The Organization of the Petroleum Exporting Countries (OPEC) just had one of its regular meetings and reported that for the four quarters of 2018, it saw drawdowns from a deficit in its production against the sales from its member producers. And Saudi Arabia is arguing for a cut to official OPEC production limits.
This is perhaps a threat to the lucrative U.S. oil refinery market and for many of the leading companies and their dividend payments.
However, OPEC has released a report claiming that 2019 will find stockpiling of crude with softer demand against its attempt to bump-up production. But it’s not by a huge margin from its more bullish report just two months ago. It views global demand at 31.5 million barrels per day (BPD), which is only 500,000 BPD less than the prior report. And 1.4 million BPD below current OPEC production.
Interestingly, the OPEC report is claiming that non-OPEC production will increase, which ignores the major production estimates revised further down from 2018 for Canada, Brazil, Mexico and others. OPEC still fears the U.S. as the world’s largest oil producer.
Meanwhile, daily demand is expected to drop by 70,000 BPD with emerging markets expected to have lower economic growth.
But given the major political battles between Saudi Arabia, Iran and other OPEC members, this call for a cutback in production may be more about internal Middle East politics than for good business. Saudis continue to have proxy battles with Iran and reducing income from a proposed cutback would harm some of their “frenemies’” current accounts.
In addition, Saudi Arabia would like to cut the legs off of U.S. producers with lower prices, which hasn’t worked and likely won’t work given overall supply and demand conditions for petroleum won’t endure going forward. And with U.S. West Texas Intermediate (WTI) and regional crude prices at discounts due to pipeline and other infrastructure limitations, this has increased the urgency to get more pipe and other assets online quickly in 2019. So, as the largest oil producer in the world, the U.S. is set to supply refiners with more crude oil regardless of OPEC.
This is also seen in the amount of imports from OPEC to the U.S. The overall amount of imports has fallen over the past five years. With U.S. production on the incline, overall imports have fallen by 54.71% since October 2012 through to October 2018.
U.S. Takes Less OPEC
This means that oil refiners have been relying less on OPEC and its higher-priced crude oil, as U.S. production is at a discount (WTI is now sitting at a discount of 14.98% to global Brent crude).
The key to a refiner’s profitability and its ability to pay better dividends comes from the margin between the cost of a barrel of crude oil and the price of refined products, including gasoline, diesel, jet fuel and other distillates. This is known as the “crack spread.”
The current broad measure of the crack spread in the U.S. WTI price at the Cushing, Oklahoma hub is against U.S. Gulf Coast refiners. And while this spread is down from recent highs this past June, it is still up 45.88% from its lows in March.
Still Cracking
But this spread doesn’t reflect even better discounted prices for crude coming from fields in the Permian Basin, The Bakken Shale and Western Canadian fields.
The clogged pipeline networks mean that oil refiners are able to contract for crude at discounts from the glut of production that’s finding ways to them … then there’s the addition of train- and truck-delivered crude, which is also making its way to refiners.
Tying It Altogether With MPC Stock
One of my favorite refiners for dividends and growth is Marathon Petroleum (NYSE:MPC). This company recently completed its acquisition of Andeavor to become a major national refinery. It is now pulling crude from around the U.S. and Canada for its refinery operations.
Marathon’s operating margins are quite good at 6.10%. And they are up significantly from earlier this year by a factor of 2.63 times better than in the first calendar quarter.
This is driving an impressive return on its expensive refinery capital and other assets at 14.50%. For Marathon Petroleum shareholders, the return on their equity is running at 27.40%.
Revenue is climbing over the trailing twelve months by 20% and this is piping in profits to fund dividends that are up this past year by 20.27% to a current payout of 46 cents. All of this equates to a yield of 2.86% for MPC stock. And projections for the next dividend set to be declared in January would be for a further increase in the distribution to 50 cents.
Yet, despite the great underlying fundamentals, MPC stock has been deeply discounted. The stock is valued at a discount of 64% of its trailing sales. And Marathon Petroleum’s price-to-book value has gone from 2.62X in late September to a bargain-bin level of only 1.91X. Also remember that it is very difficult for oil refineries to get permitted, so its assets are truly valuable and hard to replicate.
Ultimately, MPC stock has less to fear from OPEC and more to capitalize on from U.S. producers, which makes it a good dividend-paying stock for income and growth over time.
Neil George is the editor for Profitable Investing and by company policy does not have any current holdings in the securities mentioned above.
