Seasonal Action Will Lift Refiners

With refinery stocks having rallied so strongly almost immediately after my recommendation to get in, I'm going to take a short victory lap. I'll take another turn around the oval for my double whammy idea of Chinese refineries like Sinopec (China Petroleum and Chemical (SNP - commentary - Cramer's Take)). But more important, I'm going to explain what I think has happened and expand on the timing of the trade now that we're in.

In my last column, I pointed out the similar motion between the crack spread chart and the stock chart of Valero (VLO - commentary - Cramer's Take). Guidance released Tuesday for both Valero and Chevron (CVX - commentary - Cramer's Take) pointed to much lower-than-expected quarterly profits.

In Chevron's case, after a warning of eased profits, UBS lowered its forecast for third-quarter earnings per share to $1.92 from $2.16. For Valero, while the Street expected earnings of $1.91 a share, management gave guidance indicating a range of $1.20 to $1.30.

Oil stocks should have hit the floor Wednesday based on the news. Instead, all the refiners performed valiantly: Valero closed up $2.06 at $74.25. Tesoro (TSO - commentary - Cramer's Take) was up $3.25. Chevron managed to close down a mere 72 cents. Yesterday they all eased a bit on the generalized weakness in the market. But still, what the heck is going on here? Where is this unexpected strength coming from?

Refining margins are naturally skinnier in the winter months than they are in the summer. Remember that in cracking a barrel of crude oil, two units of gasoline are created, making that part of the barrel the most important, at least from a revenue standpoint.

With the end of the summer driving season, we would expect to see lower crack values in the winter with naturally tighter margins. In fact, we saw them represented graphically already, all during the spring. Take another look at this chart, which I used in my previous column, showing the November gasoline crack:

Click here for larger image.

Source: CQG, Inc.

You see crack values between $5 and $6 for the November contract all during late 2006 and through the first quarter of 2007. Then you see the empathetic effect of the monster summertime crack move, followed by the retreat to what are now unnaturally low values, even for the winter.

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At the time of publication, Dicker was long Valero and Sinopec, 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.