9.6 million barrels a day and stays there -- way above what the EIA is forecasting for the second and third quarters. 

Sun Cover
U.S. gasoline stocks compared to demand
Source: Energy Information Administration, Bloomberg Gadfly analysis
Note: Assumes demand of 9.6 million barrels a day through the second and third quarters.

As you can see, that number is coming down, but not precipitously: The latest figure -- 25.2 days -- is actually higher than where it stood this time last year.

Exports provide a further outlet for coastal refiners, and both PSX and Valero highlighted their importance on their earnings calls. Here, though, they face pressure from foreign rivals attempting to clear excess supplies.

Ultimately, like the E&P companies, the refiners are also dealing with a glut. This summer should provide some relief. But the first quarter's drubbing should act as a warning about what could follow.

Correction: A chart in an earlier version of this column indicated that Tesoro missed its first-quarter EPS forecast. It actually beat that forecast. The earlier figure reflected Tesoro missing the forecast for the fourth quarter of 2015.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net