Posted on 10/15/2006 7:32:04 AM PDT by thackney
The falling price of gasoline is good news for motorists, but not everyone is celebrating.
U.S. refiners are seeing thinner profit margins because pump prices have fallen to their lowest point since March, fuel stockpiles are high, and fears that hurricanes will knock out Gulf Coast refineries again this year have eased.
This big shift suggests that last year's hurricane-fueled earning spike may be nearing its end.
But not all the signs indicate gasoline prices will stay down. Many of the same fundamentals are in place today that had drivers crying uncle every time they gassed up a year ago. Oil prices, then as now, hovered around $60 a barrel. Demand remains strong. Mideast tensions persist.
While conspiracy theories abound about the 75-cent drop in gasoline prices over the last two months — a survey last week found many voters thought it was the work of Washington politicians seeking re-election — there appears to be a simpler explanation.
And refiners play an important role in that explanation.
After Katrina and Rita walloped Gulf Coast refineries last year, those facilities that were not damaged were running flat-out to keep up with demand at a time when oil companies were also paying premium prices for imported gasoline.
Earlier this year, fears that another monster hurricane season could create problems led refiners to build up fuel supplies in preparation for the worst — again.
But this year has been different.
"Once it started to become clear that the fundamentals were not supporting that, and the hurricane season wasn't going to repeat, everybody looked around and said: 'You know what? We got more crude than we need, we've got more products than we need,' " said Steve Arbogast, executive professor at the University of Houston's Global Energy Management Institute.
Since then, refiners have been "de-stocking" fuel in order to bring the situation back into balance, which has contributed to weakening profits, he said.
Refining profits typically decline this time of year, after the busy summer driving season ends and refiners switch to making less-expensive winter gasoline blends. But the drop this year came earlier than usual and was bigger than expected.
"The bloom hasn't come off the rose entirely," said William Veno, industry analyst at Cambridge Energy Research Associates in Cambridge, Mass. But refining profits are starting to return to more normal levels, he said.
Higher visibility soon The sudden drop in refining profits is likely to be a topic of conversation in coming weeks as the largest U.S. refiners report financial results for the third quarter.
"It's starting to be factored into the numbers," said Jeff Dietert, analyst with Simmons & Co., an industry consultant in Houston.
But a government report last week suggested refiners may soon rebound from recent lows, which could push pump prices higher again.
Refining margins jumped 17 percent from the prior week during the first week of October amid a lower-than-expected rise in fuel inventories and increased demand for gasoline and other refined products such as jet fuel and heating oil, according to a Department of Energy report released Thursday.
Refiners may be helped this fall when many companies close facilities for routine maintenance, which could help the industry work off its high inventories or even tighten supplies and boost profits in the near term, according to Dietert of Simmons.
Consumers are expected to take advantage of lower prices by filling up more, which could also help boost refiner profits in coming months.
"The picture for gasoline margins is improving" for refiners, Bill Kleese, chief executive of San Antonio-based Valero Energy Corp., said in a recent statement. The largest North American refiner owns a refinery in Houston.
Valero expects to post record third-quarter profits and sees a strong fourth quarter despite narrower margins of late. Other big U.S. refiners, including Tesoro and Sunoco, also expect to come out ahead for the quarter.
Yet they might have fared better had it not been for the big swing in refining profits during the period.
The estimated profit margin for refining a barrel of crude stood at $10.39 per barrel in the third quarter, down from $17.31 per barrel during the July-September period a year ago, according to Simmons & Co.
And this closely watched profit indicator, the so-called U.S. Gulf Coast 3-2-1 crack spread — which assumes three barrels of crude oil are "cracked" into two barrels of gasoline and one barrel of heating oil — is expected to narrow further in the last three months of the year.
Big decrease in margins Simmons predicts fourth-quarter margins will come in at $5.43 per barrel, compared with $9.78 per barrel during the same period in 2005, when Gulf Coast refineries were still repairing damage caused by hurricanes Katrina and Rita.
While the slip has been sudden, it brings profits closer to historic levels, suggesting that margins will settle back into normal territory rather than contract further.
For the full year, gas-refining margins are expected come in at $6.04 per barrel, down sharply from last year's $10.71 per barrel, but close to the five-year average of $5.90 per barrel, according to Simmons.
Tough act to follow The drop looks worse than it really is because last year's post-hurricane profit margins were so extreme, said David McCollum, a spokesman for Houston-based Citgo Petroleum Corp., which is owned by Venezuela's national oil company.
"Particularly after last year, anything would look like a significant drop."
But the decline also reflects the calmer attitude toward potential risks to U.S. refining supply, he said.
No matter what explanation is given for falling gas prices, there are still those who believe more sinister factors are at play.
According to a Washington Post-ABC News poll released Monday, three in 10 Americans believe sliding gasoline prices are the result of a plot by Washington politicians to influence the outcome of the November midterm elections. Only slightly more attributed the situation to market forces.
Trouble with low prices is now there is little incentive to build new refineries.
And during the last run up in prices and Katrina, it was universally agreed that we need more capacity.
If you think that falling prices won't go up again, you are dreaming. The measure of the American consumer public was taken and tolerance of higher prices was noted. The speculators drove it too high too fast, that's all.
If you believe that sellers can get whatever price they want, you have a poor understanding of commodity markets and history. Falling prices will rise again, and fall again, and rise again, and fall again...
The margin of return on investment may go down, but the gross gets much higher.
The economics of the situation is that, building new capacity has to be done as older capacity is either exceeded (demand) or becomes economically infeasible because the costs of maintenance exceeds the replacement costs.
If the new capacity is not built here, it shall be built elsewhere. And instead of importing crude oil, we import finished product.
Any market can be manipulated. Do you remember in the seventies when the Bass brothers from Texas nearly cornered the Silver market?
The pure sense of the market economy is that we can control our own destiny by how much we drive and what kind of fuel we use. But there are other forces in play as well.
I and Lawrence Kudlow agree with you, my friend. I am taking off my tin foil hat as we speak.
I suppose another historical question would be the basis for the supply drop of after 02.
Mom-and-pop refinery owners in breadlines! Down with Bush!
;-)
Historically, refineries are the worst part of the oil business to be in. Sure, they get some periods where they're wildly profitable, but they also have periods where they're actually selling at a loss.
Plus, they tend to blow up, so you always have a liability anvil hanging over your head.
Integrated oil companies keep them because they tend to be counter-cyclical. They make money when your upstream exploration operations are marginal, and they tend to lose money when you're going great guns finding new crude.
And they feed the retail operations where you make your biggest profit selling coffee and hamburgers at the gas stations.
The dumb companies are the ones who only operate refineries. They tend to go belly up because nobody can predict how long the lean times will last.
It was not a supply drop but a demand increase combined with a stagnant supply. This was following a period of low prices so most of the oil companies were still recovering financial. It takes time for investment dollars to become producing oil.
International Petroleum Consumption, Most Recent Months and Years
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