Oil refining stocks took it on the chin today after two analysts issued downgrades this morning. Both

UBS Warburg's

Christopher Stavros and

Credit Suisse First Boston's

John McNulty released similar negative comments on the independent oil refiners this morning, mainly covering the secondary players.

Stavros' decision to lower his ratings was prompted by last night's report from the

American Petroleum Institute

on crude and distillate oil supplies in the U.S. He wrote that the report "showed alarmingly high week-to-week builds in crude oil, gasoline and distillate stocks. We subscribe to the position that inventories, particularly for refined products, should be viewed as a leading indicator for refining margins."

The

Dow Jones U.S. Secondary Oil Company Index

lost 4.2% today, while the broader range

Dow Jones U.S. Energy Index

fell 3.4%. Comparatively, the major oil players fared a little better, as the

Dow Jones U.S. Major Oil Company Index

lost 2.4% today.

The API figures showed that in the latest week, the U.S. crude oil supply increased by 8.3 million barrels, rather than the decrease of 3.5 million barrels that had been expected. Gasoline inventories also increased more than analysts projected, jumping by 3.1 million barrels rather than the expected 1.2 million.

The concern here to the analysts is that rapidly growing supply of oil may push prices, and thereby margins, down. "Such an inventory build would likely result in a downward trend in margins from the current record highs," wrote McNulty, a thought echoed by Stavros in his own note. The underlying concept here is basic supply and demand -- oil and gas prices have skyrocketed recently due to a short supply. As a result, oil refinery stocks have seen massive increases, on the expectations that higher prices lead to higher margins -- the difference between what the customer pays for the oil and what the company pays for the oil -- and thus greater profits.

Increasing margins, and the expectations of oil and gas prices continuing to rise through the summer, have sent the refiners' stocks higher recently. The Dow Jones U.S. Secondary Oil Company Index has been on an upward trend during the last six months, gaining nearly 20%. The first half of that six-month period saw a downtrend in the Dow Jones U.S. Major Oil Company Index, the larger cap players, which eventually reversed and has been climbing steadily alongside its secondary counterpart. The major oil company index has gained nearly 13% since the end of March.

Individual companies, such as

Sunoco

(SUN) - Get Report

, have been following steady rising trends since early last fall. Sunoco's shares have gained more than 50% since mid-September, while

Tosco

(TOS)

has risen more than 62% since the end of October.

Each analyst included some valuation strategy in this morning's downgrades. In a specific discussion of

Ultramar Diamond Shamrock

(UDS)

, which Stavros downgraded to hold from strong buy, he said the downgrade was "essentially based on price, as the stock is within 10% of our $49 a share price target. We believe that most of the anticipated revaluation in Ultramar's shares is now reflected in the stock as a result of the company's large share buy back." He also downgraded

Valero Energy

(VLO) - Get Report

to reduce from hold, Sunoco to buy from strong buy, and

USX-Marathon

(MRO) - Get Report

to hold from buy.

Noting that Marathon has "essentially reached our $32 price target," Stavros wrote that the company "has the greatest leverage to refining margins among the domestic integrated oils, which could pressure the shares if the margins subside."

McNulty's conceded that "the significant cash flows will facilitate the strengthening of the companies' balance sheets, share repurchase programs and the pursuit of growth through acquisitions," but he added "it is our belief that when cyclical industries/companies reach peak earnings, fair valuations and the earnings fundamentals start to deteriorate, the stocks will underperform."

The companies downgraded by McNulty indeed underperformed today, as the

Dow Jones Industrial Average

fell just 0.5%.

Ashland

(ASH) - Get Report

slipped 6.2% to $40.58. Sunoco dropped 5% to $36.34. Tosco tumbled 4.9% to $43.47, and

Tesoro Petroleum

(TSO)

slid 6.8% to $13.88 today. All four companies were downgraded to hold from buy.

Stavros' foursome fared just as poorly today. Valero lost 9% to $43.55, Ultramar fell 5.8% to $41.85, and Marathon slipped 4.3% to $30.29. Sunoco was downgraded by both analysts.