Poor refining profitability puzzles investors
An Aug. 16, 2021 article titled Phillips 66 Stock: Advantaged By Its Refining-Adjacent Businesses, by Laura Starks was published on seekingalpha.com. Below are excerpts of investors’ comments on seekingalpha.com
Comment by Fwc3030 17 Aug. 2021, 7:31 AM
Thank you for a well written over-view of Phillips. Your writing style is to be commended as it was clear, concise and when appropriate supported with factual data and charts.
Have been long in PSX since mid year last year. There is something bothering me that perhaps you can explain? I keep wondering when (or if) PSX’ refining business will turn profitable?
The 2nd quarter Pre-Tax Profitability Chart shows PSX’ refining business loss $729 million. This is perplexing as (i) Figure 5 indicates crack spreads were generally higher than crude costs for the second quarter (though that fell in July), (ii) gasoline usage is about 90% -95% back to 2019 normal levels, and (iii) I am (and consumers in general are) paying retail gasoline prices 50% greater than a year ago.
By gosh, if PSX refining can’t make a profit with these kinds of tailwinds, well, I doubt it ever can.
Any illumination regarding PSX’s inability to operate profitably would be appreciated. I am extremely interested in its refining 3rd quarter results due out in October.
Comment by George Hoekstra 16 Aug. 2021, 10:27 AM
Thanks, Laura, for this thorough analysis. PSX has had record low refining margin capture rate in 2021, in 2nd quarter the realized margin was $3.94/barrel versus a benchmark market crack spread of $17.76.
Half the difference is well-explained by management in the earnings calls but the other half is poorly explained. It seems for some reason they are not capturing the benefit of high wholesale gasoline prices. Do you have a theory on why this is, and will it continue?
Comment by Laura Starks 16 Aug. 2021, 6:34 PM
Author’s Reply To: George Hoekstra As noted above under 2 Q results, two key issues were high RIN costs and high crude costs.
Per the earnings call transcript and referring to page 9 of the 2Q earnings presentation, high RIN costs (biofuel blending) are most of the $7.84–as you refer to in ‘half’. “Secondary products” (-2.38/bbl) means they didn’t make as much as expected on products like butane and coke. I’m not sure what they mean by configuration (-3.89), but in the transcript they note the following issues: a) unplanned FCC downtime, b) some products had wider differentials to market reference than expected, in part because weak European markets meant Europe was exporting more product to the US than typical, c) on some heavy sour crude feedstocks they didn’t get the normal discount, and there is reference to d) inventory effects. PSX expects better 3Q refining results.
comment by George Hoekstra 17 Aug. 2021, 8:44 AM
To: Laura Starks Thanks Laura, I have a theory on the low margin capture which also addresses FWC3030’s comments.
Set aside for a moment the RIN issue, secondary products, and the refinery configuration factor. I believe the big unexplained part is low realized gasoline margins compared to the market benchmark crack spread. This low capture of gasoline margin is caused mainly by the new 10-ppm gasoline sulfur specification known as Tier 3.
It is a bit complicated how this occurs and why it’s happening now; it involves octane and is explained in brief posts on my blog (links below), and in detail in publications on my web site. Tier 3 is a huge, overlooked issue that affects refiners differently, depending on how efficiently they can produce low sulfur, high octane blend stocks from crude IN THEIR OWN REFINERIES (versus buying them from India which just exports the gasoline margin to India). See these three blog posts:
Comment by George Hoekstra 17 Aug. 2021, 8:57 AM
To: Fwc3030 Your question is right on the nose! I believe the low refining margin is caused by low capture of wholesale market gasoline margins (especially premium),
and that is caused by the new Tier 3 ultra-low sulfur gasoline specification which causes octane destruction in some refineries. Tier 3 is an important overlooked issue. See my other comment and discussion with Laura.
Comment by Nasikitika 17 Aug. 2021, 1:41 PM
To: George Hoekstra This may very well be the explanation.
The two common ways to make premium gasoline economically are from:
1) The FCC unit heavy cracked naphtha (HCN) stream, and
2) The Alkylation unit stream.
The FCC feed is much higher in sulfur, and needs to be desulfurized before or after it is processed in the FCC to make a stream low enough in sulfur.
Not to get too techy, but worth mentioning: Also if the refinery is processing a high level of light tight oil (LTO) this crude produces lots of light naphtha with a sulfur content up to 30 ppm. To become a suitable Tier 3 (10 ppm sulfur) gasoline blend stream additional desulfurization costs will have to be absorbed. Also light naphtha from LTO crudes is sub-octane (about 70 AKI) and depending on aromatic content, may impose an additional octane burden if catalytically desulfurized.
So, maybe PSX competitors have better access to Alkylate?
Comment by George Hoekstra 17 Aug. 2021, 2:42 PM
To: Nasikitika These are great points. The most critical factor is 99+% of the sulfur must now be removed from the FCCunit heavy cracked naphtha (HCN) stream.
Far too many US refineries do that in “post-treaters”, i.e., AFTER the feed is cracked. That is a huge disadvantage, profit-wise, compared to doing it in FCC feed pre-treaters, BEFORE the feed is cracked. This critical difference has been ignored by refiners and investors and is coming to roost on the bottom line today.
Comment by Laura Starks 17 Aug. 2021, 2:20 PM
Author’s Reply To: Nasikitika This is a good explanation and fits with the product differential issue PSX cited, though 2 things:
1) PSX themselves said about half the difference was RIN costs and
2) premium gasoline is a surprisingly small percentage of the total gasoline market.
comment by jacksalmon 16 Aug. 2021, 2:31 PM
To the author: Since VLO and MPC have business plans that involve mostly refining and they made money last quarter,
why did PSX’ refining operations lose so much money? I would not think it would be the crack spread because I would assume that the crack spread is mostly the same for all refiners. So, if VLO and MPC were able to make refining money, why couldn’t PSX?
comment by Laura Starks 16 Aug. 2021, 6:37 PM
Author’s Reply To: jacksalmon Good question. Please see my answer to George Hoekstra
comment by George Hoekstra 17 Aug. 2021, 9:02 AM To: jacksalmon I have offered a theory in my comments/discussion with Laura.
Short answer: Marathon and Valero’s refineries are better able to produce the ultra-low sulfur high octane blend stocks needed to meet the new Tier 3 gasoline specification.
This discussion is continuing on seekingalpha.com., see continuing excerpts
Hoekstra Research Report 8
In a 3-year, $1 million research project, our client group developed new methods and tools to help refiners avoid hidden pitfalls and improve profitability of Tier 3 gasoline. All our data and tools are available to anyone for immediate application at negligible cost. Just see this offer letter and join our client group by sending a purchase order today: Hoekstra-Trading-Offer-letter-Research-Report-8-refiners-under 1 million barrels/day