Independent refiners have outpaced the rest of the sector since last fall, when hurricane activity disrupted operations sufficiently to reduce inventories, inflating margins while creating bottlenecks that widened crude spreads. Despite normalization of operations, the strong margins and wide crude spreads have persisted, creating a very favorable environment for refiners. Although elevated gasoline inventories present a risk, distillate inventories are near five-year lows, while demand for both is strong and the economy is healthy, suggesting total margin strength will continue. Meanwhile, pipeline constraints don’t appear likely to be alleviated until late 2019, likely extending wide crude spreads for another year. At that point, the impact of IMO 2020 is likely to begin, which could ultimately extend the favorable market conditions another couple of years until the global refining system adjusts. In short, the outlook is good. While we see valuations as largely reflective of this outlook, cash returns to shareholders are likely to be strong as well, offering a reason to hang on. Marathon Petroleum (MPC) remains our best idea in the sector, largely on valuation.
Gasoline Margin Weakness Could Spoil the Party
Since last fall, refining margins have been strong, reaching their highest levels since 2015. However, the strength has largely been concentrated in distillate margins, as gasoline margins have fallen below 2017 levels. While we previously expressed concerns about gasoline demand, given rising prices, it has performed relatively well, falling just 0.2% through August compared with the same period in 2017 despite a 12% increase in prices. In fact, weekly demand reached record levels in late August even as gasoline retail prices were about 15% higher than the same week a year before.
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Allen Good does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.