Morgan Stanley: Downstream recovery begins

With commodity prices rising, downstream margins improving, and spending holding steady, free cash flow (FCF) is set to rise sharply off an already strong base for the US majors and Canadian energy, according to a research note from Morgan Stanley.

In first-half 2021, the North American integrated oil sector generated the highest FCF in over a decade, even eclipsing years in the early 2010s when oil was above $100/bbl. These results, aided by cost reductions and spending discipline, were delivered despite continued weakness in downstream margins. Now, downstream margins have begun to recover as well, supporting strong third-quarter results, and underpinning further upside into 2022, Morgan Stanley continued.

On the back of continued inventory draws and improving mobility statistics, Brent finished the third quarter at an average $73/bbl, up 6% quarter-on-quarter (q-o-q). In Canada, WTI-WCS differentials were roughly flat quarter-on-quarter (q-o-q) at $13/bbl, supporting realizations.

On the downstream side, jet fuel demand continues to lag but the crack spreads are improving. In the US, jet fuel demand continues to lag at around 90% of 5-year average levels, vs. gasoline and distillate which have fully recovered, Morgan Stanley said. That said, cracks have continued higher. In the US Gulf Coast, cracks were up about 11% q-o-q, while cracks in Europe were up 16%. In the midcontinent, which is generally more indicative of profitability for Canadian refineries, cracks were up around 5%. Together, Morgan Stanley expects this to drive an improvement in downstream earnings before interest, taxes, depreciation, and amortization (EBITDA) of 60% for its covered group.

For chemicals, polyethylene-ethylene margins in the US were up 10% q-o-q, compared to an 18% decline q-o-q in Europe and an 80% decline in Asia.