Refiners as a canary in the coalmine

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I am on record for expecting a drop in oil prices in the very near future due to demand destruction. Regarding the super spike, I believe much of the end rally in oil prices had little to do with fundamentals and everything to do with commodity market liquidity.

Proof comes from refining margins. ‘ Big Oil’ has been sounding the alarm on downstream profits — refining margins have been depressed since at least the beginning of this year. Today, Valero Energy, the leading independent oil refiner in the United States, came out with its earnings for Q2 and they were very poor — down 67% from last year.

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Valero Energy Corp., North America’s largest refiner, said Tuesday its second-quarter profit fell 67 percent as refining margins for products like gasoline shrank.

The San Antonio-based company said net income for the April-June period fell to $734 million, or $1.37 a share, from $2.25 billion, or $3.89 per share, a year ago.

Revenue rose to $36.6 billion from $24.2 billion in the prior-year period.

Analysts surveyed by Thomson Financial were looking for profit of $1.33 per share on average, and revenue of $34.93 billion.

Shares rose more than 3 percent, or $1.05, to $33.00 in premarket trading.

As expected, refining margins fell markedly in the second quarter — mirroring the first three months of 2008 — as the cost of crude and other feedstocks grew more rapidly than the prices of gasoline, asphalt, fuel oil and other products.

Those margins reflect the difference between the cost of crude and what the company makes on refined products.

The company noted benchmark Gulf Coast gasoline margins declined 77 percent to $6.60 a barrel in the second quarter. They were nearly $29 a barrel a year ago.

NY Times, 29 Jul 2008

If Valero can’t make money in this environment by refining heavy sour crude and is signalling that the peak driving season is a bust for the refiners, doesn’t that tell us something?

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Demand destruction is in place, refining margins are down. It’s only a matter of time before oil prices give way.

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