Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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A new golden age of oil refiners
Peter Garnry
Chief Investment Strategist
Summary: Oil refining is typically not a high ROIC business except for the Finnish based Neste, but the recent jump in crack spreads are causing revenue growth to soar to above 70% y/y and with crude oil supply remaining tight these refining margins will remain high for a considerable time period. The question is how long this new golden age of oil refining will last. As long as capital expenditures are not being raised considerably in the energy sector the market will remain tight for quite some time.
Oil refiners are seeing growth rates that would envy Silicon Valley
In our Friday’s equity note When growth stocks are no longer growth we highlighted how technology companies previously enjoying rapid growth rates are seeing growth grinding to a halt while classic low growth industries are suddenly where the growth is. The seven largest publicly-listed pure oil refiners (see table of companies with most exposure to the oil refining business) below are growing revenue on average of 73% over the past year compared to a previous pandemic growth winner Zoom Video growing only 21% y/y in its latest fiscal quarter. The reason is that crack spreads, the difference between the refined product and the price of crude oil per barrel, are galloping to the highest levels in 10 years across gasoline, jet fuel, and diesel; US east coast diesel price has hit highest level since early 1990. Our Head of Commodity Strategy, Ole S. Hansen, wrote about these dynamics in his Friday’s commodity note WCU: Fuel price surge lifts inflation and risks killing demand. The sanctions and self-sanctions on Russia are limiting supply of crude oil for oil refiners making it more difficult to meet demand.
| Name | Mkt cap (USD mn.) | Revenue growth (%) | ROIC (%) | 5yr return (%) |
| Reliance Industries Ltd | 242,198 | 57.0 | 7.0 | 248.6 |
| Marathon Petroleum Corp | 49,780 | 67.6 | 7.9 | 120.9 |
| Valero Energy Corp | 47,584 | 85.2 | 9.9 | 135.1 |
| Phillips 66 | 42,905 | 67.3 | 0.9 | 39.4 |
| Neste Oyj | 33,837 | 76.3 | 24.6 | 267.3 |
| HF Sinclair Corp | 8,704 | 93.8 | 6.6 | 73.7 |
| Ampol Ltd | 5,651 | 60.7 | 13.2 | 36.6 |
The recent surge in crack spreads has not yet filtered through to 12-month rolling return on invested capital (ROIC) with only Neste and Ampol delivering ROIC above 10% and Neste being the only oil refiner delivering ROIC above 20%. Historically the oil refining business has not been a high ROIC on average, but given the energy crisis we could have an extended period that will turn onto a golden age for these oil refiners.
Oil prices are still not high enough to spur large investments
The Q1 earnings season has shown that none of the oil and gas majors are increasing their expected capital expenditures in 2022 focusing instead on buying back their own shares returning capital to shareholders. Many might wonder why oil and gas majors are not investing more in new oil and gas assets when the active Brent crude futures contract (July 2022) is trading at around $108/brl which is on par with prices observed in 2012-2013 before the big correction in oil prices in 2014-2015.
The issues behind lack of investments are many but some of the important factors are ESG mandates constraining financing for industries with high ESG risk scores such as oil and gas. Another factor is that the 5-year forward price on Brent crude is around $70.50/brl which is roughly a third below the current spot price and 25% below the average 5-year forward price in the years 2010-2013. Developing new oil and gas assets require a lot of investments and time to be profitable and the regulatory environment is currently not supporting oil and gas majors investing a lot in new assets. Finally, the industry is finding itself in a dilemma as the current energy crisis might sow the seeds for a recession or lower demand in the future, so oil and gas majors may be reluctant to invest too much when the macro volatility is as high as it is.
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