Today a strike was called at nine major refineries in the U.S. as talks broke down between the United Steelworkers Union and Royal Dutch Shell (RDS.A), the lead negotiator for the refineries. The strike might help to drive refinery shares temporarily lower, which also highlights an opportunity I've come back to in a difficult oil sector: the refiners.
One thing that must be remembered is that the refinery sector is not to be lumped in with the rest of the oil patch when figuring its fortunes. It can be possible for the refiners to do well in a low oil price environment, and do poorly when crude prices are high. That's because the refiners are at the whim of both the crude and the product markets in their margins. Crude oil, while it gets all the press, is not the only traded hydrocarbon -- both gasoline and heating oil, the two largest refined products, are as well.
That means that markets determine the margins for refiners and times -- despite the sinking gasoline price -- have been very good indeed. Big gluts of domestic crude, now at record levels, have allowed refiners a very cheap supply source. Meanwhile, for the most part of this year so far, gasoline prices have not cratered to the same degree as crude has. Cracks in NY harbor gasoline vs. West Texas Intermediate crude are over $15, a very heady premium indeed.
And refiners are showing the quarterly results. Valero (VLO) showed a fourth quarter beat of $1.83 vs. $1.30 estimate and Phillips 66 (PSX) posted a $1.63 vs. $1.41 expectation. And those kinds of results are likely to continue.
Of course, there is the low crude price, which helps. But also, the contango of the crude curve (when prices in the future are more expensive) is always useful to prompt barrel users like refiners. Then there's the spread between domestic and global crude prices, represented by Brent crude. The premium on Brent has again gone above $5 a barrel from a recent parity.
These market forces are not easy to figure out and remain complicated, I know. The extent of a small column isn't enough to explain how they all work. Just believe that the times are looking very good for refiners, and are likely to get better still.
Add to that the instantaneous "value release" that most of the independent refiners can add by dropping down storage and transport assets, now at a big premium because of the contango. I expect most of the refiners to take advantage of that premium and use 2015 as a big year for dropdowns to their sister master limited partnerships (MLPs). In this opportunity range, Marathon Petroleum (MPC) is due to report on Wednesday and has already announced that its dividend is solid.
Lots of reasons to continue to like the refiners here, even if it seems like a counterintuitive move with gasoline prices under $2 a gallon. They've suffered when the markets have cut their margins, but are basking now. Both crack spreads and WTI/Brent spreads are favorable, the market remains in contango for months to come, accelerated dropdowns are likely this year and they're even giving out reasonable dividend returns of around 2%. It's a great place to invest while waiting for the rest of the oil patch to "work itself out."
If this workers' strike allows shares of Marathon and Phillips 66 to drop a bit, it's an opportunity worth buying into.