The refiners have been a very feast-or-famine trade group that I have been wary of playing. But with widening Brent-WTI spreads, along with the collapses of other benchmarks here in the U.S., I now believe that there is a long-term positive margin trend that is developing.
I've watched the refinery group make tremendous gains in 2011 and 2012, as WTI/Brent spreads, which are a proxy for refinery margins, soared to unbelievable heights, reaching more than $20 at one point. Those stocks just as disastrously fell as the spread did, dropping to near parity at one point this summer. Many of the refinery stocks still have not moved much from that low price point.
But WTI has again shown tremendous weakness to the European benchmarks, because of increasing production from the Bakken, Eagle Ford and Permian shale plays, as well as the endemic outages of refineries in the Gulf Coast and slow refilling of the critical pipelines that service that area.
Some analysts believe that these are temporary trends, but I'm convinced they are not. One reason I'm in the camp of long-term refinery advantages is because of the relative price action of two OTHER benchmarks of crude pricing, Mars and Louisiana Light Sweet.
If you're not an oil trader, you might never have heard of these benchmarks, but Mars is the most traded sour (higher sulfur) blend and LLS is used as a benchmark for Gulf Coast crudes.
What this chart shows is the premium that both Mars and LLS held to WTI. Even during the huge glut and discount that WTI carried, Mars and LLS were mostly unaffected, still getting more global pricing through much of 2013. So, if you were a refiner, you needed to use WTI solely to capture a margin advantage. If you were a sour refiner or using LLS on the Gulf Coast for export, you were out of luck. As the spread collapsed, so did the premium of Mars and LLS to WTI. This makes a lot of sense.
But now that the spread is again widening, we are NOT seeing a concurrent premium returning to these other important benchmarks.
Bottom line: now virtually EVERY refiner will experience a tremendous margin advantage, whether they can isolate WTI grades or not.
Further bottom line: this is a sustainable trend and creates a new golden age of refining which will carry at least into the first quarter of 2014.
Now is the time to buy refining stocks. I had thought that a better opportunity to position this trade would be AFTER quarterly reports, as I was convinced that the refiners would report horribly after spreads declined so rapidly in the third quarter.
Valero (VLO) reported precisely as I expected -- badly -- then proceeded to rally anyway.
No one is fooled by bad quarterly reports that are yesterday's news and you shouldn't be either. Tomorrow's news is going to be great for them and refiners like Tesoro and Phillips are headed back to their highs.