Gasoline prices have been creeping up as the crude market has continued the bottoming process I promised this summer. But could a few interesting headlines deliver a quick play in gasoline futures or maybe somewhere in the refinery space?
Time to take another look.
My take on the refiners has been that the one-off profit margin between West Texas Intermediate crude and refined gasoline was not reliable or sustainable and so the refinery stocks were an overly speculative and dangerous play this summer. The business of refining remains difficult with the folding of Sunoco's (SUN) last refineries and Conoco-Phillips (COP) retreat prime indicators. I expected some consolidation and a lot of outright failures, but have gotten more of the former and far less of the latter with the Carlyle buy of one refinery and the Delta Air Lines (DAL) buy of another. Today we got a big consolidation from Tesoro (TSO) buying the LA-based assets of BP (BP). (Boy, did I sell THAT one too soon).
The recent fire at a Chevron (CVX) refinery in Richmond, Calif. highlights one of the fundamental facts about the refining business that gets far too often overlooked: the aging infrastructure. The Richmond refinery, while having had several upgrades, was originally built more than 100 years ago and points out the fact that no brand new refinery has been built in this country in more than 40 years.
And finally, the UN recently advised the United States to scrap its ethanol production program in light of recent droughts and continuing upwards pressure on food and other commodity prices. While it is highly unlikely that the U.S. will immediately scale back ethanol blending requirements, it begins a pressure on Congress to end what has been the most foolish and uneconomical energy program ever created: ethanol.
So, how are we to combine all of this information to make a rational (and hopefully profitable) investment decision?
With the California outage and pressure to curtail ethanol production, my first instinct is to find a way to be long gasoline itself and use counter-intuitive spreads in the futures market to do it, something like Dec. 12/ May 13, now trading around 11 cents and I'd look to sell the richer summer contract. Another big rally in gas prices in the early fall would send that spread in, whether that came from another refinery problem or a stronger demand for product from the curtailment of ethanol.
But with the stocks, there's less to like. The big mid-cons like CVR (CVI) and Western (WNR) have already had big runs and I think Phillips 66 (PSX), the new divested refiner from COP has equally gone too far. I'd actually look to sell Tesoro on this acquisition news. It was a great buy, but they've run too far, much too fast. At $40? Please.
The one stock I'm going to say represents a little value in an independent refiner is Valero (VLO), still laboring under bad quarterly reports and only getting a little upwards draft from the sector. One way to play this is another spread buying VLO and selling TSO, These two have historically had pretty good correlation, while in the last weeks are at extreme opposites. This may be the opportunity for a trade.
Despite the summer winding down with little demand expansion, it seems like the gasoline market is only starting to heat up. Have a look at some trades in the space.