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Why Investors Should Avoid Alon Energy USA, For Now

|Includes:Alon USA Energy, Inc. (ALJ)

Alon USA Energy (NYSE: ALJ) recently released its first quarter 2014 earnings. Operating income for the first quarter of 2014 was $39.0 million, compared to $125.8 million in the same period a year earlier. Alon USA's sharp decline in profitability during the first quarter confirms investors' expectations. At the outset of the year, investors were predominantly bearish on Alon USA, as signaled by the high short interest at the time.

Year-to-date, Alon is down around 13 percent. Some investors are seeing this as an opportunity to snap up some shares. While the 'buy low sell high' strategy works in most cases, Alon USA's case is unique in that the stock's decline is not driven by the usual stock market forces, but broader factors in the overall refining space. For a significant part 2014, the price differential between the Brent benchmark price for international crude oil and the WTI benchmark price for U.S. crude oil has been relatively lower when stacked against prior years.

The lower WTI/Brent spread has negatively impacted profit margins across the U.S refining space. This is because a low spread erases the cost advantage that U.S. refiners get relative to their international counterparts when acquiring feedstock. With the cost advantage reduced, it becomes hard to price competitively and realize higher margins. This explains why most of the bigwigs, including ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX), have attributed their slackened profit growth to leaner downstream margins.

Spread Could Narrow Even Further

The WTI/Brent spread could narrow even further going forward. This is because of the increased calls from European nations to expedite the approval of U.S. natural gas exports to Europe. These calls have been prompted by Europe's need to reduce reliance on Russian gas following Russia's and Europe's monumental disagreement on how the conflict in Ukraine should be resolved.

The U.S. green lighted a liquefied natural gas (NYSEMKT:LNG) export terminal in March, bringing the total number of approved LNG export terminals to seven. Going forward, analysts expect more export terminals to get approval even faster. This will have two negative impacts for refiners.

First, it may strengthen the case to finally revise the 40 year crude oil export ban. If this happens, the WTI and the Brent may converge owing to the fact that U.S. crude oil will be fully exposed to the market dynamics in the global market. This will entirely erase all cost advantages related to the WTI/Brent spread that U.S. refiners enjoy, reducing margins for players such as Alon Energy USA.

Second, exportation will prompt an uptick in production of natural gas and crude oil. As production increases, especially in unconventional plays where technologies such as fracking are used, environmentalists and alternative energy companies will be able to easily push for government regulation that supports increased domestic use of renewable and environmentally friendly energy sources. A possible rebalancing of the U.S. energy mix in favor of alternative energy companies could reduce oil refiners' addressable market, slowing sales and leading to lower profitability.

Despite its individual strengths, Alon needs to put forth a stronger case that clearly illustrates how it will circumvent all the prominent sticking points in the U.S. refining space. Till then, investors should

Stocks: ALJ