Turbulent Times Ahead For Refiners

The crude markets stayed relatively flat for the last week, as the real battle continued to be waged between the major movers of oil prices. The fundamentals of supply and demand continue to work in favor of a crude spike higher while the financial battles of those who think oil is going up and those betting, or at least guarding against, oil prices dropping again precipitously is biasing prices to the downside.

Between the two, there is a disconnect between U.S. oil production – definitely on the upswing among shale players and global production, being cut by both OPEC and non-OPEC members like Russia, in line with their agreed production quotas. Instead of picking a winner in these struggles again, I'm going to point out one place where there will be consistent problems, and worth avoiding: U.S. refiners.

In the U.S., the higher than $50 price for oil has encouraged E+P’s to take advantage of 'low hanging fruit' wells that have become profitable above $50. The number of rigs is increasing weekly, even if the total number is still more than 1000 down from the highs in 2014. And there’s a lot of bluster about the increasing stockpiles here in the U.S. that are pulling out the production drops from OPEC, again animating the argument of oil's next move. But let's not miss an even easier conclusion:

Looking domestically, there’s an enormous gasoline glut that is just choking the pipes and putting a cork in crude oil throughput. This is an endemic problem in the U.S. that just won’t go away – gasoline demand, despite historically low prices, continues to sag down about 6 percent, year over year. That’s all about efficiency with gas engines and increased use of hybrids. We might have all thought that hybrid technology would hit reverse with low gas prices, thinking that everyone would put aside their dreams of a Toyota Prius to buy that Ford F-150, but instead, manufacturers are continuing with projects undertaken years ago, to increase efficiency per EPA guidelines. And consumers are loving it.

This might be temporary trouble for domestic crude stocks, as gasoline will find overseas markets eventually, but a long-term problem for refiners, who, with Trump, have gotten a respite on RIN pricing but face a tougher battle with shrinking domestic demand. This is a trend that is going to stick around. A trend that most oil analysts have been aware of.

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It's not just that February is historically the worst month for gasoline demand – it is. It's the combination of low oil prices, ample supply, and cheap ethanol substitutes that should lead to boom times for refiners, but instead, is resulting in scrambling for export opportunities. That's a very bad long term sign. All the independent refiners have been in a stall in their stock prices since the beginning of the year – Valero (VLO) in the mid-$60's, Tesoro (TSO) in the high $80's and Phillips 66 (PSX), around $70 a share. Right now, I wouldn't own any of them.

While the battle rages in the oil market between fundamentals and the financial players, who will decide which way the oil price breaks, you could make a case for either side. But, with the refiners, it seems that only one case can be made. Everything should be going their way and, in a rising stock market, we should have seen better performance from them. Instead, I think they're all setting up for a year-long slump.

By Dan Dicker for Oilprice.com