Stick with Refiners and Wait for the OPEC Decision to Shake Out

OPEC decision - Stick with Refiners and Wait for the OPEC Decision to Shake Out

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There are few things that can move the energy markets more than the Organization of the Petroleum Exporting Countries (OPEC).

While OPEC’s influence on crude oil prices has been drifting lower in recent years thanks to the shale boom, the cartel’s meeting are still an important piece to the supply/demand puzzle. So, when OPEC talks, the oil markets react.

With OPEC meeting this past weekend, the energy markets did a whole lot of reacting. Straight down that is.

As the cartel voted to finally start lifting production, crude oil sank lower. That’s bad news for energy producers.

But its wonderful news for the refiners and those firms that use crude oil as feedstock. For investors, the best way to play the OPEC decision comes down to cracking some crude.

OPEC Turns on the Spigot

Back in 2014, it was the OPEC decision to keep production humming that initially sent crude oil plunging to lows not seen in decades.

And it was OPEC’s decision to cut production that eventually led to the current drops to supply that sent prices right back up again.

For the cartel, the problem lies in the fact that fracking shale is very efficient and quick process. It’s super easy to turn it on or off. So, while prices have been high, American energy stocks have enjoyed all the proceeds.

Natural, OPEC hasn’t really enjoyed that fact. To that end, the cartel has moved to raise production quotas on its members to get a bigger piece of the action.

Recently in Vienna, OPEC- led by Saudi Arabia- agreed to raise production between 600,000 and 1 million barrels a day beginning next month. That’s about equal to 1% of the globes total supply.

Initially, that agreement boosted prices as investors were fearful, OPEC would flood the world. As a result, West Texas Intermediate (WTI) prices jumped 4.6% to $68.58 a barrel, while the price of Brent gained 3.4% to land at over $75 per barrel.

The question remains whether or not, supplies and demand will remain in a tight balance and keep prices elevated. Investors aren’t so sure anymore and prices have drifted lower after the initial euphoria.

This is especially true if the trade war and continued saber rattling on tariffs become more fact than fiction.

And we can’t ignore that U.S. oil inventories are now 29% above their five-year averages and production is nearly 140% above where it was a decade ago.

There’s a lot of moving parts here.

Betting on the End Users

So, while it may be tempting to keep plowing some heavy investment dollars into producers like EOG Resources (NYSE:EOG) or Hess (NYSE:HES), a better bet could the end users of crude oil. And that would be the refiners.

It’s beginning to look like the halcyon days once again for stocks like Marathon Petroleum (NYSE:MPC), Valero (NYSE:VLO) and others. The reason? Feedstock costs and better crack-spreads.

Firms operating in the downstream sector make money based on the difference between their crude oil costs versus what they can charge for refined products.

For most refiners, oil inputs are priced in WTI oil or Western Canadian Select (WCS). However, global gasoline pump prices, along with prices for other refined products, are generally based on the price of Brent crude.

This is the so-called crack-spread and thanks to rising supplies in the U.S., it’s as juicy as it has been in years. And it could stay that way.

OPEC isn’t exactly dumping a ton of oil on the market with its current plans and based on bottlenecks in countries like Iran and Venezuela, the amount oil extra oil may not be felt at all.

At the same time, if there is a major boost to supplies, the refiners will still be able to profit from the price differential. The issue with the E&P firms is that they need oil to be high to reap any benefits.

The refiners just need the difference between the two to be wide. So, if oil prices drop, feedstocks are cheaper and if the spread remains, the sector will be able to get some sort of gains.

Given the absolute uncertainty of what’s going on, the major refining stocks could be the best way to play the current oil market. You sort of get some stability with the pricing differential.

Making an OPEC Refining Play

The question is- which of the refining stock makes sense to buy? The answer is two-fold.

First up would be Marathon. MPC was already one of the strongest names in the sector. But it’s getting bigger. Back in April, Marathon agreed to buyout rival Andeavor (NYSE:ANDV).

That will create a $90 billion refining, marketing, and midstream giant. A giant that will have plenty of access to ultra-cheap West Coast and Permian Basin crude oil.

With the merger, which should close in the second half of this year, the company should be able to take advantage of the better crack-spreads and any additional oil supplies from OPEC.

Another top-notch choice would be Delek US Holdings (NYSE:DK). DK isn’t exactly a household name, but the firm is quickly becoming refining royalty.

A well-timed merger and asset sale has made it a nearly 100% Permian-focused refining firm.

That gives it access to the cheapest crude available in the U.S. and some of the sweetest margins around. if the current environment persists, Delek should have the most to gain. No wonder why shares are up by more than 50% this year.

The Bottom Line on the OPEC Decision

The OPEC decision to produce more crude oil can go either way. We could be looking at similar conditions or we could be facing rising supplies and lower prices.

It’s a tough nut to crack. Which is why the refiners may make perfect sense here. There’s much more wiggle room to play the decision if things go bad or stay the course. Both MPC and DK make ideal selections in the sector.

Disclosure: None

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