COM - Valero Energy: Pressure On Refining Spreads Is Bearish For The Oil Refiner

2023-11-02 12:30:56 ET

Summary

• Valero Energy Corporation is the largest U.S. independent refiner and biofuel producer.
• The company's earnings depend on crack spreads and margins for processing corn into ethanol and soybeans into biodiesel.
• Gasoline and distillate crack spreads have declined due to seasonality and recession fears, impacting Valero's profitability.

Valero Energy Corporation ( VLO ) is the largest U.S. independent refiner and marketer of petroleum products. VLO owns refineries throughout the United States, Canada, and the United Kingdom. Meanwhile, the company is a leading biofuel producer with ethanol refining plants in the Midwest.

Valero reports financial results through three segments: petroleum refining, ethanol, and renewable diesel. VLO shares fell to an eight-year low in March 2020 and surged to a series of record peaks in 2022 and 2023. The latest high was in September 2023, when the stock ran out of upside steam at over $150 per share.

A crack spread is the refining margin for processing a barrel of crude oil into oil products, gasoline, and distillates. VLO’s earnings depend on crack spreads and the margins for processing corn into ethanol and soybeans into biodiesel.

Gasoline crack spreads have declined- Seasonality and recession fears

Gasoline crack spreads reflect the refining margin for processing a barrel of crude oil into the world’s most ubiquitous fuel.

The weekly chart of the continuous RBOB gasoline crack spread highlights the decline from $42.57 per barrel in July 2023 to the most recent $7.09 per barrel low during the week of October 9. At just over the $12 level on November 2, the gasoline crack remains near its low.

Gasoline demand tends to decline during the winter, with the gasoline crack falling as the cold season approaches. Meanwhile, rising economic concerns have weighed on gasoline, crude oil, and all product prices over the past months.

Distillate cracks moved lower- Recession fears weigh on the refining margins as distillate are year-round fuels

Heating oil is a seasonal fuel. However, it is also a proxy for other distillate products that do not suffer from seasonal supply and demand influences. Jet and diesel fuels are year-round petroleum products, so heating oil futures experience less seasonal price influence than gasoline.

A sign that economic fears are weighing on the oil and oil product market, heating oil crack spreads declined from $58.08 in late August 2023 to $36.80 per barrel in early October. At below $44 per barrel, the distillate crack spread remains closer to the recent low.

Crack spreads are real-time indicators of refinery earnings

Crack spreads are real-time indicators of crude oil demand because petroleum is the primary ingredient in oil product refining. However, the cracks also tell us what profit margins are for refining companies. High crack spreads indicate robust earnings while declining and low crack spreads point to lower profits or losses.

As the global pandemic gripped markets across all asset classes and NYMEX crude oil futures fell below zero in early 2020, gasoline and distillate crack spreads fell to negative $3.85 and $6.44 per barrel, respectively.

Refiners lost millions at the low crack spread levels. Valero Corporation ((VLO)), the twenty-eighth leading oil refining company by market cap and one of the top U.S. oil refining companies, fell to a $31 per share low in March 2020.

VLO had an explosive move from the March 2020 low

The explosive rally in crude oil, oil products, and crack spreads caused VLO shares to soar from the March 2020 low.

The long-term chart shows the rally that took VLO shares 391% higher from the March 2020 low to a record $152.20 peak in September 2023. Heating oil crack spreads reached a record high in October 2022, while gasoline refining spreads reached an all-time peak in June 2022. However, crack spreads remained elevated until September 2023, leading to robust VLO earnings and all-time highs in the shares.

A correction from the all-time high- VLO is a volatile stock- Expect wide price variance

Crack spread declines, economic uncertainty, corrections in oil and oil product prices, and seasonality created an almost perfect bearish storm for VLO over the past weeks.

The nine-month chart shows a 15.2% decline from $152.20 on September 21, 2023, to $129.00 on November 2. Technical support for volatile VLO shares is at the May 4, 2023, $104.18 low. Distillate crack spreads, and oil prices reached lows in May 2023 before turning higher. Gasoline rallied due to seasonal factors as the market entered the 2023 peak driving season.

With the winter on the horizon and economic uncertainty, the demand for oil products has declined. VLO shares could be heading lower, as the trend has turned bearish and crack spreads have dropped. However, lower prices for the refiner could be a golden opportunity to load up later this year or early 2024 if VLO challenges the $100 per share level. The wars in Ukraine and the Middle East, low levels of the U.S. Strategic Petroleum Reserve, and OPEC+’s control of global pricing could send crude oil (CL1:COM), oil products, and crack spread prices much higher in 2024. Continuing oil price declines and a significant selloff in Valero Energy Corporation could be a golden buying opportunity over the coming months at lower levels. Put VLO on your radar for the coming months, as the odds favor a significant bottom before spring 2024.

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