The U.S. Energy Department’s weekly inventory release showed a larger-than-expected decline in crude stockpiles, while gasoline supply logged another surprise decline. The agency’s report further added that inventories of distillate fuel posted a smaller-than-expected rise, and refinery capacity use fell.
Crude Oil
The federal government’s Energy Information Administration (EIA) reported that crude inventories dropped by 1.9 million barrels for the week ending May 28, 2010, well above analyst expectations. The decrease in crude stocks, the first in seven weeks, can be attributed to a decline in production and lower imports.
At 363.2 million barrels, crude supplies are 2.8 million barrels below the year-earlier level but remain above the upper limit of the average for this time of the year (depicted in the first EIA chart below). The crude supply cover was down slightly from 24.2 days in the previous week to 24.0 days. In the year-ago period, the supply cover was 25.2 days.
U.S. Crude Oil Stocks Graph.
Gasoline
Supplies of gasoline fell for the fourth consecutive week, again defying analyst expectations for a rise. The 2.6 million barrels drop came mainly on the back of higher consumption (with the beginning of the summer driving season) and lower imports, partially offset by higher production. At 219.0 million barrels, inventories are at their lowest level this year. However, current gasoline supplies still exceed the year-earlier levels and are above the upper half of the historical range, as shown in the following chart from the EIA.
U.S. Gasoline Stocks Graph.
Distillate
Distillate fuel inventories (including diesel and heating oil) were up by 445,000 barrels last week, lower than analyst expectations. The increase in distillate fuel supplies reflects increased volumes, somewhat offset by higher demand. At 153.0 million barrels, distillate supplies remain above the upper boundary of the average range for this time of year. This is shown in the following chart, also from the EIA.
U.S. Distillate Stocks Graph.
Refinery Rates
Refinery utilization fell slightly (by 0.3%) from the prior week to 87.5%. Analysts were looking for a 0.4% increase in refinery run rate.
The overall demand picture has improved somewhat, as reflected by the increase in the total refined products supplied over the last four-week period, a proxy for overall petroleum demand. It was up by 8.1% from the year-earlier period.
Our Take
The inventory data was mostly positive, in light of the higher-than-expected crude and gasoline inventory draws, and lower-than-anticipated distillate stockpile build. However, product inventories (gasoline and distillate stocks) remain above the upper boundary of the average range for this time of year, along with soaring commercial oil supplies.
We take this as a sign that energy consumption in the world’s biggest economy remains slack and there is no problem with the commodity supply. As such, the latest EIA report is not as fundamentally bullish as it looks.
In particular, we maintain our cautious view on the refining sector. While we currently don’t have any Sell-rated stocks in this group, we believe upside will be limited over the next few months and the group will likely underperform both the broad market and other energy sub-sectors.
Margins have been quite robust in the current quarter, helped by the European debt crisis, depressed oil prices, higher U.S. exports and better-than-expected demand. However, we believe that the relatively stronger margins are unlikely to persist, as refiners increase production with more conversion units resuming operations from their turnaround activities. Utilization rates are likely to hover around the high 80’s/low 90’s during the near-term amid too much supply of petroleum products.
Though margins have rebounded from the troughs of the fourth quarter, they still remain way off the levels achieved a few years ago, and are insufficient for refiners to get back into the black.
As such, we have a bearish stance on companies like Sunoco Inc. (SUN), Tesoro Corp. (TSO), Valero Energy Corp. (VLO) and Western Refining Inc. (WNR), given that the overall environment for refining margins is likely to remain poor.
All the above-mentioned companies currently have Zacks #3 Ranks (Hold), meaning that these stocks are expected to perform relatively the same as the overall market during the next 1-3 months. Therefore, investors should maintain their current positions in the stocks over this time period.
Despite signs of improving demand and economic growth, the scenario remains fragile, in our view. The industry is grappling with unpredictable oil prices, a weak global economy, excess refining capacity and a huge environmental disaster (the Gulf of Mexico oil spill).
We, therefore, stick to our short-term Hold rating for integrated oil players such as Exxon (XOM) and BP Plc (BP). In particular, firms like Chevron Corp. (CVX), Marathon Oil Corp. (MRO) and ConocoPhillips (COP) — oil majors that have significant refining operations — are also expected to remain under pressure until pricing and demand improve.
The companies have scaled back their worldwide downstream operations, as they believe oil refining margins are unlikely to improve substantially this year. Profitability has collapsed in recent times due to the global economic rout and a glut of new capacity in the emerging economies of Asia and the Middle East.
Read the full analyst report on “SUN”
Read the full analyst report on “TSO”
Read the full analyst report on “VLO”
Read the full analyst report on “WNR”
Read the full analyst report on “XOM”
Read the full analyst report on “BP”
Read the full analyst report on “CVX”
Read the full analyst report on “MRO”
Read the full analyst report on “COP”
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