News flash: Refining is an awful business. And today's miserable miss by Tesoro (TSO) on its fourth-quarter earnings shows just how bad it is, as it showed a loss of $0.55 a share when the Street expected positive earnings of $0.74. Oops.
One of the great calls I made in 2011 was warning investors away from the refining space late in the year and showing how the very strange and unnatural gap between Brent oil and West Texas Intermediate oil traded on the IntercontinentalExchange (ICE) and the Chicago Mercantile Exchange (CME) was artificially goosing refining margins, particularly in the mid-continent. Any drop in that silly premium was going to weigh heavily on the refining space, and Tesoro used that collapsing spread as a primary reason for its disappointing results.
Yes, refining is just a lousy business, when you have to rely on a contrived financial disconnect to spur profits. ConocoPhillips (COP) announced that it will spin out its refining business in 2012 in an attempt to clarify its platform by isolating this horrible division, a move I expect most of the oil majors to follow. But things may be looking up as the share prices of the major independent refiners, such as Valero (VLO) and HollyFrontier (HFC) and Western Refining (WNR) and CVR Energy (CVI) continue to swoon.
That's because people need refined products, such as gasoline and jet fuel and heating oil, and no business model can continue to survive with a losing margin. Sooner or later, we know that some of the players will just refuse to play, dropping capacity and therefore supply, and causing the types of fundamental shortages that will ultimately drive refined products' prices and margins higher.
That's already beginning to happen, as one of the longtime players in the refining space, Sunoco ((SUN), is set to permanently leave as a refiner. The company has whittled down its refining assets to two lone East Coast facilities, one in Philadelphia and one in Marcus Hook, Pa., and it has been looking to sell those two remaining assets since September 2011. Not surprisingly, considering the lousy margins, there have been no takers. ConocoPhillips has also indicated that it will either sell or close its 185,000-barrel-a-day refining plant in Trainer, Pa., adding to the chances of a real gasoline squeeze on the East Coast come the summer of 2012.
It's been an easy time for consumers at the pump. Despite oil prices that have hovered globally around $110 a barrel, here in the U.S. we are still looking at a relatively benign $3.20 a gallon nationwide average for gasoline.
That's going to change.
And with it will come a tremendous opportunity to pick up these refining stocks at bargain prices.
Of course, timing is everything, but this latest huge miss by Tesoro should bring on a few nice cheap prices in the shares of the sector and give us an opportunity to start positions. I wish I had a favorite to share out of this sector, but I don't. All of these stocks have acted poorly in the last three months and do not indicate enough relative strength to differentiate them. And this is a trade you need to get into slowly -- once gas prices begin to rise, so will the stocks.
There is opportunity potentially knocking in refining. Just go at it slowly.