From September 14 to September 19, 2012, crude oil prices dropped about 8% from approximately $100 per barrel to $92 per barrel. Many major international oil producers (explorers and refiners) including Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX) saw their stock prices decline when stock investors decided to sell due to their worries over the diminishing short-term profit margin outlook for oil producers. In this example, investors' concerns were warranted because an oil producer does see its profit margin squeezed when its unit sales price drops and its unit production cost per barrel stays relatively constant.
Unlike an oil producer's gross profit, an oil distributor's gross profit normally stays within a tight range. The oil distributor's unit sales price (wholesale gasoline and diesel prices) and their revenue (market price) go up or down because its input price (the price an oil distributor pays to an oil refiner) roughly moves in tandem with its sales price. For those investors interested in oil stocks, but want to avoid the risk of crude price movements, oil distributor stocks are the way to go. Table 1 illustrates the quarterly net profits of six oil companies - Kinder Morgan Energy (NYSE:KMP), Enbridge Energy Partners (NYSE:EEP), Enterprise Products Partners (NYSE:EPD), Exxon Mobil, ConocoPhillips (NYSE:COP), and Chevron - for the past eight quarters. Table 2 shows the correlation between each company's quarterly revenue and gross margin.
Table 1: Oil Companies by Revenue and Gross Profit
2011 - Q3
2011 - Q4
2012 - Q1
2012 - Q2
Quarterly Gross Profit
Table 2: Oil Companies by correlation between Revenue and Gross Profit
As we can see in Table 2, oil distributors' gross profits have very low correlation with their quarterly revenues, while oil producers' gross profits are highly correlated to their revenues.
There is only one little issue with big oil distributors: most of them have a slow growth rate on sales volume right now because they have covered most areas in North America and Europe, and oil markets in these regions have already matured. Developing business in a less mature market such as China is the answer since it's the second largest oil market in the world, and has a fast rate of oil consumption growth which would provide opportunity for big oil distributors to resume accelerated oil revenue growth rates. The problem for this plan is: the China government will not give licenses for wholesaling and distributing oil products in China to a foreign company. The only way to get around this issue is to buy a Chinese oil distributor. Longwei Petroleum (LPH), an established oil distributor in China that is already in the U.S, is a perfect target. KMP, EEP, and other western energy distribution giants or even smaller ones like Valero may want to take a hard look at this acquisition target. With any of these western oil distributors' funding and the combined knowledge of an western oil distributor and a Chinese oil distributor, the buyer can use Longwei's two national licenses to quickly expand to multiple provinces in China and grow Longwei's revenue to $10 billion and net profit to $1.5 billion in 5 years, giving them an outrageous return on their take over price of $500 million ($5 per share) today.
As with all investments, there are potential risks for the buyer. One apparent risk is the economy of China. The annual growth rate of the Chinese economy has slowed down from 11% last year to just below 8% this year. If China experiences a hard landing and the economy comes to a halt (no GDP growth), all industries including oil wholesaling and distribution will suffer. Relatively speaking, though, the risk in oil wholesaling and distribution is much lower than that in other industries because oil consumption typically contracts less than the consumption of other goods in a bad economy. Another risk is if the Chinese government suddenly issued a lot of new oil wholesale and distribution licenses, increasing the competition in the industry. Because of the sensitive nature of oil, the chance of this happening seems to be small from what I can see.