Look who gets rich on $40-a-barrel oil
In a climate of record highs, refineries are cashing in
By Lisa Sanders, CBS.MarketWatch.com
Last Update: 8:30 PM ET May 21, 2004
DALLAS (CBS.MW) -- America is playing the blame game.
With crude oil at $40 a barrel and average U.S. gasoline prices hitting a record $2 a gallon this week, consumers are demanding to know who, if anybody, is cashing in on the spike.
The Democrats blame Big Oil and the Bush administration. The industry and its backers blame OPEC. And many consumers blame their local gas stations. The list goes on.
But one thing is certain. Companies that are benefiting handsomely from the latest surge in prices in the commodities markets are also the ones that make money by producing crude oil and refining it into products ranging from unleaded gasoline to jet fuel to kerosene. Interactive feature: Where your gasoline dollars go.
The winners include integrated oil giants such as ExxonMobil (XOM: news, chart, profile) and ChevronTexaco (CVX: news, chart, profile), which also have refining operations. Companies that specialize in refining are led by independent outfits like Valero Energy (VLO: news, chart, profile) and Premcor (PCO: news, chart, profile).
By contrast, the main losers are retailers such as the local 7-11 (SE: news, chart, profile) or Pantry (PTRY: news, chart, profile), which are paying higher credit-card fees on gas sales even as their sales of high-margin snacks and drinks slow down.
Refiners' margins are more than five times the margins generated by retailers on a gallon of gasoline. But even they deny any suggestion they have anything to do with driving up prices.
Following the process
"ExxonMobil's refining, distribution, and marketing businesses operate on very thin margins in an intensely competitive marketplace," said Sandra Duhe, a spokeswoman for ExxonMobil, the world's largest refiner. "Those margins are set by the difference between the price we pay for raw materials (primarily crude oil), and the price we get for the products we make -- and the global marketplace controls both."
In its journey from oilfield to the gas tank, crude passes through four main production and distribution phases. It starts at the wellhead, where it's found and lifted out of the ground.
After the crude producer's job is done, the oil travels by pipelines or tankers to a buyer, which may sell it to a refiner. Or it may refine it at its own facilities into unleaded gasoline, such as in the case of Exxon.
Refined gasoline is sold to marketers, which sell the product to retail service stations. Ultimately, the gasoline is pumped into the cars, vans and sport utility vehicles of the nation's consumers.
Based on last week's U.S. average pump price of $1.98 per gallon of unleaded gasoline, about 97.5 cents of that reflects the average cost of the production of a single gallon of crude, according to an analysis by the Oil Price Information Service, a research firm in Lakewood, N.J. The firms' data was calculated assuming last week's price of $41 a barrel on futures markets.
Gene Gillespie, an analyst who covers integrated oil companies for Howard, Weil, Labouisse Friedrichs in New Orleans, said his firm estimates producers will post a profit margin of $10.50 a barrel in the second quarter.
"Producers earn a heck of lot less than they are currently earning," he said. As a comparison, companies posted profit margins of about $4.50 a barrel, on average, he said.
Of the 42 gallons of crude in a barrel, 19 gallons are turned into gasoline, according to the American Petroleum Institute. When that process is completed, the profit margin for refiners is about 44 cents per gallon.
Meanwhile, distributors' margins are currently 3.8 cents a gallon, and retailers' margins are at about 8.2 cents a gallon. Federal and state governments, which vary state by state in their assessments, are collecting 44.6 cents.
"It's like asking who's doing better -- Bill Gates or Warren Buffett," said Tom Kloza, publisher of OPIS, of the difference between producers and refiners. "Refiners are getting perhaps triple the normal margin...they are doing better than they have ever done."
A barrel of gasoline on the U.S. futures markets closed at $60.91 on Thursday, at a record $20 higher than the $40.92 closing price of the June contract for crude.
However, the market is already anticipating a decline in gasoline prices as the October contract settled a little over $9 above $39.18 crude, November gasoline settled at $7.76 above a barrel of $38.57 crude and December gasoline settled at $6.90 above a barrel of $38.01 crude.
"The market is telling you that they know that these are ridiculous and unsustainable levels," Kloza said. "They (refiners) are enjoying a renaissance right now. There is real supply/demand tightness but more so the perception of supply/demand tightness, and there's huge speculative interest in it."
After September, gasoline demand begins to decline, and high prices could eventually put further pressure on demand for refined products, Kloza said.
"It would only take a subtle shift of one or two percent in gasoline, diesel, or jet fuel demand to swing refined products supply/demand fundamentals back toward plentiful," he said.
Tallying the costs
In making a gallon of gasoline, industry executives say the costs vary widely. One independent oil producer may spend on average $7 a barrel on finding and developments costs, and another $7 a barrel on pulling it out of the ground. Add to that $2 a barrel on transportation and marketing, plus about $1 to deduct for the quality of crude oil. Overhead costs amount to about $1 for a grand total of $18 per barrel.
Above the price of crude, the average cost to refine petroleum into gasoline is about $3.25 to $3.50 a barrel, Gillespie said.
"Crude is the biggest element of the cost of a gallon of gasoline, though it's certainly not the only one, said Jim Burkhard, director of oil market analysis at Cambridge Energy Research Associates in Cambridge, Mass.
Companies like Valero, the biggest independent company in the refinery business, insist they have no control over their gasoline profit margins, pointing instead to "market" forces.
"Right now, demand is outpacing supply, but refiners are absolutely doing their part," said Mary Rose Brown, a spokeswoman for the San Antonio-based company.
According to Brown, refinery utilization stood at 95 percent last week industry-wide, and the facilities that actually produce the gasoline, are running at around 100 percent and have been for some time. "The average for other manufacturers is 82 percent, so we are outpacing the U.S. average and are turning out record gasoline production," she added.
Industry production is up 314,000 barrels a day over last year, while demand is up 285,000 a day. However, imports are down 58,000 a day due to new U.S. sulfur regulations. "There are fewer countries that can import to the U.S. than previously," Brown added.
Profitability picture
A major factor affecting profitability: The United States imports 60 percent of its oil. Integrated oil companies buy a significant amount of their crude in addition to producing it.
For the past five years, oil and gas sector profitability has lagged behind other industries, according to the American Petroleum Institute. Even in a climate of rising prices, that trend remains.
Profit margins of oil and natural gas companies trailed those of other U.S. industries in the first quarter, according to the API. Margins of oil and natural gas companies increased 0.6 percent to 6.9 percent in the first quarter vs. the fourth quarter while other U.S. industries on average grew 0.8 percent to 7.5 percent.
"Rising crude oil prices set internationally and strong gasoline demand are driving both gasoline prices and profit margins," said Bill Bush, a spokesman for the API.
The outlook
Of course, prices at these levels are widely expected to decline. "I don't think integrated companies will ever see a better environment than they are seeing today," Gillespie said.
Gillespie recommends clients be defensive when choosing oil and gas stocks.
"Concentrate on companies with good balance sheets and low oil price sensitivity," he said. "Right now, we're very neutral on the refiners. Their normalized earnings power is substantially less than what they're earning right now."
John Cusick, an oil research analyst at Oppenheimer & Co., said his firm expects a strong second quarter, with margins retreating in the second half of the year.
Refiners are at or near the top of valuation, he said. The only refiner Oppenheimer recommends clients buy is Tesoro Petroleum (TSO: news, chart, profile) based on its valuation level.
"We like the integrated companies, and we have most of them at a buy," Cusick said. "If you assume that the price is going to come down a little bit, they usually outperform in a declining crude oil environment."
Independent producers, such as Devon Energy (DVN: news, chart, profile) and Kerr-McGee (KMG: news, chart, profile), are very sensitive to commodity prices, Cusick said.
"We have all but one of them at a neutral," he said. "At some point, the commodity is going to come (down). In a declining crude environment, (producers) generally follow the price down."
Lisa Sanders is a Dallas-based reporter for CBS.MarketWatch.com.
