Recent sustained increases in benchmark crude oil prices have placed pressure on North American refiners in the form of lower crack spreads, softening end-user demand and higher liquidity requirements, according to Fitch Ratings. In the first quarter of 2008 (1Q08), benchmark West Texas Intermediate (WTI) prices averaged approximately $98/barrel, a 67% increase over prices seen during the 1Q07. At the same time, benchmark crack spreads have contracted as increases in refined product prices failed to keep pace with fast-rising crude. Year-over-year, Gulf Coast 3-2-1 crack spreads fell by 22% to $8.00/barrel in the first quarter. Mid-continent crack spreads fell approximately 26% to $10.85/barrel, while West Coast crack spreads fell more dramatically, dropping 46% to just $15.47/barrel from last year. While these declines are partly explainable by seasonal impacts (the first quarter is typically a lower demand shoulder season), high retail fuel prices and a softening U.S. economy have also begun to erode end-user demand. According to Energy Information Agency (EIA) data, implied gasoline demand fell approximately -2.4% in the first quarter, from 9.85 million barrels per day (bpd) to 9.61 million bpd.
While 2008 results are weaker than last year, it is important to note that crack spreads remain above their long-run averages at this point. If margin weakness persists, Fitch expects refiners will respond by continuing to throttle back refinery runs to help restore balance and improve profitability. Across the industry, refinery utilization levels dropped to just 82% as of March, with Valero Energy Corp. recently indicating that its FCC (gasoline-making) units were running at just 73% of capacity.
In addition to weaker gross margins, credit concerns for the downstream sector center on the potential for additional shareholder-friendly activity, higher capital expenditures, and higher liquidity needs prompted by record crude and feedstock prices. Slumping stock prices across the refining sector may create additional pressure for shareholder-friendly activity, especially share buybacks. Fitch notes that several refiners have announced the potential sale of non-core refineries, including Valero (the 275,000-bpd Aruba, 85,000-bpd Krotz Springs, and 195,000-bpd Memphis refineries); as well as Sunoco Inc. (the 85,000-bpd Tulsa refinery). The use of proceeds from these sales remains an issue, especially if cash were redirected exclusively to share buybacks without proportionate decreases in debt.
The high cost of adding downstream capacity in today's environment also raises concerns for those firms looking to expand organically. Examples of recent investments include Marathon Oil Corp.'s $3.2 billion, 180,000-bpd expansion of its Garyville, LA., refinery; and Motiva Enterprises LLC's $7 billion, 325,000-bpd expansion of its Port Arthur, TX, refinery. Finally, higher crude oil prices have increased liquidity needs across the sector, although the impact on individual companies is firm-specific and depends on several variables, including the trade credit extended by crude sellers, the geographic source and distance of crude supplies, and the timing of cargo liftings.
Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.
Contacts:
Mark Sadeghian, 312-368-2090
Adam
Miller, 312-368-3113
Brian Bertsch, 212-908-0549
(Media
Relations, New York)
