However, assuming conditions do not improve, many weaker credits could falter and we may see the first rash of defaults in the industry since the 2002 downturn.
Weak demand and overcapacity continue to plague refiners
This is shaping up to be another difficult year for the refining industry, if not the roller coaster that 2008 was. Still, the struggling U.S. and global economies and increasing worldwide refining capacity frame a bleak outlook.
Lower prices for refined products have failed to improve demand significantly, and once-mighty diesel prices have come back to earth. As a result, margins will remain volatile and could weaken significantly if the summer driving season is weak. The Energy Information Administration [EIA] is forecasting average summer gasoline prices of $2.23 per gallon, not far off current levels. The EIA's estimated summer diesel price of $2.27 per gallon is approximately $2 lower than year-ago levels, reflecting lower crude costs and a weakened market because international capacity has increased at the same time economies have swooned. Finally, the infusion of ethanol into the fuel supply continues to pressure gasoline margins. The EIA expects ethanol use in the U.S. to average around 670,000 barrels per day [bpd], which is about 7% of gasoline demand this summer.
As a result of the uncertain market, companies continue to position themselves for difficult operating conditions ahead. Building on 2008's initiatives, they are deferring capital projects, optimizing utilization levels, and managing working capital needs. Although last year saw a move to greater diesel production, 2009 may see a decline in production because increased international supplies have weakened margins and are now making the U.S. gasoline market more attractive. The biggest surprise in 2009 may be the continued strength of asphalt. Despite a drop in demand, lower asphalt production helped keep margins healthy in 2008, a trend that appears to be continuing in 2009. In addition the U.S. stimulus package should boost infrastructure spending and thus, asphalt demand, potentially supporting asphalt margins through 2009 and into 2010.
Given the struggling global economy, additions to refining capacity, and continued weak product demand in spite of lower gasoline and diesel prices, we expect refining performance to remain below average in 2009. Not all companies in the sector will suffer equally, however. Refiners that operate large, high-conversion facilities should continue to fare better than smaller players. These facilities have logistical advantages and can produce large proportions of clean fuels from discounted, low-quality crudes such as heavy or high-sulfur grades. Companies operating in niche markets also have an advantage over those in more competitive regions such as the Gulf Coast. As a result, higher complexity refining companies such as Flint Hills Resources, Frontier Oil (FTO), and Valero Energy (VLO) should continue to achieve better-than-average results for the industry.
