Skinny and sweet: US refiner earnings depend on the oil diet

Smaller independent refiners with less complex facilities are surging in the stock market of late, as investors expect strong earnings growth thanks to the recent fall in price of their primary cost - light, sweet crude oil coming out of West Texas. Over the last 20 years, the nation's biggest refiners spent billions building units capable of turning heavy, sour crude into gasoline, diesel fuel and other products.

But the US shale revolution has boosted crude production to a record 10.5 million barrels per day, upending the global oil market by adding millions of barrels of very light crude to the supply mix. A majority of that new production is light, sweet West Texas crude.

Recent trends have turbocharged this shift: full pipelines in West Texas, where light U.S. oil originates from, have depressed prices for Midland, Texas, crude to more than three-year lows. On the other hand, OPEC production cuts and supply issues among big producers of heavy crude like Venezuela and Mexico have raised the cost of heavy, sour oil. That gives an advantage to some independent refiners equipped for lighter crude, which is less complicated to process. Investors have been buying up independents with less complex refineries like Delek US Holdings Inc and HollyFrontier Corp, as they could benefit from low Permian prices for several quarters to come.

"To have your major feedstock be in such abundant supply is unequivocally a positive for U.S. refining," said Matthew Blair, a Denver-based refinery analyst with Tudor Pickering & Holt.

“The benefits of that are going to be unevenly spread through the group.”

To be sure, shares of most refiners have been rallying, as refining margins recently hit a five-month high and U.S. gasoline demand is near record levels. Results are likely to show strong profits across the sector, beginning with Valero Energy Corp on Thursday.

However, over the last three months, as Permian crude has slumped, Delek shares have soared, returning more than 30 percent, with HollyFrontier close behind at 25 per cent, besting all other independent refiners. 

The two are also ranked highest among US refining companies in the Thomson Reuters earnings revisions model, which looks at analyst revisions for earnings and revenue and recommendation changes.

“Light” grades are distinguished based on what is known as API gravity - a measurement of density. A majority of US shale crude output growth is at the top of the scale with API gravity above 40 degrees.

More complex US refineries are configured to run on grades of crude with an API gravity of around 31-33 degrees. Most refineries cannot simply take in only lighter crude, because it would affect operational efficiency.