Investors are bullish on the energy sector as a whole in 2017 according to a recent survey, and with good reason. Oil prices are starting to come back to life, but many stocks in the space have already impounded those improvements into their share price. There are still areas of the energy market that represent good value, and one of those areas is certain refiners.
Refiners’ profits and ultimately their stock prices are largely driven by crack spreads. And today more than ever, crack spreads are being driven by geography and the particular oil blend being used.
Crack spreads refer to the amount of money a refinery can earn by cracking a barrel of oil. In the U.S., three barrels of oil are used by refiners to produce two barrels of gasoline and one barrel of diesel. If refineries can buy oil inexpensively and sell gas and diesel for more, then they earn a substantial profit.
Today, despite the improvement in crude prices, the world is still awash in oil. While prices are starting to rise, it will still take several quarters before the supply and demand in the oil markets balances out. While crack spreads are not as strong as they were a couple of years ago, the long-term outlook for the business is still very attractive. New refineries are very difficult to build in the current environment after all, even with President Trump pledging to make the process easier. Related: Has Big Oil Bought Into The Oil Price Recovery?
Crack spreads are increasingly coming under pressure in many areas as the laws of supply and demand come into balance. The highly profitable crack spreads of the past have drawn more refining capacity online and lead to more supply for many derivative oil products. Many established refiners are struggling to combat already high inventories of gasoline and other products by cutting production at key plants, but that effort has not been enough to sustain cracking margins over the short term.
The crack spreads are dramatically different in different geographies though. While the crack spreads for products coming out of the Permian Basin look strong, energy analysts are forecasting that cracking spreads will fall substantially and margins in certain areas of the country such as the Midwest are already under severe pressure or even negative thanks to limited storage capacity for final delivery products.
The situation is little better overseas. Asian fuel producers are facing increasing competition from China which is exporting a surging level of refined crude products. Chinese net product exports are forecast to rise by 30% this year. Diesel exports rose double digit levels from China last year much to the chagrin of Indian and South Korean refiners. Related: Top 10 Bankruptcies Of 2016 Feature 9 Energy Firms
China has started allowing many independent Chinese refineries to ship their output aboard. Diesel margins are particularly as risk as the product has seen a significant slowing of domestic Chinese demand and thus a very rapid build in export volumes.
With diesel exports authorized up to 1.8 million barrels per day for China versus 900,000 barrels per day last year, there is little doubt that Asian diesel prices will fall dramatically. This may cause a chain reaction that slowly spreads west perhaps ultimately hampering margins in Europe as well.
Crack spreads are likely headed lower in China and the region as a whole. CNPC predicted that net exports of diesel will surge by 55 percent this year to about 450,000 bpd. In addition, slowing growth in the world's second-largest economy and the shift to renewable energy will hamper the consumption growth for oil products.
By Michael McDonald of Oilprice.com
ADVERTISEMENT
More Top Reads From Oilprice.com:
- Research Warns Cheap Solar Will Dampen Oil, Coal Demand
- Is Iran Planning On Breaking Its OPEC Pledge?
- The Oil War Is Only Just Getting Started
