Supply growth is bottoming out, demand is at its lowest point. Refining
margins have fallen 75% since their peak last year. Our quarterly refining
demand-supply model now suggests that global refining supply growth is
bottoming out – we see slowing momentum beyond 1Q10. Absolute demand
has bottomed, and a rebound is imminent – the magnitude is debatable. We
see a margins/earnings bottom in 2H09, as inventory gains from rising oil
prices dissipate.
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Oversupply, inventories and seasonality cap gains. Global refining
oversupply is near its highest point this decade (2001). Operating rates in
OECD are low, and can rise to absorb demand. Inventories are high,
especially for distillates. The US driving season is over. A pop in distillates
would need to be big to overcome the gasoline monolith. 2011 could be
above mid-cycle, but unless we get a repeat of 2003-04 demand blowout
(global oil demand in excess of 2.5%), margins are unlikely to average
anything higher than US$6-7/bbl (2005-1H08 average of US$11.5/bbl).
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2011 capacity growth could be lower. Most of the Asian capacity growth is
in the bag. Capacity growth in 2011 is underpinned by shutdowns in Japan.
The Asian market should get tighter in 2011. Capacity growth ex. Asia could
get delayed or pushed out again, especially if margins fall in 2H09.
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Raising Asia refining sector to MARKET WEIGHT. Pure Asian refiners
have underperformed the markets, while those with PX/chem exposure have
done well. We see residual downside risk on earnings for most of the refiners
in Asia in 2H09, providing better entry points. We focus on Reliance as a
beneficiary of a refining cycle bottom, given its strong gas-driven earnings
growth. While valuations seem rich, they are attractive in the Indian context.
We prefer Thai Oil over PTTAR. Also, we prefer SK Energy over the rest of
the PX heavy names in Korea.