Back in July 2011, in one of my first articles here at Seeking Alpha, I suggested that the best way to play the Conoco-Philips breakup was to bet on the refiner. After being hammered by commenters, I backtracked by the following February, suggesting refiners were not ready for the wild prices swings of the market.
Turns out my first instinct was right.
Had you played the Conoco-Philips breakup as I suggested, preferring the Philips 66 (PSX) refining unit over the Conoco (COP) production unit, your patience would by now have been rewarded. PSX is up 88% since the split became final last May, while COP has stood still. It's the same story with Marathon -- the production unit, called Marathon Oil (MRO), is down 20% since their 2011 breakup while the refining unit, Marathon Petroleum (MPC), is up 105%. What I saw then was mainly declining refining capacity, a lack of investment that I figured had to result, eventually, in better margins for the survivors. But there is something more fundamental going on.
The U.S. is in its fifth oil boom. The first one, in the 1860s, created the industry. The second one, in the early 1900s, made Texas its center. The third one, in the 1930s, created a regulatory regime designed to maintain prices. The fourth one, in the 1970s, created the current market structure.
The fifth, today's oil boom, is going to emphasize the importance of infrastructure. The fact is that while the oil industry loves to claim the Obama administration hates it and that prices would decline if it was just allowed to "drill, baby drill," its over-drilling is getting in the way of profit. A third of the gas found in the Bakken is being flared -- burned away -- because there isn't enough infrastructure to get it to market. Pipeline owners like Kinder Morgan (KMP) and railroads like Warren Buffett's Burlington Northern (BRK.A) are making out like bandits, naming their price for getting supplies to market. And this oversupply is about to wash over the refining market in 2013.
After all, the infrastructure problems are going to be solved. Supplies from the Bakken are going to reach East Coast refineries and West Coast refineries over the next year. This will reduce their feedstock costs considerably. Meanwhile, prices for the finished product are not going down. Gas prices, once set based on supply and demand, are now set based on utility. Producers find it worthwhile to create any excuse -- a fire, a foreign war, anything -- and keep prices high. This is especially true since, to an increasing degree, the commodity in question is American-made.
As noted, refining is in short supply. The supply of gas depends far more on refining capacity than it does on crude prices. Thus, refiners have their finger on the trigger of the market. They will have the capacity to control the market over the next few years in ways they couldn't imagine before, and they are going to take advantage of it.
If you want oil prices and gas prices to decline, you need alternatives. Oil producers aren't going to drop prices by themselves. Neither are gas producers. It doesn't matter who or where the producers in question are -- it is not in their interest to give you a bargain.
Until renewable energy supplies increase, oil refiners have consumers over a barrel. Which means your money, invested in refining, is in very safe hands. Whether you're in the two stocks mentioned earlier, MRC and PSX, or in alternatives like HollyFrontier (HFC), Tesoro (TSO), or Valero (VLO), you're not likely to lose. Not so long as the boom continues.
Disclosure: I am long KMP.