US Integrated Oils and Refining: Differentials, Why You Have To Be So Crude? (Except You SJV)

Deutsche Bank Markets Research North America United States Industrials Integrated Oil Industry US Integrated Oils and Refining Date 14 June 2015 Industry Update Differentials, Why You Have To Be So Crude? (Except You SJV) Despite Investor Concerns, First Pass at 2Q Estimates Appears Reasonable ________________________________________________________________________________________________________________ Deutsche Bank Securities Inc. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 124/04/2015. Ryan Todd Research Analyst (+1) 212 250-8342 ryan.todd@db.com Igor Grinman Research Analyst (+1) 212 250-4278 igor.grinman@db.com David Fernandez Research Associate (+1) 212 250-3191 david.fernandez@db.com Top picks Marathon Petroleum Corp (MPC.N),USD51.03 Buy Valero Energy (VLO.N),USD58.85 Buy Tesoro Corporation (TSO.N),USD83.55 Buy Source: Deutsche Bank Sentiment across the energy space remains largely directionless, with range-bound crude and relatively healthy valuations sapping near-term momentum. While debate within crude/E&Ps remains robust (pace/potential of onshore declines, global supply outlook, growth/spending trends), refining largely appears to have been relegated to the "other side" of the trade, with overall lack of conviction translating into largely rangebound performance. We remain relatively positive US refining, and within we examine dynamics around the lone bright light in what has been a challenging crude differential environment of late: West Coast heavy diffs, with positive implications for TSO, VLO, PSX. Crude diff’s not too friendly as of late (likely a 3Q EPS headwind)... Mid-Con and Canadian crude differentials have narrowed significantly over the course of 2Q, with WTI-Brent/Clearbrook/Midland/WCS/Syncrude trading at $3.00/$2.00/$0.40/$7.55/$(2.50) as of 6/11 (and similarly over a large part of May). Other regions’ key diff’s have lagged as well, with LLS and ANS both at ~$0.85-0.90//bbl parity to Brent in the month of June. The Alberta fire exacerbated the already seasonally weak CAD diff quarter and is likely one of the culprits behind weakness in other regions’ diff’s (pulling LLS/other crudes inland). While the light at the end of the tunnel may be in sight (CAD producers ramping up to pre Alberta fire levels), we expect the recent weakness to nonetheless act as a headwind for capture rates, but expect it to be more of an issue for 3Q results vs 2Q, given the lag effect (deliveries vs. purchases lag). ...though forecast looking relatively sunny in California (heavies) The California heavy differential (SJV/Kern) has remained supportive throughout 2015 and even improving vs. the likes of Maya/WCS in 2Q15/1Q15 (which already saw notable widening vs 2013-2014 average levels), partially a result of Torrance outage (uses ~100 MB/d of CA/PADD V offshore heavies, or >15% of total CA prod’n, which is mostly heavy). The impact to SJV/Kern diff’s from PAA’s line 901 spill (carrying ~30 Mb/d of CA heavies) is up in the air depending on whether the barrels get stranded (XOM recently denied permit to truck volumes) or if they ultimately move to market via more expensive means. We highlight TSO, PSX, and to a smaller degree VLO as the exposed names in the refiners group with CA heavies accounting for 13.5%/7.6%/1.5% respectively of average ’14 crude slate; in PSX’s case, the lost volumes from PAA’s spill (pipe fed Santa Maria refinery) is the offsetting factor. Valuations and Risk Companies in our refining coverage are mostly valued under a 2016 multiple-based (EV/EBITDA) SOTP valuation. We value ownership in the MLP as follows: LP ownership valuation is based on the underlying LP units held by the refiner and at current market prices. The refiner’s GP ownership is valued on a 2016 multiple to GP cash flow. Risks to the upside include improving widening of crude differentials, stronger than anticipated domestic product demand while downside risks include a removal of the crude export ban, narrowing of differentials and weakened product demand. 14 June 2015 Integrated Oil US Integrated Oils and Refining Page 2 Deutsche Bank Securities Inc. Diff Weakness Galore but Smooth Sailing on CA Heavy Side Within, we highlight one of the potentially underappreciated bright spot in today’s (well-telegraphed) narrower differential world – California heavies. SJV/Kern differentials have rem