The market is focused on a seemingly poor outlook for Brent/WTI differentials, however crack spreads in the Mid-Continent region are firm. This would suggest an out-of-consensus opportunity in Mid-Con refiners (CVI, DK, HFC), and we see positive data points potentially emerging in 2Q earnings and 3Q revisions. However, the product balance will be tested in coming periods as regional refinery utilization recovers from lower than normal 2Q levels and holds peak throughput.
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What is the best possible outcome for the IOC group as Icahn engages OXY plans – As OXY shareholder activism accelerates, we believe a Blue-Sky IOC scenario would be 1) XOM acquiring OXY and breaking up the APC merger and 2) CVX acquiring APC on its original terms. This scenario could also serve as a TOT catalyst, although we believe the company will likely put forth a convincing case for its APC-Africa acquisition on its 2Q19 call.
In 2Q19, the highest margin LNG was Brent-linked point-to-point term sales, which represents most IOC LNG operations. However, given the weakness of spot pricing in 2Q, there may also be an opportunity for strong trading results from portfolio players like RDS; cash costs to produce LNG are generally less than $3/mcf for vertically integrated IOC capacity, so margin opportunity is preserved even into depressed spot markets priced in the ~$4.50/mcf range in 2Q. Meanwhile, cheap spot LNG could be lifted by IOC portfolio players and sold into premium priced term contracts, generating a trading profit. We explore LNG trading upside in this note.
Trends in EIA weekly fuels demand data are improving, despite ongoing concerns on the pace of global demand growth. Typical drivers of gasoline and distillate demand in the US imply some potential for 2H19 mean reversion higher in demand, while the current trends do not resemble 1H08 in any way.
Following the conclusion of the CVX/APC/OXY/TOT merger sequence in April, 2Q19 was a relatively quiet quarter for IOCs, which appears to be what the market wants: IOCs have outperformed the XOP by 11% and 33% YTD and LTM, respectively. Our 2Q19 estimates are below consensus due to commodity headwinds in both Upstream and Downstream, which could create a short-term interruption of the trend. Longer term, we believe a risk to thematic IOC outperformance on the quarter is if oily E&Ps beat both capex AND production on a broad basis, but even in that case M&A risk would be reduced as IOCs will only pursue materially underperforming targets, in our view.
Underlying figures and additional commentary inside. Overall takeaways are neutral. Our above consensus draw is somewhat offset by June AG OPEC exports ending nearly level with May. “Other Supply” still appears elevated, but massive aggregate OPEC cuts (both discretionary and decline-driven) are keeping the market balanced.
2Q refining earnings could show a dispersion in “capture rate” – margin performance vs benchmarks – between regions, with strength in the Mid-Continent and headwinds in the Gulf Coast and West Coast. This dispersion could drive a sustainability debate, but we note idiosyncratic drivers of the headwinds, particularly this quarter.
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