[Edaily Reporter Shin Ha-yeon ] On the 9th, IBK Investment & Securities analyzed that for S-OilCorporation(010950), interest rate hikes—typically viewed as negative for refining stocks—could actually serve as a factor that enhances the scarcity value of existing refining facilities, and maintained the company as its top pick in the refining sector. The firm believes that high interest rates, while constraining investment in new refining facilities, also exacerbate low inventory levels, thereby increasing the likelihood that strong refining margins will persist.

Lee Dong-wook, an analyst at IBK Investment & Securities, noted, “Interest rate hikes are typically perceived as a negative factor for refining stocks,” explaining, “This is because people tend to first think of an economic slowdown and a contraction in demand for petroleum products.” However, he added, “In the refining sector recently, it is necessary to consider the impact of the supply side as much as that of demand.”

Refining is a quintessentially capital-intensive industry, requiring massive upfront capital investment and a long payback period. The explanation is that as interest rates rise, the cost of capital and required rates of return for new projects increase; when combined with long-term uncertainty regarding oil demand due to the energy transition, the economic viability of new investments rapidly declines.

The analyst explained, “High interest rates are a factor that raises the barrier to new capacity expansion and increases pressure to phase out high-cost, aging facilities,” adding, “Unless demand declines sharply, the utilization rates and relative asset values of existing refining facilities could actually increase.”

In particular, he believed that S-OilCorporation, which has already made large-scale investments, could benefit. He emphasized, “S-OilCorporation’s refining facilities, where substantial investments have already been made, are likely to be viewed as assets that are difficult to replace as the economic viability of new facilities declines.”

Another link connecting interest rates and refining margins is inventory. Since holding crude oil and petroleum product inventories requires significant working capital, rising interest rates increase financing costs for inventory not only for refiners but also for traders and distributors. Consequently, there may be a stronger incentive to reduce inventory across the entire supply chain.

Of course, he drew a line, noting that current low product inventories cannot be explained by interest rates alone. This is because more direct factors—such as disruptions and closures at refining facilities, as well as regional supply-demand imbalances—are also at play.

The analyst explained, “The key point is that the lower the inventory, the less capacity there is to absorb supply-demand shocks,” adding, “In an environment of low inventory, spot prices for products react more quickly.” He continued, “If the prices of gasoline, diesel, and jet fuel rise faster than crude oil prices, the crack spread widens.”

The analysis suggests that while interest rates do not directly drive up refining margins, they can create an environment where even minor supply-demand shocks lead to larger margin fluctuations.

Accordingly, he emphasized that when assessing the refining sector, attention should be focused on the “duration” of refining margins rather than their “peak.” He explained that while economic recovery and increased demand for petroleum products were historically the starting points for margin increases, it has now become crucial to determine how long low inventories and limited supply capacity can sustain high operating rates.

The analyst noted, “Even if demand does not increase significantly, refining margins will find it difficult to quickly revert to historical averages if there is insufficient supply-side flexibility,” adding, “In particular, companies with high refining rates and stable operating capacity are at a relative advantage in this environment.”

He went on to predict, “The earnings of domestic refiners, including S-OilCorporation, are also likely to become more sensitive to the levels and duration of gasoline, diesel, and jet fuel cracks and high operating rates, rather than the absolute level of oil prices.”

In the stock market as well, high interest rates were seen as a factor that could enhance the relative value of refining stocks, including S-OilCorporation. This is because when interest rates rise, the present value of growth stocks—which place a heavy emphasis on future earnings—is significantly discounted, whereas refining companies generate current cash flows from their existing facilities.

The analyst explained, “The difference becomes even more apparent when the EBITDA and free cash flow generated by existing refining facilities are channeled into dividends, share buybacks, and debt reduction,” adding, “The higher the investment barrier for new refining facilities, the greater the relative value of the cash flow generated by existing, competitive facilities.”

However, the analyst noted that if the economy and demand for petroleum products contract sharply, refining stocks would also find it difficult to avoid the negative impact of interest rate hikes.

He explained, “The situation could change if high interest rates persist for an extended period while demand remains above a certain level,” adding, “In the short term, high financing costs for inventory make it difficult to build up stockpiles, and in the long term, high capital costs constrain investment in new refining facilities and additional investment in aging facilities.”

He also cited the fact that refinery stocks have performed well during past tightening cycles as further evidence. According to the trends in Federal Reserve (Fed) policy rates and Singapore refining margins shown on page 3 of the report, high refining margins were observed during both the 2004–2006 tightening cycle and the period of steep rate hikes in 2022–2023.

The analyst stated, “Investors should take into account that refining stocks outperformed the market during both the 2004–2006 Fed tightening cycle and the 2022–2023 period—which saw the steepest interest rate hikes in the Fed’s history,” adding, “We maintain S-OilCorporation as our top pick in the refining sector.”