The refining industry, including cracks and oil spreads, is going through a massive change in the current quarter. The change resulted in sharp changes in refining stocks’ prices. Notably, the industry seems to be ready for IMO 2020.
While Valero Energy (VLO) and Phillips 66 (PSX) stocks have risen by 11.6% and 13.6% sequentially, Marathon Petroleum (MPC) shares have risen marginally by 0.6%. These refining stocks have been impacted by a series of factors like refining cracks, oil spreads, RIN (renewable identification number) prices, and more.
Widening refining cracks and oil spreads
Refining cracks and oil spreads are widening in the current quarter due to the effect of IMO 2020. According to the new regulation, shippers must use low-sulfur fuel starting in January. To produce low-sulfur fuels, refiners can use sweet or sour crude oil. However, refiners with advanced refining units can use sour crude oil. Other refiners will have to process sweet crude oil.
Refiners have to upgrade refining facilities to use sour crude oil. Overall, the investments are high and take years to materialize. Currently, there are only a few refiners with that capability. The demand for sweet crude oil has risen, which has raised the spread between sweet and sour crude oil prices.
So, refiners that can use cheaper sour crude oil benefit from these changing dynamics. Refined product prices usually move in line with Brent—a relatively sweet crude oil.
As the demand for low-sulfur fuel increased, refiners scrambled to fulfill the demand. The move has impacted the production of other refined products like gasoline. The supply disruption has boosted cracks for other refined products. So, the new regulatory environment is raising overall refining cracks in the industry.
Valero’s refining crack and oil spread indicators
As refiners get ready to face IMO 2020, Valero Energy seems well placed. According to the company, its conversion capacity stands at 30% of crude distillation capacity. Meanwhile, peers have capacities ranging from 14% to 30%. The conversion capacity includes delayed coking, gas oil hydrocracking, fluid coking, and residual hydrocracking capacities.
Considering Valero Energy’s positioning, let’s review how its refining crack indicators and oil spreads are trending in the current quarter. So far, the company’s refining crack indicators have risen in three out of its four operating zones in the current quarter. The indicators have risen 31%, 34%, and 64% YoY in the US Gulf Coast, North Atlantic, and US West Coast, respectively. However, in the US Midcontinent, the indicators have fallen 3% YoY.
All of the oil spreads in the US Gulf Coast have widened. The Brent-LLS, Brent-WTI Houston, and Brent-Maya have risen 58%, 7%, and 159% YoY, respectively, in the fourth quarter. Meanwhile, the Brent-WCS Houston and Brent-ASCI have risen 6% and 14% YoY, respectively.
Better cracks and wider oil spreads show that the refining conditions are conducive for Valero. So, the company could post a higher refining margin in the fourth quarter.
Read Valero Energy Stock: Are Analysts Buying Its Growth Story? to learn more.
Marathon Petroleum’s refining indicators
Marathon Petroleum also seems to be well-positioned for IMO 2020. According to the company, it has the best distillate hydrotreating (including diesel, kerosene/jet, and other distillate desulfurization) capacity and the highest residual upgrade (including resid hydrocracking, coking, resid deasphalting, and asphalt) capacity among its peers.
Marathon Petroleum publishes refining data like the blended crack, prompt sweet differential, and prompt sour differential monthly. According to the company, a dollar-per-barrel change in the blended crack changes its net income annually by $900 million. A dollar-per-barrel shift in the prompt sweet differential and the prompt sour differential shifts Marathon Petroleum’s net income yearly by $370 million and $450 million, respectively.
In the fourth quarter, the indicators have put up a mixed trend. So far, Marathon Petroleum’s blended crack has increased 48% YoY. However, the company’s prompt sweet differential has fallen 62% YoY. Likewise, the prompt sour differential has fallen 48%. In the third quarter, Marathon Petroleum used 53% sweet crude oil in its refining system.
So, Marathon Petroleum should benefit from higher blended cracks in the fourth quarter. However, the rise in the company’s refining earnings will be partly offset by the fall in differentials. Marathon Petroleum will continue to benefit from the capacity expansion caused by integrating Andeavor’s assets.
To learn more about the company, read MPC: Elliott Ups Stake by 86% in Marathon Petroleum.
HollyFrontier’s index value
HollyFrontier publishes index values in the areas where it operates. Overall, the values have risen across the company’s operating regions. In the Midcon and Southwest, the values have increased 12% YoY each. In the Rockies region, the values have risen 34% YoY in the fourth quarter.
The rising values suggest that the company faces a robust crack environment in the quarter, which should support its refining margin and earnings in the quarter.
Currently, IMO 2020 is rapidly changing the refining landscape. Refiners have started reaping the benefits of broader refining cracks and oil spreads. However, we’ll have to see which refiner emerges as the largest beneficiary from these changing dynamics.