Now Is the Perfect Time to Buy Refining Stocks

Sometimes, markets overreact to news.


In this case, we’re talking about the recent landmark decision by the Obama administration to begin the early stages of exporting our crude oil bounty overseas.

The news was heralded by various energy firms — especially those in the Bakken and Eagle Ford producing regions of country. After all, those exports should help West Texas Intermediate (WTI) benchmarked crude increase in price and trade closer to international benchmark Brent. That means some hefty profits for those firms drilling within our borders.

Sadly, that’s not necessarily a great thing if you operate a refiner and use WTI as a cheap feedstock for your gasoline, jet fuel and other products. As such, shares of leading refining stocks like Valero (VLO) and Marathon (MPC) fell hard on the news.

Perhaps too hard.

For investors looking for a beaten-down value in the energy sector, downstream players could be one of the best bets at current fire-sale prices.

Exporting Condensate

Last week, the Obama Administration and the Commerce Department paved the way for U.S. oil exports. In a landmark decision, government officials gave Pioneer Natural Resources (PXD) the go-ahead to begin exporting a type of light oil known as condensate. The byproduct of natural gas drilling, condensate is considered a type of oil and is actually a mixture of various hydrocarbons, including everything from more traditional natural gas liquids (NGLs) to ingredients resembling gasoline or “drip gas.” A big and growing use is mixing it will heavy oil sands-style oil in order for it to be shipped through pipelines.

That makes it a very useful and profitable product for energy firms. And we’re producing a ton of it now, thanks in part to fracking.

The key for PXD and partner Enterprise Product Partners (EPD) is that, according to the Commence Department, condensate fits the bill as a “refined” product for export. That’s because it needs to go through a series of stabilizers during the gathering process in order to be used. Even though that process is really just one or two steps, it still makes condensate a “refined” product and eligible for export under current rules.

Several analysts has postulated that this is just the first step to lifting the 40-year ban on exporting straight crude oil exports. And that’s bad news if you rely on cheap mid-continent crude as your main profit driver. So it’s no wonder why shares of the refining stocks plunged on the news. VLO dipped 8.3%, MPC dropped 6.3% and PBF Energy (PBF) plunged by 11%.

A Big Overreaction in Refining Stocks

The concern is rightfully there. After all, the sheer glut of crude oil here in America is allowing refining stocks to realize insane profits on their crack spread margins. So some drop is certainly warranted. But an 8%-plus plunge? I’m not so sure.

Here’s why that’s unwarranted …

First, this is condensate we are talking about. No one ever said anything about raw crude oil. In fact, the Commerce Department basically stated that there had been “no change in policy” toward crude oil exports. Exporting crude oil has become this year’s hot-button issue, and the debate around it resembles the vitriol surrounding TransCanada’s (TRP) Keystone XL pipeline. That pipeline is still bogged down in regulatory muck. I suspect that raw crude oil exports will mostly face the same fate.

Those exports — if they happen at all — will most likely resemble what is going on in the natural gas and LNG sectors. Controlled facility approvals, export quotas and the like are the norm for the LNG producers. Only a slight handful of facilities have been given the green light to begin exporting to nations with trade agreements with the U.S. (and those that do not share such deals are even fewer in number).

In the meantime, we’re still producing ton of crude oil that remains locked within the United States borders. The WTI/Brent spread should remain favorable for quite a while. Nothing about the current condensate export deal will crimp margins or profits today for the refining stocks. In fact, they might actually get bigger.

As we said before, one of the main uses for condensate is thinning out heavy oil, like the kind Canada is blessed with. West Canadian Select (WSC) crude oil trades for even cheaper prices that WTI or Brent. I’m sure the refiners would love to get their hands on more of this cheap oil. Sending condensate upwards would make that possible.

Let’s not forget that many of the refiners are now becoming petrochemical powerhouses that have been getting into processing some of these light oils/NGLs. Add in the fact that many of them own export terminals for gasoline that could easily add capacity for shipping condensate and you can see how the market has basically panicked over nothing.

Time To Buy Refiners

Essentially, the market is extrapolating a lot of “what if” from the recent decision to export condensate. For opportunistic investors, that provides plenty of chances for them to potentially add some of the top refiners to the portfolios on the cheap.

The drop in refining stocks has sent price-to-earnings ratios down to historic lows and dividend yields to new highs. Valero trades for a P/E of just 10 and with a 1.7% dividend yield, while Phillips 66 (PSX) and Western Refining (WNR) both trade at just 13 times earnings along with a 2.5% payout. All feature growing profits, vast product lines and MLP subsidiaries providing hefty tax-deferred payouts.

And those are just some of the candidates for inclusion. The bottom line is that market has overreacted to a bit of news that really has zero implications on today or the near future. Investors looking to shift through the noise are able to snag some deals in the downstream players.

As of this writing, Aaron Levitt was long MPC.

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