The U.S. Energy Department’s weekly inventory release showed a larger-than-expected decline in crude oil stockpiles, while demand from refiners was above expectations. However, on the negative side, gasoline and distillate supplies increased from their week-ago levels.Crude Oil
The federal government’s Energy Information Administration (EIA) reported that crude inventories dropped by 5.0 million barrels for the week ending Jul 2, 2010, well above the analyst expectations. The decrease in oil stocks, the second in as many weeks, can be attributed to lower crude imports and ramped-up refinery operations.
At 358.2 million barrels, crude supplies are 3.1% above the year-earlier level and remain above the upper limit of the average for this time of the year. The crude supply cover was down from 24.0 days in the previous week to 23.6 days. In the year-ago period, the supply cover was 23.3 days.
Gasoline
Supplies of gasoline rose for the second consecutive week, broadly in line with forecasts. The 1.3 million barrels jump came as imports climbed to their highest level since March 2009. At 219.4 million barrels, current inventories exceed the year-earlier levels and are above the upper half of the historical range.
Distillate
Distillate fuel inventories (including diesel and heating oil) were up by 321,000 barrels last week, lot less than anticipated. The increase in distillate fuel supplies reflects soaring imports and steady production levels that more than offset a surge in demand. At 159.7 million barrels, distillate supplies remained above the upper boundary of the average range for this time of the year.
Refinery Rates
Refinery utilization was up 1.4% from the prior week to 89.8%. Analysts were looking for the refinery run rate to remain unchanged at 88.4%.
Fundamentals Remain Depressed
Though the 5.0 million barrels weekly plunge in crude oil supplies makes for a bullish reading of the latest EIA release, we remain concerned in light of the higher-than-expected gasoline inventory build and a sequential distillate inventory build.
Soaring commercial oil supplies, above average product inventories (gasoline and distillate stocks), together with concerns about the pace of the economic recovery in the U.S and China – the world’s biggest crude users – continue to place downward pressure on commodity prices. These factors have dragged the oil prices to around $76 a barrel, down from an 18-month high of around $86 per barrel reached in late April/early May.
Our Take
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).
In particular, we maintain our cautious view on the refining sector. We believe that refinery run rates are likely to hover around the high 80’s/low 90’s during the near-to-medium term, which will ensure the continuation of robust light end product output (like gasoline, heating oil, diesel, and jet fuel) from the domestic source.
Though refining margins have rebounded from the troughs of the fourth quarter, they still remain way off the levels achieved a few years ago. We believe that the imbalance between supply and demand will remain in place for the next 6 - 12 months and negatively impact the bottom line.
As such, we have a cautious stance on major independent refiners like Tesoro Corp. (TSO: 11.42 0.00 0.00%) and Valero Energy Corp. (VLO: 17.92 +0.02 +0.11%) – (both with Zacks #3 Rank or Hold) – given that the overall environment for refining margins is likely to remain poor. We believe upside for these firms will be limited over the next few months.
Firms like Chevron Corp. (CVX: 71.9301 +1.5201 +2.16%), Marathon Oil Corp.(MRO: 32.10 +0.02 +0.06%) and ConocoPhillips (COP: 52.39 +0.84 +1.63%) – 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 think that 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.Within the oil refining and marketing group, we are positive on Sunoco Inc. (SUN: 33.97 +0.13 +0.38%).
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