Oil prices extended their decline on Tuesday, slipping to new multiyear lows on fears that Saudi Arabia, the world's biggest exporter of oil and other related liquids, could be gearing up to compete with U.S. shale oil. West Texas Intermediate crude oil futures are hovering around $77 a barrel, down from $80 a barrel when markets closed on Friday.
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The Saudi kingdom has reduced its selling price of oil to the U.S., while raising prices in some of the other regions, such as China. The cheaper imported prices are putting even more pressure on domestic oil prices. Cheaper oil means refiners can capture higher margins.
The refiners buy the crude oil and refine it into other products, like gasoline. Usually, gasoline prices do not fall as quickly, or as dramatically, as crude. For instance, over the last 12 months, the average weekly gasoline price in the U.S. has fallen by around 8.3%, as compared to 18% decline in WTI crude futures.
The widening split between prices for crude and refined products allows refiners, such as Valero, to capture higher profits. Deteriorating crude prices lower their input cost, as gasoline prices stay relatively strong.
This was evident in Valero's third quarter results, released earlier today, in which the world's largest independent refiner increased its income from just 57 cents a share last year to $2 a share, easily beating the market's expectations of $1.58 a share, according to data compiled by Thomson Reuters.
The strong performance was driven by an increase in throughput volumes as well as strong gasoline margins in most of the regions.
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Valero's spokesperson Bill Day did not provide any additional comments besides the press release and the ongoing earnings conference call.
Valero was not the only refiner to report blowout quarterly results. On Friday, its competitor Tesoro (TSO) , one of the largest independent refiners and marketers of petroleum products, also delivered a strong performance in the third quarter due, in part, to better refining margins. The company's adjusted earnings ballooned from just 44 cents a share a year earlier to $3.06 a share, easily surpassing analysts' estimates of $2.16 a share.
Diversified names with businesses in both refining and exploration and production likewise benefited from lower crude prices between July and September, using refined products margins to offset pressures on the production side.
However, the oil majors get a majority of income from oil production, leaving them exposed if crude prices remain low. In an Oct. 21 report emailed to TheStreet, Jefferies analyst Jason Gammel predicted around 7% drops in earnings per share for Exxon Mobil and Chevron in 2015, due, in part, to the weak pricing environment.
Gammel has said that that the oil market is struggling due to a combination of weak global demand due to sluggish economic growth and surging supply from OPEC as well as non-OPEC nations.
Further, there has been no indication of a cut in supplies from OPEC nations. On the contrary, Saudi Arabia, the founder and leading producer of OPEC, is not worried about lower prices, which is also evident in its latest move.
Moreover, the cuts in estimates of global GDP growth for 2015 from IMF last month means that the oil demand will remain challenging. Consequently, "the market could be over-supplied through the better part of 2015," Gammel wrote.
Valero's shares, currently around $50, are largely flat for the year to date.
At the time of publication, the author held no positions in any of the stocks mentioned.This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.
TheStreet Ratings team rates VALERO ENERGY CORP as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:
"We rate VALERO ENERGY CORP (VLO) a BUY. This is driven by multiple strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its revenue growth, solid stock price performance, growth in earnings per share, increase in net income and attractive valuation levels. We feel these strengths outweigh the fact that the company shows weak operating cash flow."
You can view the full analysis from the report here: VLO Ratings Report