MARKETS:

Booming fuel exports bring profits back to refining

HOUSTON -- Strong exports of gasoline, diesel and other fuels are transforming the economics of the refining industry, at least for the time being.

Last year, oil and gas major ConocoPhillips Co. rid itself of its refining operations, spinning off its entire downstream business segment to form the new Phillips 66 company. When that decision was made, the reasoning behind it was sound -- oil and gas exploration and production were booming, but refineries were struggling with managing tight profit margins in the face of flat-lining U.S. demand for refined products.

Back then, refining was seen as a tough business model -- refineries were squeezed between rising prices for their feedstock crude oil, a fact they couldn't control, and trying to pull a profit by selling finished products into a U.S. market that had all it needed, while actually cutting back on consumption.

But the tables are turning lately, thanks almost entirely to booming exports.

Some of the largest oil and gas companies are reporting that their first-quarter earnings have taken a hit compared to last year because of softer oil prices. But those with refining operations got a lift, helping to offset the reduced income from oil sales. Exxon Mobil Corp. and Royal Dutch Shell PLC are among those reporting this effect.

And downstream companies like Valero and Marathon Petroleum reported rising earnings as sales of refined products abroad soared, even as they continued to stagnate domestically.

The reason, say analysts, is that rising oil production is coming up against infrastructure constraints, depressing the price of much domestic crude oil. Meanwhile, refineries are increasingly able to offload this cheaper surplus crude in the form of refined products that are more closely tied to higher international crude oil prices.

"The world price for these refined products is more closely tied to the world price for oil," explained Edward Hirs, an economist at the University of Houston.

Data compiled by the U.S. Energy Information Administration show the dramatic rise in exports of refined products. Back in 2005, EIA estimates, U.S. refineries sold roughly 1 million barrels a day of finished petroleum products to foreign purchasers.

That number has since nearly tripled. EIA puts average 2012 finished petroleum products exports at more than 2.6 million barrels a day. Many market watchers, including Hirs, believe overseas sales are now closer to 3 million barrels per day on average. Hirs said that the curtailed demand for fuels in the United States has almost entirely been swallowed up by stronger demand overseas and exports to those new demand centers.

Proof in the profits

The sharp increase in sales abroad is now showing up on refining companies' income statements.

Marathon Petroleum, an independent spinoff from Marathon Oil, reported a 22 percent jump in quarterly earnings for the first three months of this year over what it reported for the same period in 2012. Likewise, Valero Energy turned a $432 million loss for the first quarter last year into a $654 million profit for first quarter 2013.

For major vertically integrated energy companies, the boost given by refining operations helped to keep stagnant or declined year-over-year earnings from becoming worse. Shell said its 6 percent net earnings decline for the quarter would have been worse were it not for the strong performance of its downstream operations.

Exxon Mobil Corp. reported the same when explaining to investors its flat financial performance, growing earnings year over year by 1 percent.

Robert Sharp, an analyst who tracks this market for the energy pricing and information firm Platts, agreed that it's the solid export numbers that are benefiting the refining industry.

"As late as June 2011 we were a net importer of products," Sharp noted. "Now we're a net exporter."

Gasoline prices have declined in the United States recently, following the decrease in oil prices. But the profit margins for refineries able to sell into overseas markets have stayed healthy, Sharp said, benefiting refining companies while simultaneously depressing earnings for producers a bit.

As the United States inches closer to becoming a net energy exporter, because of refined products exports that are not restricted by law, it's "just common sense" that the booming export market is causing domestic fuel prices to be higher than they otherwise would be, Sharp said.

"If they didn't export so much, we'd be swimming in gasoline, and then the margins would come down," he said. He also noted that refining capacity in the United States has actually been expanded recently, by Marathon and Shell, even though most energy industry analysts, including those at EIA, foresee flat and gradually declining domestic demand continuing for at least three decades.

The capacity expansions are being made to meet foreign markets, Sharp pointed out. Exporters see Latin America and Asia as the growth markets to target.

This market dynamic is expected to continue for most of the year. But Hirs at the University of Houston cautioned that it is too soon to tell whether the changed business climate will last beyond then.

"It's a good time to be a refiner," Hirs said. "Will it last? Will it continue for three or five years? Who knows?"

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