U.S. Refining Stocks Have a New Edge. These Stocks Are Up Sharply

U.S. Refining Stocks Have a New Edge. These Stocks Are Up Sharply

The equities of US oil refiners are seeing some of the most unusual dynamics in years. On average, the industry's dynamics are favorable, and the stocks have been growing. If the Ukraine situation persists, their results will almost certainly remain strong.

Refinery stocks have a slightly different performance profile than other types of oil stocks. Producers and oil service firms often experience growth in response to increased oil prices and activity. Because crude oil is an input price for refiners, stockpiles may not always grow in response to higher overall prices. They require an increase in the pricing of items such as gasoline, diesel, and jet fuel as well. Refiners perform best when product demand is increasing and product margins are increasing as well.

Demand appears to be improving at the moment, as Covid-19 declines and aircraft travel increases. However, the primary reason US refinery stocks are rising is that they are profiting from inefficiency in one of their input costs.

Prices of natural gas are particularly high in Europe as a result of Russia's invasion of Ukraine. Europe was already experiencing a gas shortage before the conflict, since the global gas supply has been limited, and Europe is vying for rare resources with Asian importers. However, the Russian incursion has increased market uncertainty and pushed prices upward.

Because European refineries depend on natural gas, their operating costs are increasing at the moment. As a result of the cost rise, they have increased the price of items such as fuel. US refiners also run on natural gas, but they have access to a far cheaper supply, as the US is the world's largest supplier and costs are significantly lower here than they are elsewhere. Thus, US refiners gain from the overall increase in product prices while paying significantly lower input costs. This has resulted in sky-high margins and surging stock prices in recent weeks.

Additionally, the uncertainty surrounding Russian energy exports has resulted in a substantial increase in the cost of certain refined goods such as diesel in recent weeks, raising refinery margins even more.

"Russia sells about a million barrels of diesel per day to the rest of the globe," Matthew Blair, an energy analyst at Tudor Pickering Holt & Co., explained. "That equates to around 4% of worldwide diesel use. For the typical layperson, 4% may not seem like much. However, for this type of business, possibly removing 4% of the world's distillate supply from the pool is a significant event. And it comes at a time when distillate inventories are already extremely low."

Refinery stocks in the United States have performed nicely this year. PBF Energy (PBF) has increased by 68 percent, Valero Energy (VLO) and Marathon Petroleum (MPC) have both increased by 17 percent, and Phillips 66 (PSX) has increased by 4.5 percent.

Par Pacific (PARR), a minor refinery firm whose stock is down 26% this year, is one exception. Par, which operates refineries in Hawaii, has typically imported more Russian crude than its competitors — around 14% of the goods that pass through its refineries, according to Blair. This is partly due to Russia's proximity to its Hawaii activities, Blair explained. Russia contributes for 8% of Valero's throughput and much less at other firms, Blair explained.

Apart from Russia's exposure, there are further reasons why the current market presents challenges for refiners—though not enough to negate the benefits of increased product margins. The oil futures market is now trading in a pattern known as backwardation, in which prices for future contracts are lower than current prices. This is a challenge for refiners since they are required to store part of the crude they purchase, and the product they are storing is rapidly losing value. "That's a little bit of a headwind every month," Blair explained.

For the time being, however, the positives outweigh the downsides for the majority of organizations.