Economy May Chase Refiner Blues

 | Apr 05, 2013 | 10:10 AM EDT
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Refining stocks are taking it on the chin.

In the past week, Phillips 66 (PSX) has fallen 10.8%, Tesoro Corp. (TSO) 9.5%, Valero Energy (VLO) 8.9%, and Marathon Petroleum (MPC) 7.8%. Those drops were considerably more severe than the decline in the S&P 500 as a whole, which was 0.6%.

Suddenly, it seems that everyone hates the refiners.  I believe there is a buying opportunity.

Let's look at some reasons why the group is disliked  -- reasons that I believe are exaggerated. Then we'll look at some factors that could propel the refining stocks upward over the next 12 months.

One reason investors are spurning the refiners is the tightening of sulfur rules. The Environmental Protection Agency proposed rules recently that would require sulfur in gasoline to be 10 parts per million or less. The previous standard was 30 parts per million, down from 300 in 2004.

If not overturned in court, the new standard will cost refiners billions of dollars, according to the American Petroleum Institute. But auto makers have backed the new limit, which is similar to the one now in effect in California and some European and Asian countries.

The rule change may be a blow to the industry, but rarely has a punch been so well telegraphed. Refiners could see the handwriting on the wall when California went to its current standard.

A second reason for the refiners' malaise is a short-term narrowing of the crack spread, the gap between what refiners must pay for oil and what they can charge for gasoline, fuel oil, and other refined producers. There are several ways to measure this spread. By one common measure, it dropped to about $32 in mid-March from about $36 in mid-February.

True enough -- but that $36 was a record. A $32 crack spread is still healthy for the refiners.

Let's look at the positives. Marathon and Valero are expected to post record earnings this year. Tesoro seems poised to have its second-best year on record. Phillips 66 in its present form is too new for that sort of analysis.)

An economic recovery is likely to mean an increase in miles driven, after several years of subdued gasoline consumption. Heating oil is more dependent on the weather, but a better economy could help there.

The most persuasive argument to a cheapskate like me is that the stocks are inexpensive. Marathon Petroleum trades for about 9x recent earnings, Tesoro for about 8, Valero 7, Western Refining (WNR) 7, and Holly Frontier 6. There is no glamour here, and no patina of high expectations. I expect the group to outperform the market over the next 12 months..

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