U.S. refiners, particularly Tesoro (TSO) and Valero (VLO), are going to have a terrific -- no, monumental -- fourth quarter. But don't get me wrong -- I'm not recommending the refiners as a trade right now. Still, so many subscribers tell me of their continuing interest that it is worth updating their very interesting story.
I was one of the earliest analysts to recognize the differential between U.S. domestic crude prices and global crude prices as a key indicator of the margin for refining those domestic refiners were likely to enjoy.
Now this "revelation" is not the only data point that matters to the big mid-con and Gulf Coast refiners. Some other good news is also on the horizon for them, but the relative continued strength of Brent/West Texas Intermediate crude spreads have caused the big refiners stay near their 52-week highs. Meanwhile, much of the rest of the energy complex has recently sputtered.
One major fly in the ointment -- which I used to make a very harsh call against the refiners -- was the ruling in favor of Pioneer Natural Resources (PXD) to export "condensate." It is a very lightly processed crude that was wrongly classified by the Commerce Department as a refined product, which has made it eligible for export. I expected an avalanche of petitions from other major oil producers for similar workarounds and equal opportunity to capture what has been a $6-plus premium for global crude barrels.
Indeed, the ruling in July did immediately crater refiner prices, as a universal workaround would, in practical terms, end the U.S. crude export ban -- and help equalize the Brent/WTI spread -- hurting refining margins. But it only hurt share prices for a brief moment. Almost as soon as the expected avalanche of petitions reached the Commerce Department, the lawmakers began rethinking their definition of condensate as a refined product. Although they could not rescind the condensate ruling that they had given PXD, the members in the department have literally refused to hear any further petitions.
And refinery stocks began to quickly recover and rise again.
The continuing backdrop of very stressed global supplies on crude with a continuing very abundant supply chain here in the U.S. has kept WTI/Brent spreads wide ¿ and I believe will send them wider still going forward. That's spectacular news for the refiners.
Add a terrific schedule on turnarounds in the Gulf Coast, which has constrained gasoline supplies and will cause a significant product short squeeze through the fall and you've got a very happy group of refiners who are going to have a stellar fourth quarter of 2014.
So why am I not recommending them?
I am watching refinery stocks at extremely stretched valuations -- even with the margin advantages they enjoy -- and I do not trust the Commerce Department to again be fickle in its definition of condensate. The department is understandably receiving enormous pressure from every other U.S. exploration and production company including many of the majors, to open the spigots on U.S. crude.
If the lawmakers at any point cave to that pressure and give others the same export opportunity as Pioneer Natural Resources -- which I think they must -- prices on refiners will quickly plummet.
I can't own stocks like that. But maybe you can. Because, if nothing happens, U.S. refiners are set to have a fabulous autumn. But they could instead have a fabulous fall.
See what I did there?