Asian refining stocks still face challenges ahead

11:39 PM ET 1/19/10 | Marketwatch

HONG KONG (MarketWatch) -- Asian oil refiners may face more challenging times ahead despite a recent improvement in margins, as a weakening U.S. dollar and a surplus capacity continue to weigh on their performance.
In some countries such as China, where petroleum-product prices are determined by government rules and not by the market, refiners continue to be at an additional risk, as concerns over inflation may force authorities to cap product prices even if crude-oil prices rise further.
Analysts at Morgan Stanley wrote in a note to clients that although refining margins in Asia have improved from an average of $1.90 a barrel in the last quarter of 2009 to $4.30 a barrel so far in the first quarter of 2010, they continued to be bearish on the margin outlook, preferring upstream energy-exploration companies to refiners.
"The dollar is getting weaker against Asian currencies, creating a double whammy for refining companies, as gross refining margins are U.S. dollar denominated," they said.
Gross refining margin -- the difference between the price of a barrel of crude-oil and the price of the petroleum products produced from it -- is a crucial factor in determining refiners' profits. Highly complex refineries, which can process cheap, low-cost crude-oil and produce high-quality outputs, are usually more profitable than the less complex ones.

Morgan Stanley also said China is increasing its supply of refined petroleum products -- such as gasoline, diesel, and liquefied petroleum gas and jet fuel -- and that, for the first time, Asia has a net petroleum product surplus, which it's exporting.
"We believe that the worst is behind us in terms of quarterly estimates, but not [in terms] of yearly estimates," they said.
Refining operations at several Asian energy companies have been hurt in the wake of the financial crisis, as their gross refining margins were squeezed by lower demand and a sharp fall in crude prices. But despite the recent improvement in GRMs, shares of several regional refining companies have vastly underperformed their respective benchmark indexes.

Regional refining stocks traded mixed Wednesday, with SK Energy Co. dropping 2.5% and S-Oil Corp. (SOOCY) losing 0.6% in Seoul, Nippon Oil Corp. (NPOIY) adding 2.1% in Tokyo, Caltex Australia (CTXAY) falling 1% in Sydney, and Esso Thailand Plc. rising 0.8% in Bangkok. In Mumbai, Reliance Industries Ltd. (RLNIY) rose 0.9%, and Indian Oil Corp. gained 0.3%.
Shares of China Petroleum & Chemical Corp., or Sinopec (SNP), fell 1.7%, while PetroChina Co. (PTR) gave up 2.2% in Hong Kong. The two companies' stocks shed 1.7% and 2.1%, respectively, in Shanghai.
The fall in shares of Sinopec, Asia's largest refiner by capacity, came after Nomura Tuesday downgraded the stock to neutral from buy, citing "disappointing execution" of a new oil-product pricing mechanism introduced by China more than a year ago.

Nomura analysts Cheng Khoo and Gordon Wai said China's oil product pricing mechanism, under which China adjusts fuel prices in line with changes in global crude-oil prices, was flawed, adding that the government hasn't "fully adhered to the mechanism" either.
"When crude-oil prices rose, product prices tended to rise by less than the crude cost. And when crude-oil prices declined, oil product prices were lowered by even more than the declines in the crude price," they said.
"Rising inflation is a significant risk for Sinopec, since its oil products will likely be controlled at low levels, while cost of crude could rise by more than expected," they said. "We think that the underperformance [of Sinopec] shares will likely continue until the regulatory risks dissipate, which isn't likely in the near term."
In wider market action Wednesday, China's Shanghai Composite fell 1%, Hong Kong's Hang Seng Index gave up 1.4%, Taiwan's Taiex slipped 0.1%, Japan's Nikkei 225 Average gained 0.2%, India's Sensex advanced 0.4%, Australia's S&P/ASX 200 inched up 0.2% and South Korea's Kospi gained 0.3%.