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Will a Recovery in Demand Allow Refiners to Turn the Corner?

Refining margins have shown improvement, but will it continue?

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Despite reporting another round of losses for the first quarter, independent refiners sounded an optimistic note during quarterly conference calls. Given the recent rally in refining margins, the fourth quarter of 2009 may prove to be the trough in refining margins. However, while margins have improved, they remain well below the levels seen only a few years ago and still may be insufficient for refiners to achieve profitability. The improvement, however, raises the question: Is now the time to finally buy refiners? To answer that question, it pays to examine why margins have rallied, as well as some factors that may contribute to additional upside.

Cutting Capacity
Refiners typically have little control over the market forces that determine much of their performance. Their largest cost of production, crude oil, is largely set by global supply-and-demand factors. Meanwhile the prices of their output, refined products, are generally set by regional forces. This disconnect can often cause refiners' profitability to vary depending on any number of global and domestic economic conditions. Such was the case in 2008, when accelerating demand in China sent oil prices to $150. Refined product prices in the U.S. failed to rise at a similar rate, resulting in dramatically narrowing refining margins. Since that time, regional factors have played more of a role in refiners' struggles. For the past year, demand levels for refined products waned as a recession in the U.S. resulted in parked cars and idle trucks. Suddenly, the U.S. became over-supplied and inventories ballooned.

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Allen Good does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.