U.S. Crude Supplies Are Up, Fuels Are Down

The U.S. Energy Department's weekly inventory release showed a larger-than-expected climb in crude stockpiles. However, on the positive side, gasoline and distillate supplies logged surprise declines. Refinery run-rates were almost flat from the previous week.

Crude Oil

The federal government’s Energy Information Administration (EIA) reported that crude inventories expanded by 2.5 million barrels for the week ending May 21, 2010, well above analyst expectations. The increase in crude stocks, the 6th in as many weeks, can be attributed to rising imports.

At 365.1 million barrels, crude supplies are 2.0 million barrels above the year-earlier level but remain above the upper limit of the average for this time of the year (depicted in the first EIA chart below). The crude supply cover increased slightly from 24.0 days in the previous week to 24.2 days. In the year-ago period, the supply cover was 25.0 days.

Gasoline

Supplies of gasoline fell for the third consecutive week, defying analyst expectations for a rise. The 203,000 barrels drop came mainly on the back of production decline and finished components drawdown. At 221.6 million barrels, current inventories exceed the year-earlier levels and are above the upper half of the historical range, as shown in the following chart from the EIA.

Distillate

Distillate fuel inventories (including diesel and heating oil) were down by 267,000 barrels last week, even though analysts were looking for a gain. The decrease in distillate fuel supplies reflects reduced volumes, somewhat offset by lower demand. At 152.5 million barrels, distillate supplies remain above the upper boundary of the average range for this time of year. This is shown in the following chart, also from the EIA.

Refinery Rates

Refinery utilization fell slightly (by 0.1%) from the prior week, broadly in line with analyst expectations. This dragged the refinery run rate down to 87.8%.

The overall demand picture has improved somewhat, as reflected by the increase in the total refined products supplied over the last four-week period, a proxy for overall petroleum demand. It was up by 6.9% from the year-earlier period.

Our Take

The bigger-than-forecast increase in crude reserves, which are now at their highest level in almost a year, again indicates that energy consumption in the world's biggest economy remains slack. Further, the large build in crude stockpiles came even as refineries operated at a healthy 87.8% of capacity. We take this as a sign that there is no problem with the commodity supply.

This piece of bearish news was contrasted by unexpected drawdown in gasoline and distillate supplies. But then again, we note that the drop came on the back of lower output, and not due to increased demand. As such, the latest EIA report is not as fundamentally bullish as it looks.

Still Avoid Refining Exposure

Though the weekly data looks positive for refining, we maintain our cautious view on the sector.

Margins have been quite robust in the current quarter, helped by the European debt crisis, depressed oil prices, greater U.S. exports, and better-than-expected demand. However, we believe that the relatively stronger margins are unlikely to persist, as refiners increase production with more conversion units resuming operations from their turnaround activities. Utilization rates are likely to hover around the high 80's/low 90's during the near-term amid too much supply of petroleum products.

Though margins have rebounded from the troughs of the fourth quarter, they still remain way off the levels achieved a few years ago and are insufficient for refiners to get back into the black.

As such, we have a bearish stance on companies like Sunoco Inc. (SUN), Tesoro Corp. (TSO), Valero Energy Corp. (VLO) and Western Refining Inc. (WNR), given that the overall environment for refining margins is likely to remain poor.

Firms like Chevron Corp. (CVX), Marathon Oil Corp. (MRO) and ConocoPhillips (COP) -- oil majors that have significant refining operations -- are also expected to remain under pressure until pricing and demand improve. The companies have scaled back their worldwide downstream operations, as they think that oil refining margins are unlikely to improve substantially this year. Profitability has collapsed in recent times due to the global economic rout and a glut of new capacity in the emerging economies of Asia and the Middle East.

All the above-mentioned companies currently have Zacks #3 Ranks (Hold), meaning that these stocks are expected to perform relatively the same as the overall market during the next 1-3 months. Therefore, investors should maintain their current positions in the stocks over this time period.