Tread Carefully With Refining Stocks

Bumper time for the sector might be in the rear-view mirror

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Few sectors can deliver short-term return numbers like refining stocks do when they have the wind at their backs. A near-perfect environment in the third quarter has led the refiners to post incredible earnings results, driving their stock prices to outstanding returns in recent weeks.

The year-over-year profit results point to an industry with everything going its way: Valero Energy (NYSE:VLO) reported growth of 297%, while Tesoro Corp. (NYSE:TSO) profits rose 516%. Marathon Petroleum (NYSE:MPC) — which was spun out of Marathon Oil — said its earnings quadrupled, while Alon USA Energy (NYSE:ALJ) moved from a net loss of $15.6 million to a gain of $28.6 million. Western Refining’s (NYSE:WNR) net income jumped from $6.9 million to $84.9 million.

Table1 Tread Carefully With Refining StocksThese results haven’t been lost on investors. From the Oct. 3 market low through Nov. 8 (27 trading sessions), some refining stocks have produced gains that are nothing short of parabolic:

The reason for these gaudy results is straightforward: soaring profit margins. The past year has been characterized by an enormous spread between the prices of Brent North Sea crude and West Texas Intermediate Oil. At its peak, this gap rose to an unheard-of level of $27.90 because of a glut of WTI supply in storage.

Why is this important for refiners? Very simply, many U.S. refiners are able to buy cheaper WTI oil and sell their finished products at prices tied to Brent crude. In other words, it’s a license to print money. The result has been explosive gains in profit margins and a surge of investor cash into the refiners once the markets returned to “risk-on” mode in October.

This type of positive news flow has made for an outstanding autumn if you already own shares in the refiners. If not, it might pay to wait at this point rather than trying to catch up. Consider that the crack spread, which measures the difference between the cost of crude oil and the price at which refiners can sell their finished product, averaged record levels in the third quarter, but it has since come down quite a bit. Similarly, the gap between Brent and WTI has narrowed in recent weeks, indicating that the fourth quarter might not be as dramatically positive as the quarter just passed.

Consider, too, that demand for gasoline continues to fall. According to the U.S. Energy Information Administration, consumption had lagged 2010 for eight consecutive weeks through Oct. 21, while the national average of gasoline prices had fallen from a peak of $3.91 in May to $3.45 in October.

Add it up, and the takeaways are:


Article printed from InvestorPlace Media, http://investorplace.com/2011/11/tread-carefully-with-refining-stocks/.

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