Crude oil prices continue to get hammered as all the oil-related stocks go down as well. I've spent a lot of time measuring the extent of the oil drop, and the resulting winners and losers in the exploration-and-production space.
But the refiners have also fared somewhat badly in this oil melee, even despite the fact that they are unquestionably beneficiaries of a lower price for oil. That said, as with all sub-sectors of energy, there are better and worse candidates to consider in this patch. So let's look at the refiners today.
Refiners, despite also being energy companies, skate happily away at lower crude prices. Most obviously, they are buyers of crude oil, so a lower price is an instant input-cost reduction. But what makes a difference in profit is the price that they are able to realize for their refined products -- the refining margins. Those margins, represented by crack spreads, have been recently weak but historically strong throughout this oil decline. From a margin standpoint, we have a terrific reason to be targeting refiners.
A second obvious point is that sustained lower crude prices bring lower gas prices at the pump, which spur greater demand, and I believe we are looking at six months to a year of depressed gas prices. Truck sales are is a great indicator of the confidence of consumers in gas prices, and those sales have been rising off the charts. Demand is about to spike in gasoline. We have reason No. 2 for looking at refiners now.
Supply of cheap crude matters, too -- so we should look at those that are near the most distressed of the E&Ps, finding choice barrels at bargain-basement pricing. In this regard, new pipelines coming online would benefit the Gulf Coast refiners to an almost equal degree to what mid-continental refiners have enjoyed for the last year. I'd be biasing my picks toward those relatively underpriced Gulf Coast players.
Finally, we have the potential value release of midstream dropdowns inside many of the larger refiners, either into master limited partnership (MLP)-type entities, or outright into already-existing sister firms. This is a tremendous value potential that is still almost entirely unrealized in many refining names. Those that have already begun to monetize midstream assets have seen booming share increases, and there is still much to be done inside many of them -- Phillips 66 (PSX), Tesoro (TSO), Valero (VLO) and others.
So, we are convinced that refining is a fantastic place to invest inside a distressed-energy world, but we are looking for names that have access to continued cheap crude. They should be relatively undervalued to others in the space, work the Gulf Coast and have a terrific portfolio of midstream pipes, tanks and terminals to dropdown, releasing unrealized share value.
Two names immediately shine through: Marathon Petroleum (MPC) and Valero.
Marathon particularly stands out, as it is not only a Gulf Coast player, but it is just about to embark on the beginnings of its dropdown plans with the soon-to-come initial public offering (IPO) of its sister MLP -- MPLX Pipe Line Holdings. Marathon has held up well compared with other refiners in the last two weeks, and that convinces me shares are about to see an even greater benefit from this dropdown strategy.
Valero is almost Marathon's equal in that its schedule for continued dropdowns is extensive, and also represents a continued "free" unlocking of share value.
In a tough energy sector, refiners actually thrive. Two of them should perform at the absolute top of the heap: Marathon Petroleum and Valero.