China Raises Oil Processing 12%: Who Will Benefit?

In this schizophrenic market and with the averages having taken some punishing blows, its hard to recommend anything to the long side. However, I believe this piece of news should be followed for possible beneficiaries off this move.

“Nov. 15 (Bloomberg) — PetroChina Co.(PTR), the nation’s biggest oil producer, plans to increase crude processing volume by 12 percent this year to help ease domestic fuel shortages.

PetroChina plans to process 120 million metric tons (about 2.4 million barrels a day) of oil this year, Vice President Liu Hongbin told reporters after a conference in Beijing today. The company processed 2.15 million barrels a day of oil last year. The latest projection is also higher than a March forecast for refining volume to reach 2.25 million barrels a day in 2007.” ~Wang Ying and Ying Lou, Bloomberg

I’m not a commodity trader, so I won’t pretend to be able to call oil going to $50 or going to $100, but refined petroleum products in this case might benefit refiners and oil shippers. Refiner capacity is not just shorthanded in the U.S. where we haven’t built a refiner in decades, but not enough refiners are being build worldwide to keep up with demand.

According to comments made in the past by Valero, this means oil might be refined on one continent where the refinery is and shipped to wherever the gasoline is sold. Also, this is another validation that there is a significant shortage of oil processing facilities, confirming the strong backlog by engineering and construction companies who build such facilities.

With China boosting oil processing as well as delaying refinery maintenance to process more oil, this takes spare refining capacity off the market. Other refineries around the world will have to pick up the slack for other global refined products demand. At the moment, I own the refiner Tesoro (TSO), which Kirk Kerkorian’s Tracinda Corp has just taken a big stake in. Valero is also a cheap refiner.

For the moment, aside from Kerkorian on the same side of the trade, I am bullish on refiners as they have historically done well going into the spring. However, the signal for me to ditch the trade would be a recession that we seem to be heading towards. In such a scenario, gasoline demand might not be as high as it has been in the past few years and thus refiners won’t be printing as much cash.

A more uncertain opportunity here might be the oil shippers such as Overseas Shipholdings Group (OSG) or Teekay Shipping (TK). Oil shippers often trade in step with oil, so if you believe oil has had a short term peak and won’t break above $100, funds might not be buying up oil shippers. However, oil shippers themselves describe their business as not dependent so much on oil price as the need to move oil products.

That means, one, when oil is not too expensive (notice it doesn’t have to be cheap) and demand is high, there is a large need for oil shippers to move all the oil that’s being used. Also, when there is a shortage of refined oil products, oil shippers are more active as well, moving refined products from the refineries (which may be on various continents) to where the products are used. If China continues to need more refined products like gasoline, the oil shippers may begin to coin money to import or export refined products from all over the globe.

Finally, construction companies building the oil processing facilities stand to benefit, though I think I’ve talked about that endlessly on this site. Longterm bullish views by construction companies such as Foster Wheeler (FWLT), Flour (FLR), and Jacobs Engineering (JEC), and McDermott (MDR) (despite their ugly quarter) should be intact for at least another 5 years regardless of whether the U.S. goes into a recession.

Countries like China who are flush with cash need to build up their infrastructure. With construction projects sometimes taking years to complete, and a 6-18 month U.S. recession isn’t going to stop the governments from spending and completing these projects. Also, realize that such overruns of refiners as exist in China are a state-run affair and, later when the refiners need extra maintenance, it's ok because the government will pay for it.

But it also means China is still very short on refiners and since China’s future only has more people driving cars, being short of refiners now means they’ll be very short in the coming years if a refiner doesn’t pop up every other day. Along the same thought process, refiner component supplier Flowserve (FLS), trading just $3 off it’s 52 week high no less, will continue to make bank.

I’m not saying go out and buy these right now. Not really feeling heroic and going out and buying much in this market, but keep these on your trading radar as the fundamentals here still look awesome.

Disclosure: Author is long FWLT, TSO.