U.S. Refiners Cash In On Cheap Canadian Crude

by: Chris Damas

Last week I wrote about buying U.S. oil refiners Marathon Petroleum (NYSE:MPC), HollyFrontier (NYSE:HFC) and Northern Tier Energy (NYSE:NTI). here

They've been moving higher with brief profit taking in the mornings, then gaining strength on volume to close higher in the afternoon. This is classic bullish trading behavior.

At the close we have MPC up $1.62 at $64.24 on 2.77 million shares, HFC up 54 cents at $46.36 on 3.6 million shares and NTI up 7 cents at $25.46 on 561,000.

Volume on HFC was boosted by a bull mention on Jim Cramer's Mad Money, however, in my view, Marathon has better upside, and hit a new high today ($64.44).

The latest trading dynamics are these in my view:

The bearish sentiment on the Seaway pipeline restart hurting the WTI/Brent spread contracting was a red herring.

More importantly Canadian heavy oil (called Western Canada Select or WCS) is in oversupply, on sale at $51-52/barrel for the foreseeable future, and US refiners that can use it (and get it with the ongoing pipeline curtailments) are making money hand over fist on it.

This is still filtering in to US trader consciousness and not even registering with most Canadian oil and gas investors.

How much cheap WCS is actually being used by these refiners?

Marathon gets about 10% of its crude slate as Canadian heavy, mainly used at the Detroit, MI and Garyville, LA refineries. Marathon's crude charge in Q3 2012 was 1.186 million barrels per day, so heavy is about 120K.

However, note the Detroit refinery coker upgrade project increases consumption of heavy crude by 100,000 barrels, and company-wide consumption to almost 20% excluding the new acquisition (see below).

The renamed "Galveston Bay" Texas City refinery with 451,000 bbl/day capacity being bought from BP plc (NYSE:BP) potentially adds to that (the Company hasn't disclosed where it will get its feedstock yet), but since one line uses heavy oil, we can surmise it will use Canadian heavy, if and when more supply gets there.

So Marathon is and will be an even bigger beneficiary of the "on-sale" heavy crude sale courtesy of the Great White North pipeline problems.

HollyFrontier uses 80,000-90,000 bbls/day of WCS, about 20% of their 440,000 crude slate. Much of this goes to the 52,000 Cheyenne, WY refinery. Most of HFC's crude slate is locally-gathered sour oil and black wax in their operating areas, or Cushing-linked grades for Tulsa, OK and El Dorado, AR, the latter being their largest refinery at 135,000 bbls/day.

Northern Tier Energy's only refinery at St. Paul Park, MN uses about 20,000 bbls/day of WCS (or appx. 25%), sometimes rising to 30,000, as it did in the Q3 of 2012.

On a technical note, we have investment bank conferences on refineries (Barclays Capital "Basics of Refining" conference is next on Thursday but none of the above are attending for some reason).

Importantly, analysts are upping their estimates for refiner earnings for Q4 and 2013.

MPC 2013 average consensus has risen to $9.31 from $9.06. HFC up to $6.50 from $6.20. NTI $3.09 from $2.89.

The refiners kick off Q4 earnings releases at the end of the month, with VLO on Jan 29, MPC and PSX on Jan 30.

HFC should report EPS and their dividend late February, which has often included specials. Northern Tier will report its second distribution February 11 but earnings won't be released until March 26, quite a delay.

All this is great, but some caution may be warranted here, after four or five days of rising prices.

We have significant refinery turnarounds scheduled for Q1 2013, especially by HollyFrontier, Valero (NYSE:VLO) and Northern Tier will be completely shut for 25 days in April. It remains to be seen whether the stocks will trade through these periods when cash flows will be less. My bet is they will continue higher, until they stop going up, and who knows when that will be?

If you are a buy and hold investor, just hang on. I think these stocks will all be substantially higher this Spring as driving season gears up and with it gasoline consumption.

The refined product in short supply is distillate (such as diesel and heating oil). Airlines, trucks, trains, all these use distillate fuels. Economic activity is driving distillate demand, as well as increasing US exports of distillate out of the Gulf, offset by warm weather and less heating oil demand.

Ironically, the trains that are moving ever more crude oil around the country and from Canada, also use diesel to propel themselves.

Side note: Canexus (CXUSF.PK) or CUS on the TSX which is building a truck/pipeline/rail oil trans-loading facility in Alberta, was initiated as an Outperform with a $10 CAD target by BMO yesterday. It's at $8.76 today and I've written about it recently and our target is $9.17.

Recently we have seen builds in US gasoline and distillate stocks which would normally be bearish for refinery stocks.

But offsetting these builds are recent refinery glitches at Motiva and Valero refineries on the Gulf, and Chevron's (NYSE:CVX) El Segundo refinery in California.

Distillate stocks are at below normal levels. European imports of gasoline and distillate no longer make it to the US as frequently, due to the contraction in the European refinery industry, and the higher EUR/USD rate.

The API stock numbers for the week ending Jan 11 are out tonight, and we could see some weakness as the refiners wait to see those. I might guess that the numbers could be surprising, as year-end tax effects had boosted the Jan 4 numbers.

Post Script: API numbers just coming in are crude oil stocks up only 46,000 barrels, distillates down 568,000 and gasoline up 4.1 million barrels.

For buy and hold investors, I say just hold on to the US refiner stocks, or wait for weakness to add to, or take positions.

Of the Canadian oil stocks, if you had to own one (and I don't because I think heavy oil is going to hurt them), I would choose Suncor (NYSE:SU), Husky Energy or Cenovus (NYSE:CVE), because they have interests in US refineries as well. I am not too interested in refiner Imperial Oil (NYSEMKT:IMO) because its Kearl Oil project is part of the problem bringing 110,000 bbls/day diluted bitumen (dilbit), a heavy oil like product, on stream sometime in the next few weeks.

For traders, you might want to take partial profits on MPC and HFC if you are not willing to ride some of the volatility that these stocks inherently posses.

Northern Tier, I believe, is trading off the marketing of the new CVR Refinery MLP being floated by CVR Energy (NYSE:CVI), which is to be priced tomorrow, I believe. A higher than expected price for CVRR from the indicated range of $24-26, would also boost NTI and another refinery MLP, Alon USA Partners (NYSE:ALDW), in sympathy.

Disclosure: I am long MPC, HFC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.