European refining investors wary of downturn

By Danilo Masoni

MILAN (Reuters) - A rebound in oil prices this month could test the nerves of investors in European oil refiners, a sector that has sparkled as cheap crude fattened profit margins.

One-and-a-half years of plummeting oil prices has left refiners like Finland's Neste and Italy's Saras, which convert crude oil into products like gasoline and diesel, with the winning hand.

But in the last two weeks, shares in refiners have underperformed or at best matched the main European oil sector index in what could be an early signal that it is time to get out.

Emmanuel Hauptmann, senior equity fund manager at RAM Active Investments in Geneva, said they were on the alert as oil prices on Friday were set for their second straight week of gains, spurred by hopes of a deal among oil-producing countries to tackle the supply glut.

"Any inflexion point would be a strong negative that would lead us to get out very rapidly," he said.

While the main European oil sector index has fallen more than 70% since mid-2014, tracking crude prices that were as low as $27.1/bbl just last week, Neste and Saras almost doubled in value while other refiner stocks such as Poland's PKN Orlen and Greece's Motor Oil Hellas have also done well.

While lower crude prices have meant reduced input costs, there has also been a stellar rise in demand, particularly for gasoline around the world.

But the outlook is weakening. The International Energy Agency expects 2016 daily demand to fall by one-third to 1.2 million bbl from 1.8 million last year.

Refining margins in northwest Europe averaged $14.5/bbl in 2015 and in the Mediterranean $12.7. But so far in 2016, margins averaged $10.9/bbl in Northwest Europe and $10.6/bbl in the Mediterranean, according to BP.

Pre-tax profit margins at Saras meanwhile, are expected to have peaked at 6.1% in 2015 following years of negative figures and fall to 3.6% this year.

"You'll have to watch out, for whenever oil prices turn, it will become a bit of a headwind," warned Craig Bethune, co-head of Manulife Asset Management's global natural resources team.

In spite of the watchful mood, fund managers interviewed by Reuters including KBC Asset Management's David Duchi, Ilmarinen's Annika Ekman, Bethune and Hauptmann all said that the broader backdrop for oil refinery companies remained generally positive.

Oil prices remain close to 12-year lows and this means refiners could still be a safe bet, even if 2016 is not as good as 2015.

Some brokers such as Barclays and UBS have published bullish views, highlighting how some of the companies in the sector were starting to boost returns for shareholders, after years of miserly dividends.

This month UBS upgraded Saras saying it expected the Italian company to beat consensus estimates on its dividend payout. Nomura also highlighted potential dividend increases for Neste, while back in November Motor Oil Hellas unexpectedly said it would resume paying dividends.

Yet some of the fund managers said they would not be adding to their positions as earnings upgrades were likely to slow while the sector also faced longer term structural headwinds, including the growth of renewable energy.

"For the investment case to be interesting longer term, there should be some exposure to new technologies such as renewable energy," said Ilmarinen's Ekman.