This piece originally appeared on Oilprice.com.
Several months on from the lifting of the U.S. oil export ban, it’s becoming clear that one unexpected group had benefited considerably from the restriction – U.S. refiners. Refiners had enjoyed a boom for the last few years thanks to a combination of cheap landlocked U.S. oil and falling prices for oil that were not fully reflected in falling gasoline prices. Both advantages are now lost, which is leading many refiners to have significantly lower profits than they had posted previously.
The environmental change for refiners is probably more secular than cyclical at this stage, so investors should not expect a return to the halcyon days of dramatic profits anytime soon. In particular, the oil export ban has created significant margin pressures that will not soon ease.
When the U.S. had the oil export ban in place, landlocked U.S. crude created a surplus of domestic oil that depressed prices artificially versus international prices. That in turn was good for refiners which could buy U.S. crude and turn it into higher margin jet fuel and gasoline. Those product prices did not reflect lower domestic prices but rather higher foreign prices of oil. Now that the export ban has been removed, domestic and international oil prices have equalized such that most U.S. shale output trades at levels consistent with what one would expect given the transportation costs in any particular basin. In other words, domestic prices have risen somewhat, albeit not close to enough to offset the overall decline in oil prices.
The refiners and chemical companies, both of which rely on cheap domestic oil feedstock to stoke higher margins, were very much opposed to the removal of the export ban. With that ban now gone, both industries are seeing lower gross margins. The beneficiaries of higher prices are less easy to identify as they are more widely dispersed given industry concentrations.
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On the whole, investors in refinery stocks and in integrated majors like Exxon with a substantial refinery business need to accept the reality that the world has changed. The U.S./international oil differential is unlikely to reopen any time soon and, given the structure of refining equipment in the U.S., it’s likely that U.S. oil will actually be sent to refiners abroad, while international oil is imported into the U.S. If this seems inefficient, it is important to remember that not all oil is created equal and different refineries are better equipped to handle different oils with varying specific weights and qualities.
The best hope for the major refiners like Valero now resides in a strong summer travel season. The summer driving season has significant potential to boost demand for gasoline, potentially pushing up prices to the point where margins expand somewhat for refiners.
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To be fair of course, the refiners are still largely making money, and their industry enjoys a level of tacit collaboration that is completely lacking in the diffuse and chaotic E&P field. Both advantages are the envy of energy investors in other segments. With that said, it is clear that it’s not as good a deal to be a refiner as it used to be. And that’s not about to change. Investors who once priced in rich multiples for refiners may want to reconsider their valuations in light of the evolving environment.