Rising Crude Prices Pose Conundrum to Oil Majors

Oil majors looking to sell smaller refineries in a bid to dispose of lower-margin assets

Large oil companies are faced with challenges in the form of lower refining margins since crude oil prices have jumped more than 4% for first time in seven days on Friday, June 17th, 2016 on account of a weaker dollar and waning anxiety about the upcoming ‘potential-Brexit’ polls. Brent crude futures settled up $2.06, or 4.37%, at $49.25 a barrel, while U.S. crude’s West Texas Intermediate (WTI) futures rose $2.12, or 4.54%, to settle at $48.86 at close on June 17th, 2016.

C1The rising crude oil prices over the past few months has resulted in a decline in refining profit margins for oil majors from the highs seen in 2015, when crude oil prices were below $40 per barrel, the lowest level since early 2009. With crude prices now inching towards $50 per barrel, oil majors fear that their refining margins will be squeezed since the price of gasoline does not keep pace with the rising cost of crude oil. What’s more, oil majors are being threatened on one hand by the rise of renewable energy and climate policies that will curb demand for fossil fuels, and on the other by the smaller companies that have taken the bold step to diversify into shale oil and gas production.

While some of the large oil companies have been curbing spending on drilling wells, finding reserves and developing fields, some have already announced massive job cuts. Others are considering selling their plants while margins are still reasonably high, thereby enabling them to strengthen their balance sheets.

Smaller assets on the block

Faced with headwinds from rising crude oil prices, global oil majors Chevron Corp. (NYSE: CVX) and Royal Dutch Shell PLC (NYSE: RDS.A) are looking to sell their smaller refineries in a bid to dispose of lower-margin assets, as reported by Reuters. Chevron, the second largest U.S. oil company, is looking to sell its Burnaby, British Columbia, refinery and gasoline stations, as part of its plans to streamline its portfolio and generate $5-$10 billion from asset sales over the next two years. Likewise, Shell is looking to sell its Martinez, California refinery. These two companies, along with Exxon Mobil Corp. (NYSE: XOM), BP PLC, and Total SA accounted for more than a million barrels per day of U.S. refining capacity over the past three years. These five oil majors together have the capacity to refine about 4.7 million barrels per day, as per Reuters.

Chevron has also put on the block its 75% stake in a South African refinery, while Total is looking to sell its 50% stake in a U.S. refinery.

Refining not so profitable anymore

For major oil companies, refining has been a profitable and high-margin business over the past two years; hence, these plants could fetch relatively better returns than the exploration and production assets. Since Chevron and Shell have the highest cash-flow deficits, they are looking to sell only their downstream and midstream assets because those have a steady cash flow. Moreover, these assets are seen to be a better buy for smaller companies that focus on a particular region, or for global storage and trading companies that are not into oil production.

Downstream strategy

Both Chevron and Shell plan to hold on to large, profitable refineries that are well integrated with their oil production assets. However, refineries without backward integration are likely to be sold. Chevron’s divestment strategy has focused on retaining only large refineries that can serve the U.S. and Asian markets or petrochemical plants that make very profitable products. The Burnaby refinery, however, refines light oil, rather than heavy crude, and is not seen to be a good fit to Chevron’s long-term game plan.

In April 2016, Chevron agreed to sell its 54,000 barrel-per-day Kapolei, Hawaii, refinery to a group backed by private equity, and its 75% stake in its South African unit, which includes a refinery in Cape Town. On the other hand, Shell agreed to exit its Motiva Enterprises joint venture with Saudi Aramco in March 2016, in a bid to streamline its assets.

Stock Performance

C2Chevron’s stock stood at $101.57 at close on Friday, June 17th, 2016, having reached an intraday high of $101.74 and a low of $100.40 during the session. The stock’s trading volume was at 8,761,863 for the day. The Company’s market cap was at $192.99 billion as of Friday’s close.

C3Shell’s stock stood at $51.66 at close on Friday, June 17th, 2016, having reached an intraday high of $51.71 and a low of $50.69 during the session. The stock’s trading volume was at 5,843,978 for the day. The Company’s market cap was at $210.45 billion as of Friday’s close.

With Chevron and Shell on a selling spree, it remains to be seen whether these efforts help to bolster their balance sheets if the right buyer comes by.

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