In its monthly report, the IEA forecast 2.6MM bpd of new refining capacity coming on stream in 2019, which the organization notes is the highest in 4 decades. The report adds that the increase in capacity poses a margin headwind for the sector, as new capacity almost certainly exceeds 2019 demand growth (IEA demand growth forecast held steady at 1.4MM bpd).
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We expect the EIA to report a crude inventory draw of 1.5MM bbl. While refinery utilization should be lower and imports could be higher, US crude exports should be significantly higher w/w (potentially over 1MM bpd higher), balancing out the changes. Last week, while the reported 1.6MM bbl crude draw was opposite our modeled build, the total 13MM bbl crude + products build reported by the EIA suggests some issues with the report. Notably, implied distillate demand has been down sharply the last 2 weeks, with very large builds coming even though reported production was in line with the 4-wk average. This could be a seasonal quirk, however, since distillate implied demand dropped conspicuously in the first weeks of ’15, ‘16 and ’17 (though not ‘18). By and large, without high export figures, the US likely remains oversupplied hydrocarbon liquids in the near term, and the mix of crude and refined products reported is the origin of variance from our forecasts, as opposed to overall thematic balance. We expect the general backdrop to persist for 2-3 more weeks until structurally lower US imports driven by OPEC policy take hold.
We’ve been too low on 4Q18 refining earnings as our product market fears were overcome by more positive factors including crude differentials and the late-quarter crude price drop that improved margins on non-fuels refinery output as well as Retail. Moreover, disparate crude pricing across North America opened the window for independent refineries to add operating value, capturing lower crude prices at refineries not typically benchmarked to Midland, WCS, or Bakken/Canadian Light crudes. This is a good set up for revision momentum into earnings season and refining stocks have near-term tailwinds.
This Wednesday (1/9/2019) at 11am we’re launching our bi-weekly Energy webcast series and we’re kicking it off with our 2019 conviction ideas and drivers for why we see a return to $80/bbl Brent in 2020. Within, we outline our high level Energy views and portfolio construct. Register here to have access to every webcast.
We expect the EIA to report a crude inventory build of 4.0MM bbl for the week ended Jan 4, 2019. Imports should be lower w/w, but exports could be materially lower as well, likely a one-off phenomenon. The EIA’s “adjustment” factor - meant to represent unaccounted for volumes to reflect the difference between reported production, imports, exports, refinery runs, and inventory changes – has been unusually high recently, over 0.9MM bpd for the past two weeks. Our theory is that this excess volume is incremental NGL production that’s not getting appropriately marked as “Other Inventory”, where it belongs. Nevertheless, we must account for it in our crude model until the “adjustment” anomaly is resolved. On exports last week, we note there were several VLCCs loaded by lightering last week, which could result in a reported export figure higher than our assumption. Generally, VLCCs loaded by lightering have correlated to an error factor in our export model.
PSX remains among our top Refining picks – along with MPC – as we see return of cash growth supported through multiple earnings scenarios, due to business mix, the affiliate structure of key assets, and crude differential exposure. We believe the company’s disclosure of ~$2B of affiliate distributions to the parent company at the 3Q18 earnings call would have otherwise kicked off a long tail of outperformance. While PSX shares have outperformed the refining peer group over the past month, exposure to China headwinds via the Chemicals segment and rising Canadian crude prices following Alberta’s production cut mandate interrupted the progression, in our view. We see sustainability in key share price drivers and a YE19 valuation of $137/sh.
Margins: China Refinery Yields Continue to Explain Divergence between Gasoline and Diesel Cracks – Gasoline crack spreads vs Brent are ~$1/bbl vs ~$16/bbl diesel cracks. Although converging modestly from the average November difference between the spreads of $20/bbl, the $15/bbl gap between gasoline and diesel cracks remains abnormal. Chinese refinery yields during the gasoline shoulder season explain this phenomenon; for November, Chinese distillate production was down 6% y/y, while Gasoline and Naphtha production were up 7% and 9%, respectively. Chinese refineries are producing this way because official government-set retail gasoline prices are higher than diesel, and as long as this yield skew remains in place – the trend has been observable since June – diesel margins outside China are likely to continue to materially outperform gasoline, which could lead to yield switching by other refineries until driving season.
We expect the EIA to report a crude inventory draw of 2.1MM bbl for the week ended Dec 28. Year-end tax incentives should keep overall supply/demand balance in PADD 3 short, with low net imports and high refinery utilization driving the regional draw. We see relatively unchanged imports in PADDs 1 and 5 (East and West coasts) and are modeling flat w/w Canadian imports, which were higher than our model last week. L48 production + the adjustment factor has been higher than our forecast for several weeks, and therein lies the risk to our modeled draw.
We expect the EIA to report a crude inventory build of 1.3MM bbl for the week ended Dec 21st. Note that this week’s EIA report will be released on Friday, as opposed to the usual Wednesday. Last week, our forecast of a 4.1MM bbl build was high compared to the actual 0.9MM bbl draw due to understated exports in our model, as we missed several lightering vessels mistaken for Jones Act ships. However, the high-level theme of oil balance unsupportive of prices near term held up, and this week we see a continuation. Imports should be up w/w, offset by a modest uplift in refinery utilization. Exports should be lower w/w, but the error factor in our export tracker this week could be elevated as ship-to-ship transfers were higher, which throws off the timing of when exports are officially recognized.
OPEC published a detailed production quota table delineating country-level responsibility for the 1.2MM bpd cut announced at the Dec 6th meeting, including from non-OPEC participants. History suggests granularity around cut requirements probably will not be supportive of the oil price, since the issue is not a lack of detail, but skepticism around adhering to cuts, evidenced by the post-2016 cut period, when oil prices fell in each of the first 6 months of 2017. This occurred because the cuts were not actually visible in data until 2H17, and so the task now is to implement cuts on time, not simply preview them more thoroughly.
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