While airlines spent October explaining to shareholders that fuel had eaten their guidance, somebody was collecting that money. ExxonMobil told the market it expects refining margins alone to add around four and a half billion dollars to third-quarter earnings, which is not a rounding adjustment, a one-off credit or an accounting flourish. It is the single largest piece of good news in the sector this season, and it arrived from the part of the oil business that spent the previous decade being described as a strategic liability.
Refining is the least loved link in the hydrocarbon chain. It is capital intensive, politically exposed, environmentally scrutinised and historically cyclical in a way that makes investors nervous. Through the long stretch when integrated majors were under pressure to simplify, divest and look more like upstream pure plays, the downstream assets were the ones analysts wanted sold. Then capacity came offline across several continents, product demand did not follow it down, and the surviving refineries discovered they were operating a bottleneck. Crude is a commodity. Processed product delivered where it is needed, when it is needed, at the specification required, turns out not to be.
A roaster recognises this hierarchy instantly. Green coffee is a traded commodity with a published price that anyone with a shipping line can access. Roasted coffee, consistently profiled, bagged with a date on it and delivered to the cafe on the morning the cafe needs it, is something quite different, because the roasting step is where the value and the scarcity actually live. When new roasteries are cheap to build, that step earns a modest toll. When the roasteries are full and nobody has commissioned a new one in years, the person with heat and capacity sets the price, and the farmer and the cafe split the difference between them. The barrel is the green coffee. The refinery is the roaster. This quarter, the roaster is winning.
The insight worth holding onto is that integration is not a diversification story, it is a hedging story, and it has just paid out. An integrated major holds the production, the processing and the distribution of the same molecule, which means the spread between crude and product moves against one division and in favour of another. Pure-play producers got no gift from this quarter’s cracks. Pure-play refiners got the gift and none of the ballast. Exxon got the gift and happens also to be sitting on the upstream, which is why the same market conditions that forced a profit warning out of the airline sector produced a four and a half billion dollar tailwind here. The barrel did not create new value. It relocated existing value, and the companies that own both ends of it were paid for having the patience to own both ends.
This is also the clearest available argument against the fashion for corporate simplification. A conglomerate is punished with a discount in calm markets precisely because its parts hedge each other and therefore dilute the pure exposure investors say they want. The payoff for that discount is a quarter like this one, where the hedge inside the company absorbs a shock that competitors have to absorb on the income statement. Nobody writes admiring notes about optionality until the option is exercised, at which point the four and a half billion dollars does the arguing without assistance.
So the flare stacks burn, the distillation units run at rates nobody could have justified building for five years ago, and the cheque that the airlines wrote this quarter clears somewhere downstream of a crude cargo. Every barrel has two ends. This season, the market finally bothered to look at the profitable one.
Source: RTT News, “ExxonMobil Expects Q3 Earnings To Boost By $4.5 Bln From Refining Margins”