Could Regulatory Changes Boost MPC’s Refining Margin?

Marathon Petroleum’s (MPC) third-quarter performance was robust. The company’s earnings rose despite analysts expecting a fall. Also, the company’s refining margins grew, contrary to peers’.

In the third quarter, MPC’s refining margin expanded by $0.40 per barrel to $14.70 per barrel. Meanwhile, Valero Energy’s (VLO) and Phillips 66’s (PSX) margins narrowed by $0.40 and $2.20 per barrel, respectively. To learn more, read MPC, VLO, and PSX: Who Surprised Wall Street in Q3?

However, things could soon change due to the upcoming IMO (International Maritime Organisation) regulation on sulfur content in marine fuels. Before we look at the regulation’s impact, let’s see how MPC’s refining earnings indicators are shaping out.

MPC’s refining indicators

Every month, Marathon Petroleum publishes its refining indicator data. MPC’s leading indicators are the blended crack, the prompt sweet differential, and the prompt sour differential.

According to the company, a dollar-per-barrel increase in the blended crack raises its net income by $900 million annually. Furthermore, dollar-per-barrel expansions in the prompt sweet and sour differentials increase its net income by $370 million and $450 million, respectively.

MPC’s blended crack in Q4

In the fourth quarter, refining indicators have been mixed. While the blended crack has expanded, the sweet and sour differentials have narrowed.

Quarter-to-date, MPC’s blended crack has expanded by 48% YoY (year-over-year) to $13.90 per barrel. The blended crack is derived from three main regional cracks: the Midcon WTI 3-2-1 crack, the USGC (US Gulf Coast) LLS (Light Louisiana Sweet) 3-2-1 crack, and the WC (West Coast) ANS (Alaskan North Slope) 3-2-1 crack. The USGC, Midcon, and WC cracks are weighted to reflect the proportion of MPC’s regional refining capacity to arrive at the blended crack, at ratios of 38%, 38%, and 24%, respectively.

In the fourth quarter, the USGC and WC cracks expanded by 122% YoY and 98% YoY, respectively, while the Midcon spread contracted by 5% YoY. The WC crack is the widest, at $23.20 per barrel.

Role of IMO 2020 in boosting cracks

The IMO 2020 regulation has strengthened refining cracks. The new regulation requiring shippers to buy low-sulfur fuel is going to change the sector’s dynamics. Refiners need more advanced processing units to produce low-sulfur fuels, and refiners that can produce the required quality of fuel are set to benefit.

In PBF Energy’s third-quarter earnings call, CEO Tom Nimbley said, “IMO is starting to take hold. This started over the late summer with high-sulfur fuel oil cracks coming off.” He added, “Asia has stopped calling for high-sulfur fuel oil, and trade flows have been disrupted. High-sulfur fuel oil has backed up into the Atlantic Basin and into Europe and is seeking alternative disposition from the traditional home in the bunker market as the industry prepares for IMO.”

MPC’s differentials contract in Q4

In the fourth quarter, MPC’s prompt sweet differential has narrowed by 62% YoY to $2.50 per barrel. Similarly, its prompt sour differential has contracted by 48% to $4.80 per barrel, which could impact MPC’s refining earnings. In the third quarter, 53% of MPC’s input was sweet crude oil, and the rest was sour oil.

Overall

The blended crack’s expansion and higher capacities due to MPC’s Andeavor integration should boost the company’s refining earnings this quarter. However, that rise could be somewhat offset by the company’s differentials contracting.

Valero’s and HollyFrontier’s indicators

Valero Energy’s and HollyFrontier’s refining indicator data also shows improvement. Valero’s refining crack indicators have expanded across its operating regions in the fourth quarter. Like MPC’s, Valero’s West Coast indicator has expanded significantly, by 93% YoY. Its Gulf Coast, Midcon, and North Atlantic cracks have grown 37%, 3%, and 44% YoY, respectively.

Meanwhile, HollyFrontier’s refining index values have also risen across its operating regions this quarter. Its Midcon, Rockies, and Southwest index values have increased by 12%, 34%, and 12% YoY, respectively.