• MARKETS

• HEARD ON THE STREET

America’s Refiners Are Running on Premium

High natural gas prices in Europe and steeper discounts in sour crude oil are helping U.S. refineries squeeze out more profit

It is a great time to be an American refiner.

Marathon Petroleum Corp. MPC 4.91%increase; green up pointing triangle on Tuesday said its refining and marketing segment generated $4.6 billion in segment income from operations—nine times what it did a year earlier. Its shares rose 3.9% by early afternoon. Valero Energy Corp., VLO 3.54%increase; green up pointing triangle which reported last week, saw its net profit swell to $2.9 billion in the third quarter from just over half a billion a year earlier. While margins have come down since the records set in the second quarter, they are still multiples of prepandemic norms.

Marathon’s gross profit for the quarter more than doubled year over year to $30.21 per barrel. Valero’s was $21.34 per barrel, also more than doubling. In the five years leading up to 2019, the average gross profit for Valero’s third quarter was less than $11 per barrel. Despite complaints about pump prices from the White House, refiners are running full tilt in such business conditions. Why wouldn’t they? Marathon and Valero’s utilization rates were 98% and 95% in the third quarter, respectively.

And they still have some tailwinds working in their favor. One is that a significant input cost—natural gas—remains much cheaper in the U.S. than in Europe. Even though a warm start to winter helped natural gas prices descend from their peak in Europe, the Dutch benchmark price is roughly 5.7 times more expensive than that of the U.S.

High natural gas prices are “setting a higher floor on margins,” Valero Energy Chief Executive Joseph Gorder said in the company’s earnings call last Tuesday.

Furthermore, the price that U.S. refiners pay for the heavy, sour crude for which many refineries are optimized has been decreasing relative to light, sweet varieties. Part of that is because sanctions on Russia have caused a reshuffling: Indian and Chinese refiners are using up heavily discounted Urals oil from Russia in lieu of other heavy varieties. That has “backed up Mars and heavy Canadian [crude]” into the Gulf Coast, according to Valero. Mars is a sour grade of crude produced in the U.S.

Higher-than-expected maintenance at U.S. refiners—some of which had deferred maintenance in the second quarter—also contributed to the glut.

There are some additional factors adding to the sulfur-heavy sour crude discount: High natural gas prices have spurred European refiners to buy light, sweet crude oil, which is less energy-intensive and less hydrogen-intensive to process than sour crude. IMO 2020, an international rule that limits sulfur content in marine fuels, compounds that effect by raising demand for lower-sulfur fuel.

An economic downturn could ruin the party for refiners, of course. Gary Simmons, chief commercial officer at Valero, said last week that petroleum product demand was hit twice as hard as gross domestic product in prior recessionary periods. But he noted that two “unique situations” will still prop up fuel demand. First, jet fuel demand is still recovering. The U.S. Energy Information Administration figures show that U.S. jet fuel demand is still 19% lower than what it was in 2019. Second, Chinese oil demand, which has been down by a fifth, should bounce back once the country comes out of the pandemic. Marathon Chief Executive Michael Hennigan reminded investors on Tuesday that roughly 4 million barrels a day of refining capacity has been shut down globally over the last couple of years.

Winter should continue to be supportive. Distillate demand tends to move higher in the winter as power plants in Europe and the U.S. Northeast switch from expensive natural gas to heating oil. Meanwhile, U.S. diesel inventories for October were the lowest seen in that month since 1951, per EIA data, at about a fifth below the five-year average. Tom Kloza, head of energy analysis at energy data firm OPIS, notes that if spot margins stay as strong as they were in October, the fourth quarter could end up being even more profitable for refiners than the record-setting second quarter. (OPIS is an energy-data and analytics provider that is part of News Corp’s Dow Jones, publisher of The Wall Street Journal.)

A downturn is always a risk, but U.S. refiners look better-equipped than ever to power through it.