Why Did Refiner Stocks Plunge This Week?

What led to the recent drop in shares of Valero Energy and Marathon Petroleum?

Jun 27, 2014 at 10:57AM

Shares of U.S. oil refiners such as Valero Energy (NYSE:VLO) and Marathon Petroleum (NYSE:MPC) took a nose dive following the latest news that the U.S. Commerce Department may allow the export of ultra-light oil, a step toward lifting a four-decade ban on most petroleum shipments outside the U.S. Will this development continue to drive down the valuations of oil refiners in the U.S.? 

The U.S. Commerce Department made its ruling after Pioneer Natural Resources (NYSE:PXD) filed a petition to allow the export of ultra-light oil. This ruling can be used as a precedent in future claims by other oil companies, and thus the Commerce Department opened the door to a rise in exports of this type of oil. 

What may have prompted this decision is the sharp rise in crude oil inventories in the Gulf of Mexico, which reached 215.7 million barrels of oil as of May 9. 

The news led to huge sell-offs of U.S. oil refiners, as several analysts estimated that if this decision turns into a policy for other oil producers, it could have an adverse impact on the profit margins of oil refiners: They could face additional competition from other oil refiners in Asia; this, in turn, may lead U.S. oil refiners to pay more for the oil they purchase to refine. In such a case, the margins on refined oil could contract, and thus bring down their earnings.  

But the plunge in shares of Valero Energy and Marathon Petroleum may have been an overreaction. 

First, this isn't a policy change yet. It's a long way until the U.S. Commerce Department actually changes its ruling and allows all oil producers to export oil outside the U.S. 

Second, refiners aren't likely to sit on their hands; they could adjust down the line to the new reality: Valero Energy plans to expand its light crude processing capabilities by allocating a portion of its $3 billion capital expenditure budget for 2014. Perhaps the potential changes in U.S. Commerce Department policy would lead the company's management to allocate additional funds to this cause. 

Keep in mind, during the first quarter, Valero Energy was able to expand its margins, despite the drop in Brent to WTI premium, partly due to the rise in margins of sour oil over Brent oil prices. This means, the company's margins on other types of oil such as sour oil also play a significant role in its profit margins and might not by affected by this recent turn of events.

Nonetheless, if the company were to face higher light oil prices, the margins could come down. The Gulf Coast, where the light oil is concentrated, accounted for nearly 58% of its total throughput in the first quarter. Thus, a decline in oil margins from this region could have a strong impact on the company's total profitability. For Marathon Petroleum the Gulf Coast is also a very important region, and it accounts for roughly 50% of its volume.  

Final note
The recent market reaction may have been too harsh. The U.S. Commerce Department opened the door to oil exports, but it's a long way until other major oil producers could start exporting ultra-light oil. Moreover, the impact of such a change in policy on oil prices is unclear. This could all lead to only a modest drop in U.S. refiners' margins.

Finally, refiners could change their strategy by increasing their ultra-light oil throughput, thus modestly reducing, over time, the adverse effect of this policy change on their profit margins. 

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Lior Cohen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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