Refiners: Will WTI/Brent Spread Widen Again?

That glorious party in the gasoline-refining sector is over, and the smartest investors have already taken their bags of cash out of those stocks. But there are reasons to plot an eventual re-entry into the sector.

Gasoline refiners are capable of producing phenomenal returns at times, as they did until recently. Between January and March 2013, share prices of HollyFrontier (HFC), Tesoro (TSO), Marathon Petroleum (MPC), Valero (VLO) and Western Refining (WNR) all more than doubled, as seen in a stock chart. With dividends, Western Refining tripled investor money.

HFC Chart

HFC data by YCharts

But highly cyclical stocks can turn ugly quickly. For the refiners, the decline started about six months ago. Earnings forecasts throughout the sector have been slashed, and those share prices above are down 14% to 27%. Most analysts are convinced that things will get worse before they get better.

HFC Chart

HFC data by YCharts

The problem? During the jolly days of late, those refiners got rich from an unusual market quirk that gave them outsized profits. Certain well-positioned refiners were able to buy their crude at West Texas Intermediate prices and sell closer to Brent Crude prices. Supply issues – namely, not enough pipe and trains to transport supply out of the new shale fields – caused a disconnect in WTI and Brent prices like never seen before. As we can see by the Brent/WTI Spread chart below, that spread has been returning to more normal levels.

Brent WTI Spread Chart

Brent WTI Spread data by YCharts

Right now, the refineries have so much product on the market that prices at the pump are hitting two-year, seasonally adjusted lows. Consider the United States Gasoline Fund (UGA), an ETF that closely follows gasoline prices.

UGA Chart

UGA data by YCharts

Few analysts suggest jumping into this sector now, as October and November are particularly crucial months for developing forecasts. Crude inventories drop in September and then build again, and the size of these builds are important in predicting how much refiners will pay for raw material. Earnings forecasts have been changing rapidly too, and most refiners aren’t expected to report earnings progress again until early 2014. Third quarter earnings reports should provide more clarity. Although share price valuations are down throughout the sector, they’re not screaming “bargain” yet.

HFC Price / Tangible Book Value Chart

HFC Price / Tangible Book Value data by YCharts

Most analysts believe that WTI/Brent spread will widen again. That will eventually help those strong Midwest companies like Western Refining, which recently improved its balance sheet by reducing debt. Western also just announced plans to pursue a master limited partnership, which would likely give investors large, if not steady income. Otherwise, refiners with coastal operations like Tesoro and Marathon Petroleum should get some cost relief this year as new lines of transportation for U.S. and Canadian oil come on line. For a more diversified play, Phillips 66 (PSX) has a mix of WTI-sourced and coastal refineries, as well as operations in Europe, where demand for diesel has been picking up.

Timing is everything in this sector, so it’s not particularly recommended one for long-term value investors. But clearly, investors willing to keep current on their research can make very good returns if they get that right.

Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.

Read more articles about: Investing Ideas  energy stocks   

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