Renewable Diesel – As the US election nears and individual states besides CA contemplate low carbon fuel standards, the amount of refining capacity entering strategic review to potentially convert to renewable diesel production is accelerating. During 2Q20 earnings season, several independent refiners mentioned potential shutdowns/conversions, after HFC’s announcement that the Cheyenne refinery would be shut down to convert to R/D production last month. By our calculations, ~116 kb/d of gasoline and ~117 kb/d of distillate production could be eliminated in the renewable diesel chase. MPC’s Martinez refinery is shutting down regardless of a renewable diesel conversion, reflecting structural challenges to crack spreads.
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Vince Lombardi – NFL fans might recognize the famous clip of Coach Lombardi yelling from the sideline at no one in particular: “What. The Hell. IS GOING ON OUT HERE?!?”. That’s how many feel watching MPC, which is down 6.5% since announcing the Speedway sale for $21B, setting the stage for counter-cyclical share repurchase of anywhere between 25%-40% of its market cap. Based on feedback and our sector views, this is what we think is going on: 1) market sentiment is extremely poor in refining right now, creating friction in the stock changing hands from event-driven to fundamental investors; 2) MPLX debt remains an overhang on SoP value; 3) there is a broad perception that fees paid by MPC to MPLX render MPC a “high cost” refiner; 4) the deal closes in 1Q21, so there’s several months before the buyback commences.
CLMT reported 2Q adjusted net income per unit of ($0.25), missing consensus’ ($0.10) but slightly ahead of our ($0.28) estimate. Some operating cost items (transportation expense and taxes other than income) came in below our model. Specialty margins of almost $45/bbl were ahead of our expectations, though sales volumes were below our model. Fuels volumes were in line, but margins were worse.
HFC reported 2Q adjusted EPS of ($0.25), beating consensus of ($0.55) and our ($0.54) estimate. The beat was primarily driven by Lubricants as the segment delivered a $32MM positive variance vs our model. Lower SG&A and a higher tax benefit also contributed to the beat. Refinery throughput came in above our expectation and gross margins were in line, though opex was higher than we thought.
US oil inventory draws could last a while – Based on expected US import/export volumes and the realities in the US oil patch, it appears an extended period of US crude oil inventory depletion is ahead. At current levels of imports and exports, US crude supply/demand would balance at 11.8MM bpd of production and 15.0MM bpd of refining runs. This week’s EIA report showed 10.4MM bpd of production + adjustment and 14.6MM bpd of refining runs. Put another way, at those production and refinery numbers, the US would need to increase crude net imports by 1MM bpd to bring supply/demand balance, which based on current shipping data is not going to happen anytime soon.
Results – DK reported 2Q adjusted EPS of ($1.50) vs consensus’ ($0.51) and our ($0.69) estimates. However, DK’s adjusted number includes an after-tax impact of ($0.95) from FIFO accounting. Adding that back takes “adjusted adjusted” EPS to ($0.55), much more in line with consensus. However, CFFO was still negative ~$10MM even after adding back $130MM of WC drag from income tax receivable and inventory builds (but not the $200MM LCM reversal). Refining margins were better than we expected, excluding the FIFO impact. Retail was also stronger than anticipated underpinned by higher merchandise sale volume. The dividend was unchanged vs 1Q.
CVI reported 2Q adjusted EPS of ($0.44), slightly missing consensus’ ($0.42) though modestly better than our ($0.52) estimate. Refining margin was slightly worse than our expectation, though offset partially by stronger throughput. Opex was also less than we expected, driving the beat vs our estimate.
We won’t belabor BP’s 2Q results, except to say CFFO ex-WC of $3.3B was in line with our estimate and supported by mgmt’s characterization of “phenomenal” oil trading results in downstream. The far more important announcements were the details around the company’s total re-frame of capital employed, asset mix, and capital allocation, including a 50% dividend cut to fund debt paydown as well as a ramp in renewables spending to ~$3.5B by 2025 and $5B annually by 2030. The headline is “IOC to IEC” (Integrated Energy Company); near term, capital allocation remains shareholder friendly, oil and gas capex is high-graded and shareholder returns transition to buyback within 12 months.
Underlying figures and additional commentary inside. Takeaways are positive. Our inventory draw is well above consensus. Asia-bound AG-OPEC exports were down on the week and total AG-OPEC exports finished the month of July 24% below peak and not much above June’s level. Other Swing supply was up, but only marginally.
How Bearish is Refining Sentiment? – On news that MPC solid its retail business for $21B, setting up a likely $5B-$9B repurchase program and beating expectations by $3B-$5B, the market cap was up $220MM. Still, the stock outperformed large cap peers by >300 bps while crack spreads were up. It’s just one day, but our interpretation of the action is that investor sentiment toward refining is very weak, to the extent that transitioning to a net cash position equivalent to 24% of the market cap (ex-MPLX) is not viewed as transformative because base business headwinds are so pronounced. We remain cautious on the outlook for crack spreads and see ~2.5MM bpd of capacity oversupply next year, but we have also seen clear signs of rapid global capacity rationalization, while demand indicators are grinding higher w/w.
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