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These Oil Stocks Are Getting Crushed -- Does This 1 Metric Point to a Huge Rebound?


It's been a tale of two halves for oil refining stocks. In the first six months of 2018, share prices of these oil stocks steadily climbed higher in unison with a growing pricing mismatch in international crude oil benchmarks Brent crude and West Texas Intermediate (WTI), called the Brent-WTI spread . As the spread grew, North American companies such as Phillips 66 (NYSE: PSX)  and Delek US Holdings (NYSE: DK)  were able to purchase cheap American crude, distill it into refined petroleum products, and sell it in international markets for a quick and easy profit.

Things haven't gone quite so well in the second half of 2018. The Brent-WTI spread abruptly collapsed at the end of June and many refining stocks have slipped by double digits as a result. But investors banking on the correlation serving as a predictor for refiners have been thrown a curveball since then. The spread has quietly rebounded to the highest level since early 2014, but refining stocks are still shedding value.

That got three of our Motley Fool contributors thinking: Does the sudden divergence signal an opportunity, or is Mr. Market right to worry about refining businesses?

A pipeline leading into an oil refinery.

Image source: Getty Images.

Cashing in on cheap crude

Matt DiLallo  (Phillips 66): Refining and logistics giant Phillips 66 has invested billions of dollars over the past several years to increase its access to cheaper oil produced in North America. It has taken a multipronged approach, which sets up the company to make lots of money as it processes more of these cheaper barrels in the coming years.

Phillips 66 has completed several projects at its refineries in recent years so that it can process larger volumes of cheap North American oil . Last year, for example, the company spent money at its Billings refinery to increase the amount of heavy Canadian crude processed at that location. Investments like that have enabled Phillips 66 to import more Canadian oil than any other U.S. refiner, refining an average of 508,000 barrels per day (BPD) at nine of its U.S. locations last year. Meanwhile, the company has made similar investments at its Lake Charles refinery this year so that it can process more domestically produced oil.

The refining giant has also invested heavily in building new oil pipelines around the country to improve the flow of oil. One notable investment was in the Bakken Pipeline, which is currently moving oil from North Dakota to the company's refineries on the Gulf Coast, as well as one along the way in Illinois. Meanwhile, the company's affiliate, Phillips 66 Partners , is building an oil pipeline from the Permian Basin to the Gulf Coast to increase Phillips 66's access to cheaper oil from that region.

These strategic initiatives have positioned Phillips 66 to continue cashing in on cheaper North American crude. Because of that, the recent decline in the company's stock off its high looks like an opportunity worth considering.

A person pulling a block out of a block tower.

Image source: Getty Images.

Wall Street is baking in a contraction

Tyler Crowe : The price difference between various crude types in North America has approached absolutely absurd levels. The price of Brent is close to $10 higher than WTI, and crude oil from the Permian Basin or from Canada is selling for huge discounts to WTI. When price spreads are this high, refiners can make a killing, as evidenced by their recent earnings reports.

These price spreads aren't common and are a symptom of not enough pipelines to move oil from the wellhead to the market. Unfortunately for refiners, this period of severe infrastructure limitations and bottlenecks could clear up. There are approximately 2.9 million barrels per day of pipeline capacity , either under construction or in open season, that would move Permian Basin crude to the Gulf Coast. What's even more concerning, though, is that companies are also making significant investments to export U.S. crude oil. Current investments in export capacity could increase our current rate of crude exports from around 2.1 million barrels per day to 4.8 million barrels per day within five years. Exporting that much oil will not only reduce the regional price spreads, but it will also likely narrow the spread between WTI and Brent crude.

With independent refining stocks all trading for less than 10 times earnings, it would appear that Wall Street is anticipating that all this new pipeline capacity will hit refining margins hard and will take their earnings with it. If that is the case, then maybe this pullback in refiners' results isn't that crazy.

A laptop in the foreground and an oil refinery complex in the background.

Image source: Getty Images.

Maybe this time really is different

Maxx Chatsko (Delek US Holdings): The crude oil market is truly in unprecedented territory. Regional factors such as pipeline bottlenecks are keeping WTI priced at a discount, but pipeline capacity growth is expected to barely keep up with production growth in the next five years. In fact, producers have drilled a record 3,500 wells that remain uncompleted, waiting for more pipelines to come online before returning to finish them.

There are also complex international and geopolitical factors to consider. A new low-sulfur marine diesel standard goes into effect globally in 2020, which should boost distillate demand (refined products such as diesel) by billions of gallons per year. Meanwhile, the ongoing shale boom in the United States has disrupted global trade flows in record time. The country will go from importing 30% of its total energy consumption in 2005 to becoming a net energy exporter by 2022 (only being a net importer of crude oil, with most of that coming from Canada).

While a Brent-WTI spread above $10 per barrel may be unsustainable, the new normal may still be a healthy disparity that leaves plenty of room for North American refiners to make money hand over fist. Therefore, investors may want to acknowledge both uncertainty (Tyler's argument) and opportunity (Matt's argument) by finding companies that can exploit crude oil pricing disparities when they exist and avoid getting torched when they don't.

Similar to Phillips 66, Delek US Holdings has positioned itself to maximize cheap North American crude oil by sourcing 70% of supply from the Permian basin. It has the highest distillate yields in the entire refining industry, which will help it exploit the new global marine fuel standard when peers are upgrading facilities to play catch-up. And it sees growing global refining capacity -- in part to respond to rising U.S. exports in the near future -- as a factor that will increase, not decrease, the price spread.

Given the dramatic pullback in share price in the second half of 2018, investors may want to give Delek US Holdings -- and refining stocks as a whole -- a closer look. Just keep the sources of pricing uncertainty in mind.

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Matthew DiLallo owns shares of Phillips 66. Maxx Chatsko has no position in any of the stocks mentioned. Tyler Crowe has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.



This article appears in: Personal Finance , Stocks
Referenced Symbols: WTI , PSX , DK



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