Yesterday, the U.S. Energy Department’s weekly inventory release showed a less-than-expected build in crude stockpiles. However, the headline news was centered on a sharp drop in gasoline stocks and refinery utilization that pushed oil prices to a fresh 2009 peak and lifted energy stocks.
The federal government’s Energy Information Administration (EIA) reported a 400,000 barrels rise in crude inventories for the week ending October 9, much less than analyst expectations. The modest increase can be attributed to scaled back operations by the refiners (prompted by weak profit margins) even as imports fell. This follows last week’s report, which showed an unexpected rise in oil supply figures, against consensus forecast of a buildup.
Current crude oil stocks, at 337.8 million barrels, are 9.6% above the year-earlier level and remain above the upper limit of the average for this time of the year (depicted in the first EIA chart below). The supply cover increased from 22.9 days in the previous week to 23.3 days of supply, but it remains below the year-earlier level of 23.7 days.
Supplies of gasoline sank by a whopping 5.2 million barrels from the previous week (far exceeding estimates of a build), the biggest drop in a year, as U.S. refiners reduced processing. At 209.2 million barrels, current inventories are below year-earlier levels and are just above the upper half of the historical range, as shown in the following chart from the EIA.
Distillate fuel inventories (including diesel and heating oil) dropped by 1.1 million barrels last week (more than anticipated) to 170.7 million barrels and but remain above the upper boundary of the average range for this time of year. This is shown in the following chart from the EIA.
Refinery utilization was down 4.1% from the prior week to 80.9% (the lowest since mid-April), much higher than analyst expectations, as refiners reduced runs for repairs and upgrades.
Total refined products supplied over the last four-week period – a proxy for overall petroleum demand – went up. It was up 2.1% from the year-earlier period, with gasoline up 5.3%, distillates (includes diesel) down 10.8% and jet fuel down 3.5%.
The bigger-than-expected decline in fuel inventories (gasoline and distillates) has raised hopes that the worst of the recession-induced slump may be over and demand is picking up. Coupled with stronger equity markets and a soft dollar, this sent oil prices sharply higher to a new one-year peak of over $77 per barrel, providing a big boost to energy stocks (in particular oil refinery companies).
Though we welcome the bullish EIA data, we are not fully convinced about the sustainability of crude oil’s current gains, as the specter of a continued glut in global fuel supplies still weighs and all of the inventories remain higher compared to averages for this time of year. Moreover, the drop in petrol stocks was triggered by a big fall in refinery activity, rather than a much awaited pick-up in oil demand.
As such, we prefer to maintain our cautious stance on oil refiners like Sunoco Inc. (SUN), Tesoro Corp. (TSO) and Western Refining Inc. (WNR), given that the overall environment for refining margins is likely to remain poor going into 2010.
The sharply lower refinery utilization (at just 80.9% of capacity) provides enough evidence that refineries are cutting back on production because the economy is still struggling on the demand side. Being the largest independent refiner, Valero Energy Corp. (VLO) remains particularly exposed to this unfavorable macro backdrop. We see little reason for investors to own Valero and have an Underperform recommendation on the company.
Companies like ConocoPhillips (COP) and ExxonMobil Corp. (XOM) – oil majors that have significant refining operations – are also expected to remain under pressure until pricing and demand improve.
We would also like to maintain our cautious outlook (Neutral recommendation) for integrated oil players and oilfield service firms till the demand outlook improves. Companies such as Chevron Corp. (CVX), Marathon Oil Corp. (MRO), Hess Corp. (HES), Schlumberger Ltd. (SLB), Baker Hughes Inc. (BHI) and Weatherford International (WFT) fall in this category.
Read the full analyst report on “SUN”
Read the full analyst report on “TSO”
Read the full analyst report on “WNR”
Read the full analyst report on “VLO”
Read the full analyst report on “COP”
Read the full analyst report on “XOM”
Read the full analyst report on “CVX”
Read the full analyst report on “MRO”
Read the full analyst report on “HES”
Read the full analyst report on “SLB”
Read the full analyst report on “BHI”
Read the full analyst report on “WFT”
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