The price of gasoline has been elevated in recent months, and overall demand for fuel looks likely to rebound more substantially next year. But all is not well for the companies that refine crude oil to make that fuel. Indeed, the outlook for U.S. refiners is looking pretty bleak.
That’s one takeaway from a new report from Citigroup analyst Prashant Rao, who downgraded several stocks in the industry because of a series of negative trends.
One big problem is that companies around the world are building more refineries, but demand isn’t rising quite as fast. That’s generally a bad sign for refiners, and could portend weak margins ahead. By the end of 2024, capacity additions could outpace refinery closures or conversions by 1.1 million barrels a day, and demand growth is unlikely to fill that gap, Rao projects.
The second problem for U.S. refineries is that they have lost some of their geographic advantage. For years, oil produced in the U.S. has traded for less money than oil produced elsewhere. West Texas Intermediate crude, the U.S. benchmark, has typically traded for a few dollars less than Brent crude, the international benchmark. Some of that has to do with toihe difficulty of transporting U.S. crude — pipeline capacity has been slow to grow in some key areas. Crude oil can build up at hubs and in storage tanks and cause prices to slump.
But oil inventories are declining as producers have cut back on new projects, and WTI is trading at a smaller discount to Brent. U.S. refiners like wide spreads because they can buy oil cheap and sell products at higher margins overseas. Now, that advantage is disappearing, and Rao expects the trend to continue. WTI was trading at a discount of less than $4 to Brent on Thursday, down from more than $7 in 2018.
In general, investors have reduced the amount they are willing to pay for refiners, Rao writes. Their valuations for the stocks based on their mid-cycle earnings are down 20% from 2019 levels, he estimates.
Based in part on that re-rating, Rao thinks several refiners are less attractive investments now. He downgraded Delek US Holdings (ticker: DK) to Sell from Neutral, and CVR Energy (CVI) and Phillips 66 (PSX) to Neutral from Buy. On Thursday, Delek fell 2.6%, CVR was down 3.1%, and Phillips 66 was lower by 1.9%.
In the longer-term, Rao thinks that refinery stocks will need other attributes to make them attractive. He likes Valero Energy (VLO), for instance, because it has a promising low-carbon energy business. The company has been making money lately in renewable diesel, among other areas. Valero was down 0.8% on Thursday.
Rao also upgraded Marathon Petroleum (MPC) to Buy because he thinks that the company has made progress at cutting costs and is improving its return on capital. Nonetheless, he lowered his price target on the stock to $67. It was trading down 0.5% on Thursday to $58.35.