I live in San Antonio, Texas, the home to Valero Energy (VLO) and Tesoro Petroleum (TSO). I can't help but root for these hometown companies. I have attended several fantastic dinners at the famed Petroleum Club in the Tesoro building and fill up my truck at the local Valero Station every week. Both of these companies have several positive catalysts for future growth and have performed very well since the start of the year. Nevertheless, there is a lot of uncertainty in the oil patch as of late. The massive changes occurring regarding transcontinental and regional pipelines are fundamentally changing the market. Please review the following breakdown of the coming oil patch transformation and the possible outcomes.
Oil Patch Transformation Backdrop
When Valero's CEO Bill Klesse speaks, people listen. He is a man of few words and does not give interviews but recently made some interesting statements. Klesse recently stated, "There will be no light sweet crude imports into the U.S. Gulf Coast by 2015." Klesse believes increasing U.S. onshore shale oil output likely will displace light sweet crude imports to the U.S. Gulf Coast by 2015. The increased sweet crude going to Gulf Coast refineries also is expected to narrow heavy crude differentials to the point that Valero aims to shelve plans to add a coker unit to its 292,000 barrel-per-day refinery in Port Arthur, Texas, because it won't be economical, Klesse said. He said a big factor in the equation is uncertainty as to when TransCanada's proposed $7 billion Keystone XL pipeline can move forward to transport Canadian heavy crude from Alberta to U.S. Gulf Coast refineries with coker capability to process it.
Also, the pool of sweet crude will increase as other companies ramp up major projects to increase heavy-crude processing capability at refineries in the upper U.S. Midwest. Of those projects, ConocoPhillips' (COP) 356,000-bpd refinery in Wood River, Illinois, has started up, while Marathon Petroleum's (MPC) 106,000-bpd Detroit refinery upgrade is slated to be finished in the third quarter this year. BP Plc's (BP) conversion project at its 405,000-bpd Whiting, Indiana, refinery will increase its heavy crude processing capability to 350,000 bpd from about 80,000 bpd when it starts up next year. The light sweet crude those refineries will no longer process will back up into the Cushing, Oklahoma, hub for U.S. Benchmark West Texas Intermediate crude, adding to already high inventories. Klesse went on to say, "We've got to have the Canadian heavy come to the Gulf Coast. Otherwise we're going to have a narrower heavy sour discount."
On the other hand, some analysts raised a counter-intuitive red flag stating the Keystone pipeline may actually raise the price of gas. The immediate effects of completing the Keystone pipeline could increase domestic oil prices and raise prices at the pump. The oil wouldn't even stay in the U.S. It would go directly from Canada to refineries in the Gulf region en route to Latin America and Europe. The U.S. would be used as little more than a transit corridor.
Refiners like Marathon Petroleum Corp. (MRO) and HollyFrontier Corp. (HFC), which currently benefit from their ability to get the cheaper oil from Canada, will take a substantial hit on prices. Canadian oil is in essence isolated and priced at an average discount to Brent crude of approximately $23.50 per barrel in 2011. The effect of transporting Canadian oil to the Gulf Coast will be to raise the price of Canadian crude. Marathon and HollyFrontier will see a hit to their margins.
This will be a zero sum game. Either one group or the other will benefit. The upcoming presidential election will most likely be a precursor to the winner. On the one hand, you have Romney who is for the Keystone Pipeline, and on the other, you have Obama who vetoed the northern leg of the pipeline.
There are some big changes coming in the way crude oil will be distributed and refined in America. Many questions remain unanswered. Nonetheless, I favor my hometown companies of Valero and Tesoro in the long-run. Please review the following positives for these stocks.
Valero is up 25% since the beginning of 2012. Valero has a price to earnings ratio of 5.72, a PEG ratio of 0.71 and trades at just under 1 times book value. Valero's return on equity is 13.33% and YOY quarterly revenues are 57%. Consensus estimates for its EPS are that it will increase 12.7% to $3.81 in 2012. Other positive catalysts include Valero's partnership with Kinder Morgan (KMP) to construct a pipeline from its St. Charles refinery in Norco, Louisiana, to a Collins, Mississippi, hub. The 140 mile pipeline will transport gasoline and diesel fuel for distribution throughout the South. These developments bode well for Valero.
Tesoro is up 8% since the start of this year. Tesoro should benefit from several strategic acquisitions and planned investment programs. Tesoro trades at around $30 per share and has a market cap of approximately $4 billion. It's a fundamentally solid company. Tesoro is undervalued at 6.52 times earnings, has a PEG ratio of 0.47 and trades at slightly over book value. With an impressive ROE of 15.87% and YOY quarterly revenue growth of 40.60%, the stock appears to have significant upside potential.
Nevertheless, I may hedge myself by picking up some shares of ConocoPhillips, HollyFrontier and Marathon Petroleum. Furthermore, if there is a significant economic downturn all these companies could test their lows.
Use this information as a starting point for your own due diligence and research methods before determining whether or not to buy or sell a security. If you choose to start a position in any stock, I suggest layering in a quarter at a time on a weekly basis to reduce risk and setting a 5% trailing stop loss order to minimize losses.