It's no secret that the recession has choked gasoline demand and squeezed profits for independent refiners. But it's less well-known that anemic earnings might soon undermine refiners' debt covenants. That could make CEOs, creditors, and investors alike feel like jumping from the nearest distillate tower.
Little is fine for these refiners
According to a Bloomberg story released last week, bankers and analysts have fingered Western Refining
For the moment, however, refiners may be spared forced asset sales, share issuances, and other value-destroying measures. A Bank of America
Experts see other lenders following suit. But keeping the credit tap turned on will likely involve modified terms, possibly including current-spending restrictions and requirements that future cash flow be redirected from expansion plans and dividends to debt reduction. In other words, while any announcement of amended loan terms would be cause for relief, outright optimism could later be linked to investors having inhaled a lungful of fumes.
Crack spreads in rehab?
The problem with this whole picture is that temporary debt modifications rest on the expectation that refiners will soon enjoy a sustained recovery. Reality, I'm afraid, challenges that assumption.
The Energy Information Administration (EIA) sees 2010 gasoline demand rising a modest 0.6%, versus a roughly 1.9% year-to-date decline and a 2.2% drop in 2008. Depending on the direction of crude prices, that may not be enough to restore crack spreads -- the difference between the price of a barrel of crude and a barrel of finished product -- to historical averages. Regarding additional headwinds, Barron's recently cited sustained unemployment, fuel-efficiency improvements courtesy of the cash for clunkers program, and a decline in miles driven by graying baby boomers.
Moreover, with ample spare capacity in the system, any inspiring uptick in gasoline demand could be met with additional supply, in turn depressing prices once again.
All in all, investors might want to cap their refinery exposure to integrated majors such as Total
Ultimately, even if banks grant refiners immunity, the economy may not.
Pour some related Foolishness into your hydrocracker:
Fool contributor Mike Pienciak doesn't own shares of any company mentioned in this article. Total SA is a Motley Fool Income Investor pick. Try any of our Foolish newsletter services free for 30 days. The Fool has a disclosure policy.