2018 off to a good start for refiners

May 2018 | Tim Fitzgibbon and Emily Billing


First quarter results show that US refiners are generally doing better than the previous year. After adjusting for one-time items, refining businesses are showing a small improvement in margins, and markets and assets able to take advantage of growing domestic crude discounts are seeing the most benefit. Overall, this bodes well for a strong 2018.

US refiners reported higher earnings

First quarter earnings reports show some improvement over the same period in 2017, once one-off items are adjusted for by taking throughput margin and multiplying by throughput volume.

    • Marathon saw a ~2% improvement after adjusting for a drop down of logistics assets from the refining segment to the logistics segment. This relatively small improvement is due to higher throughput but at a slightly lower margin, compared to a very heavy turnaround period in the first quarter of 2017
    • Valero saw a ~6% improvement attributed to higher distillate values, partially offset by lower medium and heavy crude discounts
    • Phillips66 saw a ~12% improvement after adjusting for a one-time gain in the first quarter of 2017 from consolidation of value from a coking venture
    • Andeavor saw a ~45% improvement, mostly attributable to the addition of Western refining assets after the 2017 combination

Exhibit 1: Adjusted earnings show higher margins across the board

Exhibit 1: Adjusted earnings show higher margins across the board

Margins improvement strongest in inland markets

A look at reported gross margins by region shows improvement in the mid-continent and flat to slightly lower margins on the coasts.

  • Valero and Phillips66 both showed a decline in average Gulf Coast gross margins, reflecting a tightening in medium and heavy crude discounts
  • Phillips66 and Andeavor saw slight declines in West Coast margins as tighter crude markets and lower distillate prices offset slightly higher gasoline prices
  • Inland markets showed the only significant change, with both Phillips66 and Andeavor seeing gross margins increase by ~USD6/bbl, mostly due to wide crude discounts

Exhibit 2: US refiner reported throughput by region shows strongest gains in the Midwest

Exhibit 2: US refiner reported throughput by region shows strongest gains in the Midwest

Variable cash margins on the Gulf Coast show a diverging story between light and medium/heavy crude refining. Light crude margins into cracking capacity improved by ~USD0.80/bbl in the first quarter when compared to the same quarter a year earlier. This is largely due to a widening of the Gulf Coast light crude discount to the international market as growing US supply has pushed the market to higher levels of exports. With increasing volumes, Gulf Coast prices for light crude have shifted to a netback from Asia markets at close to full cost of transportation, versus previously lower discounts in line with the cost of moving crude using cheaper backhaul economics.

In contrast, margins for processing heavy and medium crudes in coking narrowed in the first quarter versus last year’s conditions. This is in line with a general tightening of medium and heavy crude markets due to reduced supply. The big contributor to this has been lower output from the Middle East as OPEC has curtailed supply in an effort to support higher absolute prices.


Exhibit 3: Gulf Coast margins remained relatively flat in Q1 2018

Exhibit 3: Gulf Coast margins remained relatively flat in Q1 2018

In the Midwest, the most significant price movement has been for heavy crude. Growing crude supply from Western Canada and bottlenecks in pipeline capacity to move it to the international market forced heavy crude discounts to widen dramatically at the end of 2017 and into early 2018. In the first quarter, WCS prices relative to Maya were lower by ~USD15/barrel compared to the same period in 2017. For refiners processing heavy crude (and with access to pipeline capacity), this more than offset the somewhat lower prices for gasoline in the Midwest relative to the Gulf Coast and slightly higher prices for light-sweet crude from the Bakken.


Exhibit 4: Midwest margins improved due to higher diesel prices and lower heavy crude prices

Exhibit 4: Midwest margins improved due to higher diesel prices and lower heavy crude prices

Outlook positive for rest of 2018

These first quarter results indicate that 2018 is likely to be another strong year for refiners. The first quarter is typically a lower-margin period for the industry, so a promising start relative to 2017 points towards a robust year overall as the industry moves into the higher-demand driving season.

Helping to support this is the continued growth in crude supply, especially from the Permian Basin in West Texas, that should help keep Gulf Coast crude exports growing and prices at a discount to world markets. Logistics constraints to move marginal barrels of Western Canadian crude to market should continue to provide Midwest refiners with discounted heavy crude, though there is significant volatility in the discount.

One area of potential concern for the market overall will be the potential return of significant refining capacity in Mexico. Very low throughput in 2017 due to major planned and unplanned outages of Mexican refineries helped provide a home for excess product on the Gulf Coast. Even a partial return of the lost Mexican capacity could cause hundreds of thousands of barrels per day of product to find a new home in more distant markets.



About the authors

Tim Fitzgibbon is a senior industry expert with McKinsey's Oil and Gas Practice in Houston, where Emily Billing is a senior analyst with McKinsey Energy Insights.



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