Refineries were the only thing standing between Canada's largest oil producers and operating losses. That boost to earnings may be coming to an end.
Plants that produce gasoline, diesel and other fuels accounted for the bulk of Suncor Energy Inc. and Imperial Oil Ltd.'s 2015 earnings, but their refining margins are poised to narrow as crude is no longer in a free fall. Refiners tend to benefit from a precipitous decline because the lag between oil's fast drop and the fall in gasoline prices allows them to reap big profits.
"Refineries are a natural hedge for Imperial and Suncor," said Robert Mark, director of research at Montreal-based MacDougall, MacDougall & MacTier Inc., which owns Suncor shares and recently sold its holdings of U.S. refiner Phillips 66 because of the outlook for shrinking margins. "The margins are still good, but the outsized returns are a thing of the past."
Crude has climbed 16 per cent from a 12-year low of about $26 (U.S.) a barrel in New York last month, and analysts expect further gains of more than 50 per cent before the end of the year, according to forecasts compiled by Bloomberg. It won't be enough of a rebound, though, to make oil sands mines in northern Alberta the profit engines they once were.
Meanwhile, the profit margin for refining heavy Canadian crude into gasoline and diesel, based on Gulf Coast fuel prices, has dropped by more than half from last year's peak to less than $23 a barrel, data compiled by Bloomberg show.
Imperial's refineries posted an operating profit of $352-million (Canadian) in the fourth quarter, countering a $289-million loss from crude production. At Suncor, the refining business earned $498-million in the quarter, offsetting a $230-million operating loss at its main oil-sands division.
A wide premium for international crude over West Texas Intermediate also helped boost refining gains last year because it meant Suncor and Imperial were getting low-cost feedstock and selling fuels at prices that were more aligned with the global Brent benchmark. That's going away, too, as U.S. producers are now allowed to seek better prices abroad after an export ban was lifted at the end of last year. The spread that reached almost $13 (U.S.) a barrel in March of last year is now less than $2.
"The view is with the spread between Brent and WTI, and with the outlook for diesel, the refineries will make modestly less going forward," Suncor chief executive Steve Williams said during a conference call last week.
Killeen Kelly, an Imperial Oil spokeswoman, declined to comment.
Imperial, based in Calgary, operates three refineries and a chain of Esso-brand filling stations, in addition to its oil sands mining and other extraction operations in Alberta. Suncor, headquartered just a few blocks away, owns four refineries in the United States and Canada, as well as 1,500 Petro-Canada stations.
Canadian drillers remain skeptical and are "revisiting" a forecast based on oil for next year at between $40 and $45 a barrel, said Mark Scholz, president of the Canadian Association of Oilwell Drilling Contractors.
"At $30 a barrel, nobody is making money, I don't think anybody in the globe is making money," Scholz said in an interview.
The strategy of using refining businesses to counter the downward pressure on oil extraction is still a good model, MacDougall, MacDougall & MacTier's Mark said. For the coming year though, the "windfall returns" of recent quarters for refineries won't be there to offset a difficult environment for drillers, he said.