Oil Refiner Profits Will Miss the Mark

Months after record profits, oil refiners are being squeezed as their slow season coincides with record crude prices

Pricey crude oil is starting to whack an important consumer: major oil refiners. On Oct. 10, Valero Energy (VLO) became the latest energy company to warn that its third-quarter profits will fall short of Wall Street's forecast. A day earlier, oil giant Chevron (CVX) and refiner Marathon Oil (MRO) also cut their income outlooks. Houston-based ConocoPhillips (CPO) had kicked off the gloomy reports Oct. 3, saying its global refining margins would be "significantly lower," hampering financial results.

The cautions represent a stark reversal of fortune (BusinessWeek.com, 5/3/07) from just five months ago when crude refiners were reaping record profits.


What's changed? The main culprit is surging crude oil prices that have raised the cost of producing gasoline and other products, as well as higher labor and materials costs. Crude has climbed dramatically over the past month (BusinessWeek.com, 7/20/07) and touched a record $83.85 per barrel on Sept. 23. Light sweet crude for November delivery settled at $81.30 on Oct. 10 on the New York Mercantile Exchange.

The dynamics of supply and demand also explain refiners' income retreat. In the spring, when crude was selling for $60 to $65 per barrel, refinery outages cramped gasoline production just as consumer demand was gearing up for the summer. That situation is now reversed: Refineries are back to typical gasoline production while consumer demand is leveling.

"The slide is a reminder that in the big picture, the refining business is a boom and bust deal," says Phil Flynn, an analyst for Alaron Trading in Chicago. Still, Flynn says refiners are accustomed to these shifts and adapt accordingly. "We're now seeing a correction from margins in the spring that everyone knew were out of whack. What before were radically offensive profits are now only mildly offensive profits."

While the disappointing news has weighed on refiners' share prices in recent sessions, investors have hardly bolted for the exits. Indeed, shares of Valero overcame an early-session drop to gain nearly 3% on Oct. 10, to $74.25, and Marathon was up 1.2%, to $59.05. Rivals Sunoco (SUN) rose 1.3%, to $77.72, and Calgary-based Suncor (SU) was up 2.3%, to $96.97, just below a 52-week high.

Cyclical Pattern

Analysts are divided about how long the profit dip will last. Some say the third-quarter slide is typical of an industry so closely tied to seasonal consumer demand for gasoline. Others say rising crude prices and a potential economic slowdown will dim the outlook late next year.

Still, analysts are nearly unanimous on one point: Oil refining is a lucrative business. "While some companies are issuing warnings, it's still a wonderful time to be in the refining business," says Tom Kloza, chief oil analyst for the Oil Price Information Service, an energy consulting firm in Wall, N.J. "It's a very bright outlook through the greater part of 2008 for gasoline."

The recent climb in oil prices has narrowed refining margins, the difference between what oil companies pay for crude and the price of the products they create with it. Margins hit $6.65 per processed barrel in late September, having slid from $20.71 three months earlier and off from a May, 2007, peak of roughly $35.

But the dip in refining margins happens each year as gasoline demand declines. "It's a very seasonal play," says Stephen Schork, energy consultant and editor of The Schork Report. "Margins always tend to come lower after summer driving season. But we're due for a rebound later this year as demand increases."

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