ANDV Andeavor

By Bradley Olson and Alison Sider 

U.S. refiners, which posted robust profits the last 18 months even as other parts of the oil business were racked by low crude prices, finally saw their roll come to a halt in the first quarter.

Many refining businesses reported earnings for the period that were down roughly by half from a year earlier. That decline helped sour results for oil giants such as Exxon Mobil Corp., which has counted on refining to offset profit declines in energy production, and for Valero Energy Corp., the world's largest stand-alone refiner by output, which on Tuesday reported its lowest first-quarter profit in four years.

"The first quarter presented us with challenging markets, with gasoline and diesel margins under pressure," said Valero Chief Executive Joe Gorder.

Two trends have helped upend the refining boom: U.S. crude is no longer trading at a steep discount compared with oil from other parts of the world. And American exports of gasoline and diesel are pushing into increasingly well-supplied foreign markets.

For years, U.S. refiners benefited because a bounty of oil unlocked by shale exploration was essentially landlocked in the country due to a ban on most crude exports, creating a glut that pushed down prices compared with barrels in Africa and the Middle East.

That allowed U.S. refiners to turn oil into gasoline, diesel and other products more cheaply than some competitors, and enhanced their ability to export the fuels to foreign markets. Between 2010 and 2015, U.S. exports of gasoline and other fuels rose 38% to 2.8 million barrels a day, helping to reduce the nation's trade imbalance.

Now that U.S. oil production is falling and the country allows crude exports, that advantage has significantly diminished. Once as high as $25 a barrel in 2011, the difference between U.S. and international crude benchmark prices now sits at a little over $1 a barrel today.

New pipelines also have further smoothed out regional price differences that had benefited some American refiners by giving them greater access to landlocked oil.

While refiners largely still make money, and are in better shape than during the industry's most recent challenging times in 2009, the lower returns illustrate how the price crash is finally reaching a piece of the business that had been insulated.

"When prices come down as they have, refining margins hold out for a period of time, but that works its way through the system and the pressure comes back on," said Richard Forrest, a partner at consulting firm A.T. Kearney.

It is hard to overstate how good the refining business has been in recent years. Since mid-2012, shortly after two companies spun out their fuel processing units into stand-alone companies, the four best-performing energy stocks on the S&P 500 index were refiners.

All four companies -- including Valero, Tesoro Corp., Marathon Petroleum Corp. and Phillips 66 -- more than doubled in value. Last year, when average U.S. oil prices fell by almost half to about $45 a barrel, Valero shares rose 43%.

Exxon's global network of refineries has been a critical bulwark against losses since oil prices began to tumble in the summer of 2014. That is the central rationale for the company's "integrated" structure of tapping wells, shipping crude and processing it into fuels and chemicals: When crude prices fall, refining will remain a lucrative business.

Yet Exxon's profit from its refineries fell 46% to $906 million in the first quarter. Chevron's fell 48%. The totals were still enough to help keep Exxon profitable in the quarter, but Chevron posted its second-straight quarterly loss, the first time that has happened in at least two decades.

On Tuesday, Valero disclosed its earnings dropped nearly 49%, to $495 million, from the first quarter of last year. Tesoro, which has large operations on the West Coast, reports on Wednesday.

Along the Gulf Coast, home to more than half of the country's refining capacity, per-barrel profit margins shrank from $10.30 on average last year to $6.75 in the first three months of 2016, according to refining consultants Turner, Mason & Co. Some refiners in the Midwest cut production rates that quarter to work off extra inventory.

Many analysts expect demand will come roaring back when U.S. drivers emerge from winter malaise and take to the road for summer trips. Refiners say they are already seeing signs of a coming strong driving season. The U.S. Energy Information Administration has predicted domestic gasoline demand will grow 1.4% this year after rising 2.7% last year.

"Strong demand and too much crude is great for refiners," Wolfe Research LLC analyst Paul Sankey wrote in a research note last month. The caveat: "It has to be said we are dependent on driving season showing up in a big way," he added.

But even if predictions for a profitable summer prove true, refining mightn't be able to keep propping up earnings for companies that both produce oil and consume it in plants that churn out gasoline and diesel.

Drivers in the U.S. raced to buy gas-guzzling trucks and SUVs last year when fuel prices first started to fall, helping to push demand for gasoline up last year. But the average vehicle sold today is significantly more efficient than just a few years ago, according to the University of Michigan's Transportation Research Institute, which tracks fuel economy.

For the past year and a half, low crude prices have encouraged refiners to buy oil and produce more fuel than the world needs, said Robert Campbell, head of oil products research at consultants Energy Aspects. That has led to a buildup of fuel inventory globally, which could cut into refining margins later this year as crude prices start to recover.

"We'll go back to having an excess of refining capacity, which was the problem prior to the fall in oil prices," he said.

--Douglas Kobin contributed to this article.

Write to Bradley Olson at Bradley.Olson@wsj.com and Alison Sider at alison.sider@wsj.com

(END) Dow Jones Newswires

May 04, 2016 02:48 ET (06:48 GMT)

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