The Oil Refining group has benefited from the rally in oil prices, as well as the general updraft in the stock market, but are in about the same place price-wise as they were when I wrote this article last spring:
There have been a few developments since then which might make holders of these stocks want to take some profits as we reach the peak of the driving season, and what will probably be a round of good earnings reports in the next couple of weeks:
1. Lack of Momentum:
With the exception of the rally in the last couple of days, this group has been drifting since April; most are zero or negative since then along with the rest of the market. The most notable exceptions was Holly Corp. (HOC) which received an upgrade from the analysts a few days ago,
Traditionally, the second half of the year is the industry's weakest. Since the futures markets started in 1983, crude oil prices declined in the six months between July 1 and December 31 in 14 of the last 27 years, despite an overall 300 plus percent increase in WTI prices in that period. It is quite true that since the market got tight in 2005, only two of the 5 years have seen a second half decline.
The effect on the stocks in the refining sector?
|Year||Jul-Dec Stock Price Change|
Even in 2007, the greatest year in the history of the Oil Refining business, the average stock price of the five independent refiners: Marathon (MRO), Tesoro (TSO), Valero (VLO), Western Refining (WNR) and Holly Corporation, declined by 30 percent in the second half of the year. In 2009, the group bounced along the bottom after most of these companies lost 3/4 or more of their market capitalization during the crash, and the aforementioned counterseasonal rally in 2010 brought them back essentially to where they are now, all are still well off their 2007 highs.
So, seasonality is traditionally a headwind in the second half of the year.
3. The WTI/Brent Spread is Vulnerable
Here's the one-year chart for the WTI/Brent spread, which has been a major driver in the abnormally high refining margins in this group since last November. There are a number of reasons for the unprecedented situation of WTI trading at a greatly lower price than Brent, but consider the following: The IEA as well as the US-EIA have announced the injection of oil from the SPR into the marketplace, and the current day rate for VLCC's is relatively low right now, at around $20,000 per day. According the Jones Act, the supply cannot be sold to Latin America or China.
The six week trip to Europe calculates out to less than 50 cents per barrel, so the signal clearly is that there is money to be made by sending some of the supply to Europe to calm the Brent market, and reduce the spread.
4. Demand is Weak
The past couple of US-EIA Weekly Petroleum Status Reports are saying that demand is unusually weak for this time of year.
Refinery utilization last week was under 87 percent, which for the beginning of the driving season is unprecedented except for 2009 when we were in the middle of the recession:
Distillates demand, which this time of year is business-heavy, also suggests the economy is still very weak:
The refining margins right now are actually higher than they were in 2007 at the height of the "Golden Era," but because demand is weak and utilization is low, the refining group stocks have still not tested their 2007 levels.
5. The Insiders are Selling
As posted the other day on my Instablog: Insiders in these companies were net sellers in the last month or two. Under the ongoing theory that the people in this industry are in the best position to know what is happening, perhaps they are putting two and two together.
As we are so fond of saying, the world is chaotic, and there are no guarantees on anything, but in light of the weak fundamentals, seasonality, uncertainty with the SPR and insider activity, the more prudent of us may wish to take money off the table.
Disclosure: I am long CLMT for their generous dividend, so I am not price-sensitive on it.