The Time for Refiners Is Nigh

It's difficult for consumers to believe that the refineries were going broke while they themselves were paying more than $4 a gallon for gas at the pumps, but that's precisely what was happening this summer. Capital began chasing all commodities, but particularly oil, as it ramped spectacularly from the mid-$90s at the start of the year to reach a high of $147 in July. That speculative and investment rush into crude oil left openly traded refinery products in the dust -- while gasoline prices soared in the summer, they still couldn't keep up with the high-flying prices of the crude barrel. Margins for gasoline refining slumped. Add, of course, the demand destruction for refined gasoline that was created by $4-a-gallon gas, and you've got a recipe for disaster for the refining sector. Prices for shares of Valero (VLO - commentary - Cramer's Take), for example, went from a steady trade in the mid-$70s as recently as November 2007 to trading around $16.50 today. What seemed necessary for the refiners to "wake up" and post significant profits again seemed simple enough -- the price of a crude barrel needed to come down.

This, of course, has happened with a vengeance -- the price of crude is down almost 60% from its highs in the summer. However, refining margins haven't improved; in fact, they've gotten worse. Cracks, which had hovered under $10 for the height of the summer driving season, have been stuck in negative territory for several months this fall despite lower crude -- a frankly unbelievable phenomenon.

Monthly U.S. Percent Utilization of Refinery Operable Capacity

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Source: Department of Energy

But the positive story through this disaster remains overlooked and worthy of revisiting, particularly at these levels. Despite calls from Washington over the summer to quickly ramp up refinery capacity and production, very little has been done so far. Utilization of refining capacity in the U.S. remains strong, even if it has been trending lower for the last several years.

Gas Sales Percentage Change

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Demand numbers for gasoline in the U.S., while down, are being far overrepresented in the cracks and margins for product. Here is my chart for domestic gas sales; it shows demand destruction recently around 6% to 8% but nowhere near the levels of destruction that would legitimize a negative margin in refining.

To top it all off, companies like Tesoro (TSO - commentary - Cramer's Take) and Valero are cash-rich dividend-payers whose stock prices are so low now that the dividend alone makes them good investments, if only because we believe the world will not end its use of petroleum products anytime soon: Valero sports a 3.5% yield, while Tesoro delivers more than 4% at these levels. That dividend seems very, very safe to me relative to other dividend producers out there. The refiners are still receiving strong margins for distillate products and are looking to restructure capacity to take advantage of this, although retooling to produce more diesel products and less gasoline is a long-term goal.

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At the time of publication, Dicker was long Tesoro, but positions can change at any time.

Dan Dicker has been a floor trader at the New York Mercantile Exchange with more than 20 years' experience. He is a licensed commodities trade adviser. Dan's recognized energy market expertise includes active trading in crude oil, natural gas, unleaded gasoline and heating oil futures contracts; fundamental analysis including supply and demand statistics (DOE, EIA), CFTC trade reportage, volume and open interest; technical analysis including trend analysis, stochastics, Bollinger Bands, Elliot Wave theory, bar and tick charting and Japanese candlesticks; and trading expertise in outright, intermarket and intramarket spreads and cracks. Dan also designed and supervised the introduction of the new Nymex PJM electricity futures contract, launched in April 2003, which cleared more than 600,000 contracts last year alone. Its launch has been the basis of Nymex's resurgence in the clearing of power market contracts over the last three years. Dan Dicker has appeared as an energy analyst since 2002 with all the major financial news networks. He has lent his expertise in hundreds of live radio and television broadcasts as an analyst of the oil markets on CNBC, Bloomberg US and UK and CNNfn. Dan is the author of many energy articles published in Nymex and other trade journals. Dan obtained a bachelor of arts degrees from the State University of New York at Stony Brook in 1982.