A Review of the Nigerian Energy Industry

As crude spread widens, margins improve for US refiners

fuel exports* WTI-Brent differential crosses $10/barrel threshold
* Wider spread promises higher margins for Midwest refiners
* Gulf Coast refiners also set to gain, thanks to pipelines
* Railroads also stand to benefit

26 October 2013 – Oil refiners in the United States – including, for the first time, those on the Gulf Coast – are set to gain from a renewed widening of the price gap between the world’s two most actively traded crude contracts.

The closely watched spread between U.S. benchmark West Texas Intermediate (WTI) and European benchmark Brent returned across the $10 per barrel threshold this week.

The price differential evaporated in July for the first time since 2010, and for the next couple of months was at an unusually low $2 to $6 per barrel in favor of Brent.

The widening spread is restoring high margins for Midwest refiners, such as Marathon Petroleum Corp, which refine cheap U.S. crude into gasoline, diesel and other products to be sold at prices linked to the more expensive Brent.

New pipelines are also making cheap inland crude easily available to Gulf Coast refiners, boosting margins for companies such as Valero Energy Corp and Phillips 66.

“This is really the first time the Gulf Coast refiners are enjoying the benefits of U.S. production in a material way,” said John Williams, investment analyst at T. Rowe Price, which owns shares in Valero and Phillips 66.

“When the differential was wide before, there weren’t pipelines bringing the oil to the Gulf Coast and now (refiners) can get their hands on the cheap oil that makes the difference to their profitability.”

Investors will need to wait at least another quarter before these higher margins show up in refiners’ earnings. Results for the third quarter, expected next week, are forecast to be weak as high crude costs have squeezed margins.

But shares of Midwest refiners in particular have begun to bounce back in anticipation of a recovery in the current quarter and beyond.

Shares of Delek U.S. Holdings Inc have climbed 26 percent in the last month. Western Refining Inc is up about 15 percent in the same period, while Marathon Petroleum is up 8 percent and HollyFrontier Corp nearly 4 percent.

“Refiner earnings have the potential to bounce back in the fourth quarter if recent crude spread trends continue,” Raymond James analyst Justin Jenkins said.


The widening spread is also positive for railroads that transport cheaper inland crude to coastal refiners.

Because the Gulf Coast is now well served by pipelines, the biggest opportunities exist for rail operators with routes to the east and west coasts of the United States, analysts said.

“Both Norfolk Southern Corp and CSX Corp stand to gain from the growth in crude-by-rail, and a lack of pipelines going east,” said Cowen and Co analyst Jason Seidl.

Other railroad operators that stand to benefit from the widening spread include Union Pacific Corp, Genesee & Wyoming Inc and BNSF Railway Co, a subsidiary of Berkshire Hathaway Inc.

The differential between WTI and Brent, however, is not necessarily on a consistent upward trend. Analysts expect it to be volatile as stockpiles rise and fall at Cushing, the storage hub and delivery point for U.S. crude.

Rising U.S. shale oil supplies, coupled with lower demand during the refinery maintenance season, has led to a build-up of crude at Cushing.

Analysts say these supplies could fall by the end of the year as refineries complete maintenance and the southern leg of TransCanada Corp’s Keystone XL oil pipeline comes into service, diverting crude elsewhere.

Williams said the spread could tighten again in November and December to a dollar-per-barrel level in the mid to high single digits, before rising back into double digits next year.
*Swetha Gopinath, Reuters

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