Oil Prices Will Be 'Lower For Longer,' But Refiners Will Be 'Stronger For Longer'

In a report published Sunday, Morgan Stanley analyst Eva Calio discussed why refiners will be the biggest beneficiary of an oversupplied oil market.

According to Calio, investors and corporations are embracing a "lower for longer" oil market when considering OPEC's actions of increasing production by two million barrels per day from a year ago. As such, the analyst suggested oil prices are expected to remain below the $65 level for the next 12 months, and the era of low priced oil will translate to a "robust" demand.

Calio said the refining sector benefits from lower oil prices when low price is the result of oversupply. In fact, the market is already oversupplied by 800-1,000 Mboe/d while Iran could add a further supply of up to 500Mbld over the first half of 2016, adding further supply gut and further delaying a "significant" oil price recovery.

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However, the ultimate question investors are asking is if all companies in the refining sector will benefit and when. The analyst answered that the third quarter 2016 will prove to be "materially higher" for the group as a whole and will support higher equity values with upside to current multiples.

Looking at the June quarter, Calio pointed out that many refiners reported "strong" results that came in ahead of expectations, even after the Street revised second-quarter estimates higher by 10 percent or more. Specifically, Tesoro Corporation TSO's earnings were 16 percent ahead of estimates, HollyFrontier Corp HFC's earnings were 13.3 percent above expectations and Valero Energy Corporation VLO exceeded its earnings estimates by 10.3 percent.

Calio also said that Tesoro is expected to see its capture rate to improve in the third quarter and report higher sequential earnings even adjusting for an expected decline in cracks. Meanwhile, HollyFrontier's management is committed towards a $2.3 billion share repurchase over the next two to three years and Valero remains on track for a second MLP drop before the end of the year.