ParrotStock's avatar
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Refining Update
After a nice uptick in August, crack spreads look to be stabilizing for the time being. Gasoline is virtually flat, while diesel and Jet are both higher.

Here's the breakdown from 8/1/22 to 9/6/22 (yesterday's close):

WTI Cushing $93.89 - 86.88
WTI Midland $95.89 - 88.68

Gas Crack $14.81 - $13.20
Jet Crack $41.98 - $52.72
ULSD Crack $48.47 - $61.52
HSD Crack $38.41 - $51.14

To highlight my previous thesis that oil (and potentially retail prices) could go down, while refining cracks could remain high (or go higher), let's look at WTI Cushing & Jet fuel:

On 8/1/22 WTI @ $93.89 + Jet crack $41.98 = a cost of Jet fuel of $135.87/bbl
On 9/6/22 WTI @ 86.88 + Jet crack $52.72 = a cost of Jet fuel of $139.60/bbl

Crude cost went down $7/bbl, while retail cost rose $4/bbl and profits rose $11/bbl.

(*Note the underlying reason for Jet price increase's has to do with refineries pushing more barrels into higher margin Ultra-Low Sulfur Diesel, thus reducing Jet supply.)

There's more that comes out of a barrel of oil than just the four products listed above (think Asphalt, fuel oil, propane, butane, etc.). We typically see total barrel cracks reported as either Spot 3-2-1 or Spot 5-3-2, meaning 3 barrels of oil produce 2 barrels of gasoline and 1 barrel of diesel, or 5 barrels of oil produce 3 barrels of gasoline and 2 barrels of diesel on average. Since most refineries are pushing as much diesel as possible, I typically look at the Spot 5-3-2 numbers.

Today, Spot 5-3-2 is $32.50/bbl, while expenses are currently on the high end of average at $8/bbl, with everyone working to run at all cost. That results in an average profit of $24/bbl as of yesterdays close. I've mentioned before, that refineries are profitable when that numbers is above $10/bbl.

In 2Q, we saw Spot 5-3-2 as high as the low $60's for a brief period... we aren't there, but we are a long way from where we were in January under $10/bbl.

I would actually love to see prices stabilize in this range. Refiners would still make a ton of money AND we could curb some of the inflation numbers. Will it though?

To me, the macro doesn't look that promising.

  • Russia cut off Europe's gas supply and there is little the US can do to help. Any incremental NGL barrels that the US can ship will only raise prices domestically and do very little to help in Europe.
  • We have our first storm of the season in the Atlantic, any disruption in oil or refining could have a huge impact on market prices.
  • Refinery outages are coming. Several refineries have outages scheduled between October and March, and those are just the planned outages.
  • Every refinery in the country has postponed maintenance through the pandemic to stay financially solvent, and then pushed run at all cost strategies the past year to take advantage of unprecedented margins. There have already been cracks in the system, so far all minor, but it's going to catch up with someone.
  • Winter is coming. Fuel oil, heating oil, diesel, Propane, etc... are all in higher demand in the winter. Storage levels are already at record low levels going into winter. A hard winter could drain supplies quickly.

My best case scenario for the economy (and my refining stock) is that Spot 5-3-2 stays in the $25-$35 range. If it falls below $20/bbl, I'll have to question my refining thesis. If it returns to above $40/bbl, inflation (and equities) likely to struggle longer.

If interested you can read more in my newsletter: Energy Crisis

My portfolio is approximately 2-1 growth vs O&G currently.

Rihard Jarc's avatar
damn, great insight as always Parrot! The refinery outages and the Atlantic storms something most people forget. Thx a lot!
ParrotStock's avatar
@rihardjarc No problem buddy... I meant to mention the SPR release as well but forgot. That's going to have an effect on oil prices as well.
Rihard Jarc's avatar
@parrot Thx Parrot!
Joshua Simka's avatar
My portfolio is approximately 2-1 growth vs O&G currently.

Nice thorough post! The nuances of the pricing and its implications are a little over my head/outside my circle of competence, but I'm particularly interested in your portfolio construction. Is this typically the level of exposure you like to oil and gas? Or do you shift that ratio on a cyclical basis?
ParrotStock's avatar
@tomato Thank you!

The portfolio I share is nearly 100% growth

The rest of my portfolio is more conservative and shifts between a small amount of growth, index funds, dividend stocks, and oil and gas. That portfolio is approx 75% refining right now. I’m in that business, so with stock options and such, it probably never gets below 20-25% of that part of my portfolio.