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What Should You Expect From Valero Energy and Marathon Petroleum in the Second Quarter?

During the first quarter, the harsh winter conditions and drop in the premium of Brent over WTI had an adverse impact on Marathon Petroleum (NYSE: MPC  ) . Conversely, Valero Energy (NYSE: VLO  ) was less affected by these developments in the previous quarter. How will the recent developments in the oil market impact these two petroleum refining companies in the second quarter?  

Refinery inputs rising, margins falling
The chart below shows the quarterly changes in both the premium of Brent over WTI and the average oil refinery inputs (in million of barrels per day).

Source of data: U.S Energy Information Administration 

This chart provides a very crude representation of the developments in the two main factors that impact the revenue (volume of refined oil) and profit margins (the premium of Brent to WTI) of refineries. 

Based on the above, volume has picked up by 3.8% year over year and by nearly 2% quarter over quarter. Does this gain translate to a rise in throughput volume for refineries such as Marathon Petroleum and Valero Energy, though?

Throughput considerations
Let's start with Marathon Petroleum. 

In the first quarter, Marathon Petroleum recorded a modest drop in its throughput volume to reach 1,650 mbpd -- nearly 1.2% lower than in the same quarter last year. One of the reasons for the modest fall in volume was the winter conditions during the first few months of 2014. There are still some lingering negative effects on the company's throughput, however; one of Marathon Petroleum's refineries in Garyville was affected by the severe weather, which is expected to reduce its quarterly volume by 5% with respect to its guidance. The Garyville refinery is projected to return to full capacity at the end of the second quarter. Thus, the company's volume is likely to come down again in the second quarter. 

Conversely, Valero Energy increased its volume by over 5%, year over year during the previous quarter. Further, the weather had a positive effect on the company's revenue because the disruptions in transportation of ethanol raised its margins significantly. Its operating income increased to a record high of $243 million, which is 17 times higher than its income in the first quarter of last year. 

The average price of ethanol in April was still at $4.82 per gallon. Since then, however, prices fell to around the $2 per gallon mark. This means that Valero Energy isn't likely to repeat the high operating income it had from ethanol back in the first quarter. 

Nonetheless, the company is likely to keep increasing its volume to meet its annual guidance. 

Margin issues
The 27% year-over-year plunge in the premium of Brent over WTI could slash the profit margins for refineries companies, especially for Marathon Petroleum. 

During the first quarter of 2014, the plunge in the spread between Brent and WTI reduced Marathon Petroleum's operating profitability to 5%. On the other hand, Valero Energy's profitability expanded during the quarter because the company also sells sour crude oil including Maya and Mars. The prices of these types of oil were much lower than Brent oil, resulting in higher margins for Valero Energy. This also means that the profit margin of Valero Energy may be less affected by the drop in the Brent to WTI spread than Marathon Petroleum. 

Bottom line
In the second quarter, Marathon Petroleum is likely to show lower throughput volume and narrower margins due to the lingering adverse effects of the winter weather and the drop in the premium of Brent over WTI. Valero Energy is likely to show lower revenue than in the first quarter due to the drop in ethanol prices. The lower spread between Brent and WTI could also reduce its profit margin, but the company's reliance on other oils such as Maya and Mars may offset the decline in the Brent-WTI spread. The company's volume is likely to keep picking up to meet its guidance. Therefore, Valero Energy is likely to keep growing its revenue, though at a slower pace than in the first quarter. 

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Lior Cohen

Lior has been a contributor for the Fool since 2012. His main interests are in commodities, and energy and materials companies.You can follow him on Twitter to stay up to date with his industry analysis. @tradingnrg

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9/3/2015 4:03 PM
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