Valero Energy Corp (VLO)

[frenchee]

Refiners May Lose Some Drive This Summer
Caris & Co.

WITH DOMESTIC MONETARY POLICY continuing to hold more sway than oil market fundamentals in determining the price of oil, we believe that continued economic and inflationary uncertainty will result in Nymex WTI oil trading in the $90-to-$110 per-barrel range this year, ahead of our previous 2008 forecast of $72 per barrel.

With pump prices set to hit new record highs this summer on the back of record oil prices and an increased likelihood of recession, we forecast that domestic gasoline demand will contract this year, following a modest expansion last year. While we expect a seasonal expansion in margins later this spring as we head into the summer driving season, it will be more modest than realized in 2007 and second-half 2008 margins will hinge on oil price trends, refinery utilization levels and the economy.

As such, we are downgrading the shares of Valero Energy to Average from Above Average and Frontier Oil, Holly, Sunoco and Tesoro to Below Average from Above Average.

We are reducing the rating on Western Refining from Average to Below Average.

We retain our Buy rating and our $34 price target on the shares of Alon USA Energy.

At this juncture, we expected that domestic monetary policy, the weak dollar and inflation fears to drive the price of oil, and not fundamentals. As such, we are boosting our 2008 oil price (Nymex WTI) forecast to $95 per barrel from $72 per barrel. We estimate that Nymex WTI grade crude oil will average $85 per barrel in 2009.

While yesterday's announcement by the Federal Reserve of a program designed to enable banks and dealers to borrow up to $200 billion of Treasuries, while pledging a variety of mortgaged-backed securities as collateral, did result in some strength in the dollar and pressured the price of oil briefly, the course of oil reversed itself as the day progressed. Further interest-rate cuts are likely to keep pressure on the dollar and thus the price of oil.

Assuming an oil price in the $95-$110 per-barrel range, we expect that gasoline prices this summer will set record highs -- from $4 per gallon on the more populous areas on the West and East coasts to roughly $3.50 per gallon across the balance of the country. This past week, the average U.S. gasoline price was $3.227 per gallon, up from $2.96 per gallon last month and $2.54 per gallon a year ago. Hurricane-induced refinery outages, such as those experienced in the summer of 2005, would place additional upward pressure on gasoline prices.

As a consequence of our revised oil price, and its impact on pump prices this summer, combined with clear signs of weaker domestic economic growth, we are cutting our projection for gasoline-demand growth to negative 0.2% from positive 0.5% this year. As such, we now forecast that total domestic fuel consumption will drop by 80,000 barrels per day from the 2007 level. Taking into account an increase in ethanol use of 130,000 barrels per day, we estimate that U.S. petroleum demand will drop by 210,000 barrels per day.

-- Ann Kohler