Refiners’ Pumped-Up Profits Might Be Close to Their Peak

Consumers wincing at $2-plus for a gallon of gasoline might wonder if Big Oil is making money hand over fist at their expense. The answer: Yes, the companies that refine oil into gasoline are turning much higher profits, but the earnings are hardly an out-of-control gusher, analysts said Friday.

In fact, the surge in pump prices and the refiners’ swollen profits might be nearing a peak because the tight supplies of gasoline--one of the main culprits in the escalation of gas prices--are starting to build again ever so slightly, some analysts said.

BP, the British-based operation that last year bought Atlantic Richfield Co. and before that Amoco Corp., this week was the latest oil company to report big gains. BP’s first-quarter earnings surged 52% from a year earlier, largely because its profit from making and selling fuel--refining and marketing--jumped 70%.

Other major oil concerns, such as Exxon Mobil Corp., Royal Dutch/Shell Group and Chevron Corp., also have posted much stronger first-quarter profits, aided by higher earnings from refining. And all of this has driven the oil companies’ stock prices sharply higher this year.

But motorists should remember that during the last two decades when gasoline prices generally stayed relatively low, refining was a rather mediocre business. Firms that track gasoline prices have noted that, even with gasoline selling for $2 a gallon and higher, prices are still about $1 a gallon below their levels of 1981 after taking inflation into account.

“There’s no question that refiners are doing really great right now,” said Paul Ting, an analyst at Salomon Smith Barney in New York. “On the other hand, if you look at this business on a long-term average, it’s a relatively low-return industry.”

Indeed, the refiners’ latest profit gains look especially dramatic on a percentage basis because they are being compared against the lackluster results of the last two years, observers noted.

“For the longest period of time, they were almost giving gasoline away, and unfortunately consumers got used to very low prices,” said Jay Wilson, an analyst at J.P. Morgan Chase in New York.

So it’s no surprise that “you’re going to hear squawks from people who are paying what they are now. . . . You didn’t hear anyone complaining when prices were low,” said James van Alen, an analyst at investment firm Janney Montgomery Scott in Philadelphia.

The so-called refinery margin--that is, how much a refiner has left from selling gas on the wholesale market after subtracting the cost of crude oil but before paying its other costs--stood at an average 74 cents a gallon for branded gasoline sold in California as of Monday, more than double its 31-cent level in mid-January, according to figures from the California Energy Commission.

Sharp increases in prices for electricity and natural gas mean that refiners’ plants, which rely on that power, also cost more to operate. But the jump in the refinery margin still leaves plenty of profit.

Refining profits in the late 1990s were so lackluster that the oil companies scaled back spending on building and expanding refineries. That’s a significant reason pump prices are surging now, because drivers’ demand for gas is outpacing refining capacity--that is, how much gasoline the refineries can pour into the marketplace.

Also, the added costs of strict environmental regulations in California have made oil producers unwilling to build new refineries in the state--especially in light of the industry’s historically low rate of return on investment.

“It is unlikely that new refineries will be built in California,” the California Energy Commission notes on its Web site. “In fact, from 1985 to 1995, 10 California refineries closed, resulting in a 20% reduction in refining capacity.”

Those same restrictions require that the refineries produce a unique type of gasoline for sale in California, what the industry dubs a “boutique” fuel. So gasoline refined in most other states can’t be shipped into California to supplement the state’s low stockpiles, and that helps keep prices propped up.

“Gasoline is a very competitive, supply-and-demand-driven product, and prices go up and prices go down,” said Chevron spokeswoman Bonnie Chaikind. She too pointed to the dearth of new refinery construction and said, “There’s not a whole lot of slack in the system right now.”

But consumers might yet be in for relief, at least after the busy summer driving season, some analysts said.

“A couple of things are changing,” said Ting of Salomon Smith Barney. “One, gasoline inventories, though still low in absolute terms, have been building” in the last two months. And second, imports of gasoline into the U.S. market are gradually increasing, as foreign producers--especially in Europe--see an opportunity to sell their fuel at attractive prices.

“They see a very hot market,” Ting said. Both trends mean gasoline supplies are at least staying in step with--and perhaps starting to outpace--motorists’ demand for gasoline. The result: “I would argue that this is nearing a peak,” he said.

Wilson of J.P. Morgan Chase isn’t so sure, noting, “You’re going to see even higher earnings [for the refiners] in the second quarter, so we’re not there yet.”

But Steven Pfeifer, an analyst at Merrill Lynch & Co., is among those who see refining profits trending lower. For example, Chevron’s pretax profit from refining and selling gasoline jumped to $141 million in this year’s first quarter from $55 million a year earlier. But that profit will peak in the current quarter at $192 million and gradually decline over the rest of the year, Pfeifer forecast in a recent report.

That doesn’t mean gas prices at the pump will suddenly drop precipitously. History shows that refiners and service station owners, after struggling with relatively low prices for periods, will try to take their time lowering prices in order to profit while they can. Unless, of course, a rival across the street forces them to cut prices sooner.

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Refiners Reign

With gasoline prices surging nationwide, oil refiners are enjoying rising profits and stock prices as they take advantage of the market’s tight supply and drivers’strong demand for fuel. Here’ how the stocks of four oil companies with large refineries in California have fared.

Source: Bloomberg News