For the past few years, there's been an anomaly in the global
Brent crude oil, which comes from the Middle East, Africa and
Europe, has been far more expensive than West Texas Intermediate
(WTI) crude, which is drilled right here in the U.S. Both Brent
and WTI are known as light,sweet crude , which means they are
easily processed into gasoline, diesel and other distillates.
So why had Brent been trading for up to $20 more per barrel
than WTI? Blame it on geography.
Although the U.S. has tapped into a mother lode of oil in the
past few years, much of the produced oil had nowhere to go.
Storage hubs were filled to capacity as a lack of pipelines kept
all of the oil from flowing to U.S. Gulf Coast, the West Coast
and the East Coast, where manyoil refineries are located.
All that has changed. The opening of many new pipelines in
recentquarters has enabled the oil to start flowing more quickly,
and as refiners boost demand for WTI crude and seek less Brent
crude oil, we're seeing the price for these two types of crude
Trouble is, gasoline and diesel are globally fungible, so
refiners haven't been able to hike wholesale gas and diesel
prices as quickly as their own costs are rising. As a result,
refiners'profit margins have fallen sharply in recent months,
taking their share prices with them.
The pullback means that the major oil refiners are now among
the cheapeststocks in themarket .
Before we go any further, you'llnote that three of these
stocks sport especially highdividend yields.
Northern Tier Energy (
Alon USA Partners (
Calumet Spec. Products (Nasdaq: CLMT)
They are structured as masterlimited partnerships (MLPs), so
they pay out almost all of theircash flow in the form of
dividends. (The rest reserve much of their cash flow forcapital
spending and growth initiatives.)
You'll also note that the super-high yields for these MLPs are
too good to be true. The decline in refining margins means the
dividend needs to be reduced, but these should still be solid
yields, even after the dividend cuts take place. For
example,analysts at Citigroup expect Alon USA Partners' dividend
falling from $2.74 per unit in 2013 to just 88 cents per unit,
before rebounding to $1.74 per unit in 2015.
Yet the fact that most of these refiners now trade for less
than 10 times projected 2014 profits should draw your attention.
More importantly, the pullback in margins, as painful as it is,
doesn't signal that profits have peaked.
Instead, look at these refiners in the context of the energy
boom that is now underway. As the U.S. produces ever-higher
amounts of crude oil over the next five years, these refinerswill
be able to generate much higher volumes of refined products,
eventually displacing much of the imported gasoline, diesel and
other distillates now coming to the U.S. from
Also, as oil production keeps rising, it should eventually
push prices down, opening up the spreads these refiners had been
profiting from. The Energy Information Administration (EIA) sees
U.S. oil production rising 30% between now and the middle of
2015, though the rising output should alter refining dynamics
well before then. Goldman Sachs anticipates "the effective
elimination of light crude oil imports to the Gulf Coast, which
we expect to occur around year-end 2013." Analysts at Merrill
Lynch add that "growth in regional production in the Eagle Ford
and Permian basins will likely 'back out' light sweet crude
imports within ayear ."
Yet for investors, it's fair to wonder if it's best to wait
until the current cycle of falling profit margins andprofit
forecasts has played out. "We find that at key inflections,
investors often look through short-termEPS revisions," noted
Goldman Sachs analysts. In other words, by the time you wait
forearnings estimates revisions to trend upward, you will have
missed out on some of the nextrally in this group.
Goldman Sachs recommends
Marathon Petroleum (NYSE: MPOC)
Western Refining (
Alon USA Partners (Nasdaq: ALDW)
Northern Tier Energy (
. The first two stocks carry more than 50%upside to Goldman's
Merrill Lynch rates
Tesoro Energy (TSO)
as a "buy," as those companies have the best organic growth
prospects in the industry, thanks to planned capacity additions.
They also think Valero will soon spin off a portion of its
business in the form of an MLP. Such moves have historically
given instant boosts to share prices.
Risks to Consider:
Any global crises that lead to a spike in oil prices wouldput
further pressure on refiners' profit margins. Also, a sharp
economic slowdown in the U.S. would hamper demand for refined
products like gasoline and diesel.
Action to Take -->
The recent share price pullbacks are a reflection of 2013
industry dynamics. But as long as you focus on the long-term
dynamics impacting refiners, you'll find the current low
earningsmultiples to be quite appealing.
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