We expect the EIA to report a crude inventory draw of 2.9MM bbl for the week ended 3/22/19, above consensus’ 0.9MM bbl draw. Disruption in the Gulf of Mexico could result in lower imports and exports w/w, although most of the delta in crude draw w/w is due to refinery downtime. We adjust production -600 kb/d as we see a high likelihood that the DOE is overstating production and the trend of negative “adjustments” in weekly reports will continue.
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While investor sentiment seems focused on weak gasoline margins from 1Q, and even potential risk to 2Q19 refiner estimates as a result of a perceived massive gasoline supply overhang, we note that current 2-1-1 crack spreads across multiple regions are close to or above year ago levels. On 4Q18 conference calls, refining managements near-universally predicted refined product oversupply to clear up as maintenance season progressed and seasonal demand accelerated. Those predictions have played out, and we believe refining stocks can maintain momentum as sentiment for 2Q improves. See inside this note for charts of y/y 2-1-1 crack spread performance for various crude grades and regional refined products since the beginning of 4Q18. All quotes below are as of 3/18/19 close. Reiterate Outperform on PSX, MPC, DK, and recently upgraded VLO.
We are moving this weekly to Tuesdays at noon to improve EIA preview accuracy and because there was no significance to Mondays with respect to international data. Since the inception of this EIA forecast, the WR estimate has been closer to EIA actuals vs consensus 7 of 13 weeks. Generally, we believe the OPEC data has been more predictive of oil price direction than EIA trends, but we believe the EIA forecast adds nuance to the global supply/demand picture.
We cannot recall another refining stock with 100% sell-side Buy/Outperform ratings, so MPC’s ~10% underperformance large cap peers over the past month could be a simple case of near-term interference around a consensus call. In our view, MPC deserves its consensus status, but short-term underperformance can be expected for as long as the commodity exposure ANDV brought into the asset base continues to lag.
At a management meeting hosted by RDS yesterday updating its Integrated Gas and New Energies segments (see note HERE), we gleaned a positive takeaway for refining: with respect to IMO 2020 implementation, sulfur scrubbers on vessels may not be a long term solution, as units produce waste with no current disposal outlet, and could be a net negative for the environment. The comment referred to the growing LNG-for-maritime-fuel market, however the nearer term implication could be lower than expected fuel oil demand post-IMO 2020, supporting the outlook for distillate margins and light/heavy crude differentials.
The most common inbound question off our Thursday night refining sector upgrade (linked HERE): What is historical sector performance immediately following positive inflections in gasoline crack spreads off <$0 lows? For reference, the question relates to our analysis of 6 and 12-month performance off <$0 gasoline crack spread instances, which has occurred 3 times since the financial crisis (we include a 4th cycle in 2016, when RINs adjusted gasoline cracks bottomed at <$3/bbl that September). The answer: for the first month following the end of $0/bbl gasoline cracks, the refining sector averaged 8% gains.
EIA Preview (Page 2): We expect the EIA to report a crude inventory build of 3.1MM bbl for the week ended 3/8/19. Relative to the larger than expected 7.1MM bbl build last week, we expect net imports to be down and refinery throughput to be up. We believe the EIA has possibly been overstating weekly crude exports, flowing through a persistent positive “adjustment”, which last week was 0.7MM bpd. In our model, we remove the adjustment and use our lower crude export forecast vs the EIA trend.
We are moving the Refining sector to Overweight from Market Weight as 1) gasoline crack spreads exit a prolonged <$0 trend; 2) IMO 2020 nears; 3) soft 1Q19 earnings outlook presents entry point against previous two items. Global capacity adds and 2020 Brent/WTI differential compression are potential negative offsets, but in the absence of a perfect set-up we see attractive risk/reward.
We are upgrading VLO from Peer Perform to Outperform and increase our Price Target from $96 to $97. The timing of this upgrade aligns with our more positive Sector view, outlined in our industry upgrade published today. We highlight two key points: 1) VLO capital projects could be under-appreciated and extend the tail of dividend growth; and 2) VLO has among the most operating leverage to IMO 2020 on a gross basis.
NYH gasoline crack spreads relative to Brent have improved, moving toward $4/bbl after exiting deep negative territory in February.
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