Schaeffer's Trading Floor Blog

Oil Refiners in Slippery Territory (VLO, HES, WNR)

Taking a closer look at refinery stocks VLO, HES, WNR, and more

by 4/25/2012 4:24 PM
Stocks quoted in this article:

With crude oil prices currently north of $100, and drivers across the world feeling pain at the pump, one would assume that oil refiners are having a banner year. The misconception that high oil prices drive profits higher for refiners is prevalent among many members of the general public. This is indeed false, as higher oil prices raise the input costs (crude that they purchase) without necessarily driving profit margins higher. There are many factors that can influence the profitability of refining companies, but perhaps the most important to consider are the crack spread, Brent Crude-West Texas Crude spread price, and seasonality.

Historically, refiners flourish between late February and mid-May, ahead of the busy driving season. For the most part, however, that hasn't been the case this year. Large-cap names such as Valero (VLO), Hess (HES), and Tesoro (TSO) have all substantially underperformed the broad market since late February. There are, however, two glaring exceptions to this generalization -- Western Refining (WNR) and Sunoco (SUN). For simplicity's sake, I'm excluding integrated oil names from this list, mainly because their increased refining costs are offset by their ability to produce their own raw crude oil.

What's even more troubling is that these stocks grossly underperformed the broad market with crack spreads near 52-week highs. The crack spread is the difference between the price of raw crude oil and the products that refiners can sell from processing the crude oil into other marketable goods, such as gasoline, heating oil, and petroleum. Below is a chart of the crack spread over the course of the past 52 weeks. While the run-up in spreads lasted until April, many of the refining names began breaking down in mid-March, indicating a potential divergence between fundamentals and technicals.

Rate Chart for CRK321M1

Another troubling factor for domestic refiners is the narrowing Brent Crude-West Texas Crude spread. Since most of these companies will acquire their oil from American drillers, the ability to buy low and sell high is no longer there. If oil can be acquired domestically at a big discount to that which is purchased across the Atlantic (Brent Crude is a type of oil produced in the North Sea), then the refiners can sell finished goods abroad at a much higher margin than if WTI was trading at par with Brent. Finished goods can demand a higher price with an elevated price of Brent Crude since it is considered the global standard. The chart below shows WTI's discount to Brent crude. For example, a reading of -20 would indicate that Brent is $20 more than WTI, a very favorable scenario for refiners. A reading of -10 would indicate that the two are priced very closely together. As you can see, the spread recently bottomed near $20, and is now bouncing here. One could argue that the annual period of high profitability for refiners is now over.

Rate Chart for CLCO1

From a sentiment perspective, analysts remain very bullishly aligned toward the refiners. Among HES, SUN, TSO, VLO, and WNR, there are currently a total of 22 "strong buy" ratings with only three ratings of "sell" or "strong sell." Additionally, short interest on these names is down by an average of 18% over the course of the past month. Now that sentiment is growing extremely rosy, and the fundamentals for these names have begun to break down, this could be an opportune time to take short positions in select refining names.


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