Pure Refiners in Play

By Brad Zigler

The current oil market – that is, the one born of the September/October short squeeze – has really been a position-player's paradise. Oh, sure, you could have made some money dodging and weaving around the margins of the NYMEX trading rings, but the real money's been made just rolling a plain old vanilla short sale forward. Just ask the owners of the two PowerShares short oil ETNs (NYSE Arca: DTO and NYSE Arca: SZO).

A ballooning contango, too, has been a boon for the short rollers. The front-month (February-March) spread as of Friday was worth more than $5 per barrel, three bucks more than this same time in December. That's earned bears an 8% bonus this month simply for staying the course. A few more rolls like that and we're talking some serious coin.

While oil prices have – you should forgive the expression – tanked, the margins earned from selling the products refined from crude have risen to levels not seen since mid-2007. Gross profit margins on a 3-2-1 crack (that is, turning three barrels of crude into two barrels of gasoline and one barrel of heating oil) spiked above 30% Friday. Yesterday, the margin jumped to 38%. It was from similar levels that margins slid a couple of years ago when oil prices were climbing. Now, of course, price momentum's headed in the opposite direction. There's a seasonal factor at play, as well, that favors a widening crack spread (for background, see "Time For Crack Spreads?").

It's not that there's anything wrong with margins at this level, mind you. It's the way they got here. Fast. Too fast.

NYMEX Refining Margin

The recent steep run-ups have the distinct aroma of fragility about them. Call it the smell of speculative excess. Normally, seasonal margin-widening moves – how shall I say it? – ploddingly. This is anything but a normal market, of course. But a pullback in the margin shouldn't be a surprise. One should, in fact, be welcomed as an opportunity for spreaders.

For the futures-averse, this is a time to consider pure refiners like Valero Energy Corp. (NYSE: VLO) or Tesoro Corp. (NYSE: TSO). Unlike integrated outfits such as Chevron Corp. (NYSE: CVX), which predicted dire fourth-quarter results last week, the refiners' stock values are more closely correlated to refining margins. That explains why Valero's gained 19% since the beginning of November while Chevron's slipped 4%.

We'll look at this more closely on Wednesday.

Comments

[I-investor:]

The NYMEX refining margins are created by subtracting the oil futures index from the refined gasoline index. As such it is highly imperfect indicator and does not capture the prices achieved by market participants. Last quarter, SUN blew away all of the analysts estimates. The NYMEX refining margins actually went negative, when in fact the refiners were making good profits. SUN said it was because they were able to buy oil more cheaply than the analysts thought. Now the speculators at NYMEX are adjusting thier positions.

Jan 14 01:48 AM

[Brad Zigler:]

But that's NOT how refining margins are derived using NYMEX prices.

First of all, indexes aren't involved in the calculation of a crack spread. The sum of the refined product prices (gasoline and heating oil) are substracted, in ratio, from the price of crude oil. The margin represents the excess value of the crack expressed as a percentage of the input cost. That's what is depicted in the article.

The 3-2-1 crack turned negative for only one day -- an anomaly caused by the short queeze in the expiring October crude contract. Other than that, its seasonal nadir was reached on October 7th at $3.62 a barrel (a margin of 4%)

The persistent negative value you reference was the 1:1 crude oil/gasoline crack which dipped into the red for about two months (October-December). Prices for othe distillates (such as heating oil), however were high enough to keep the overall crack spread positive.

You're right about one thing: a 1:1 single-product crack doesn't reflect the refining return.

On Jan 14 01:48 AM I-investor wrote:

> The NYMEX refining margins are created by subtracting the oil futures
> index from the refined gasoline index. As such it is highly imperfect
> indicator and does not capture the prices achieved by market participants.
> Last quarter, SUN blew away all of the analysts estimates. The NYMEX
> refining margins actually went negative, when in fact the refiners
> were making good profits. SUN said it was because they were able
> to buy oil more cheaply than the analysts thought. Now the speculators
> at NYMEX are adjusting thier positions.

Jan 14 04:30 AM

[I-investor:]

OK Brad, you're right, no index is used. When trading crack spread options, a single options position results in two offsetting futures positions when the option is exercised. So the resulting crack spread is derived as the product of two separate speculative bets. It has little to do with what is really happening in the marketplace where physical gasoline and distillates are refined.

Whatever falls out of some traders in Chicago is not primary information.That's why I am the only one who commented on your article, and I got two positives, to your one. If you want to know how the refinery business is going, you got to talk to the people in the refinery business.

Jan 15 03:51 PM

[Brad Zigler:]

The prices used in the margin calculation come from futures, not options. And there's a direct relationship between futures and physical prices, known as basis, which commercial users have long traded in their hedging operations.

Futures prices are not just the sum of speculative bets. In fact, commercial users make up the vast bulk of crude oil futures open interest.

The instantaneous price discovery mechanism represented by futures is a reflection -- and sometimes a driver -- of spot pricing.


On Jan 15 03:51 PM I-investor wrote:

> OK Brad, you're right, no index is used. When trading crack spread
> options, a single options position results in two offsetting futures
> positions when the option is exercised. So the resulting crack spread
> is derived as the product of two separate speculative bets. It has
> little to do with what is really happening in the marketplace where
> physical gasoline and distillates are refined.
>
> Whatever falls out of some traders in Chicago is not primary information.That's
> why I am the only one who commented on your article, and I got two
> positives, to your one. If you want to know how the refinery business
> is going, you got to talk to the people in the refinery business.

Jan 16 02:11 PM

[bones33:]

The refiners are clearly in an uptrend.With VLO reporting this week it will be interesting to see if this trend continues.I rode the refiners down now I'm hoping to ride them back up.Good luck if your invested.

Jan 27 01:04 AM