HardAssetsInvestor

Written by Brad Zigler  |

October 05, 2009

Time To Buy Refiners?

Details

A lot of comments and mail I've read recently expresses a growing investment interest in oil refiners. These are companies that busy themselves just with the downstream end of things: Valero Energy Corp. (NYSE: VLO), Tesoro Corp. (NYSE: TSO), to name a couple.

Pricewise, Valero and Tesoro bottomed out last fall after both suffered precipitous tumbles. Over the past year, they've ended up on either side of breakeven - Tesoro, the better performer, has risen 14%, while Valero's stock lost 23%.

It's certainly been tough to be a refiner lately. Without favorably priced contracts, most outfits find it very hard to survive on market rate margins nowadays. The best thing for a refiner, of course, is a world where inputs (crude oil) are cheap, and distillates (gasoline and other products) are dear. NYMEX-implied margins don't paint that kind of a picture now. At last look, gross refining margins are in the 6-7% range. And with the cost of goods sold better than 6%, the sledding's tough.

Relief for Valero and other refiners, however, may be in the shadows. The refining business is highly seasonal and margins typically bottom out as plants reconfigure for winter's product mix.

It all boils down to the crack spread, the quaintly named arbitrage of crude oil against distilled products such as gasoline and heating oil. You can simulate a refiner's wintertime profit stream by "buying the crack" through futures - that is, selling crude oil futures against the purchase of gasoline and heating oil contracts. Details of the trade can be found in "Time For Crack Spreads?".

We track crack-spread-derived margins every Wednesday in the Desktop, so check back for updates on refining trends. Momentum in refiners' stock prices tends to accelerate when refining margins are on the upswing, most especially when the differential between the gross margin and the cost of goods sold exceeds 5 percentage points.

For those impatient to do something now, take note that the spread between heating oil and gasoline is widening. Gasoline typically finds a seasonal low in October just as heating oil, er, heats up. Traders usually exploit the growing differential in fall by selling gasoline (RBOB) futures against the purchase of heating oil (HO) contracts.

NYMEX Product Cracks

So, if you're looking for something while you wait for Halloween treats, the gasoline/heating oil spread may keep you warm.

*Note: The monetary inflation rate is calculated daily and represents the change in our proprietary index over the last 12 months. We update long-term inflation in real time as well. Since 1999, the compound annual growth rate in our index is 4.9%.