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Refiner Strikes Gold After Sandy

Stocks in this article: PSX

PSX Chart PSX data by YCharts

NEW YORK ( TheStreet) -- Cross the Goethals Bridge into New Jersey and the first thing to hit you is the smell. Some of what you're smelling is the Bayway Refinery, owned by Phillips 66 (PSX), which split from former parent Conoco-Phillips (COP) last year.

Conoco got the oil exploration part of the business, Phillips, the refining and marketing end. Most of the "smart money" was on the Conoco side of the business, as was that of Conoco itself, as Forbes wrote last year.


But the smart money, so far, is wrong. While Conoco has made a gain of nearly 17% in the last year, the price of Phillips 66 stock has more than doubled, and looks poised for further gains. That smell you smell is money being made.

How is this possible? It's partly due to the fact that refining was such a bad business for such a long time. This was especially true on the East Coast, where Bayway is the largest player. Two competing refineries have closed there, making Phillips the last man standing.

The refineries closed because they had been forced to use high-priced Brent crude, instead of cheaper West Texas Intermediate. Just look at a map. The Appalachians have been a refiners' nightmare since the 19th century, and they're still there. Most oil going into plants like Bayway, still, is imported from Nigeria.

But that's starting to change. Phillips has signed a deal to finally bring in oil from North Dakota's Bakken, by rail and more deals can be expected. Given the size of the play, and that estimates keep rising, as E&E News reported recently, this should remain profitable for years to come.


The lower price of oil coming from the Bakken has helped raise the crack spread. The "crack spread" is the difference in price between what a refiner pays for crude oil and what they get from their production. Refineries are suddenly closing for maintenance much more irregularly, so those that remain open get a better spread. We saw that early in the year when the price of gas went up to near $4/gallon, despite the fact that oil prices were stable.

The spread was formerly too narrow to justify production, which is why so many refiners closed, but now manipulating refining capacity is the best way to keep gas prices at the pump high; so the crack spread is back, as the Energy Information Administration notes.

It's a simple case of supply and demand. The supply of raw material is up, the supply of production capacity is down, demand remains strong, so profits go up.

This trend should remain in the market for some time. The more Bakken oil comes in, the lower the price of Phillips' Bayway inputs, and the more competitive it becomes with refiners on the Gulf Coast, which have been using this oil for years.

The impact of Sandy is nothing but accretive. The Bayway refinery was out of action for about 6 weeks after the storm, but reopened in late November. Demand will remain strong, thanks to rebuilding, which takes a lot of engines. Phillips has other refineries besides Bayway, which will also benefit from the new market fundamentals. With Phillips now detached from the oil exploration business, all its profits can now go to either shareholders or toward improving operations.

Phillips 66 nearly doubled its income between the last quarter of 2012 and the first quarter of 2013. The company was able to increase the dividend. Cash flow should be uniformly positive in the second quarter, and continuing shutdowns throughout the industry should keep the crack spread positive.

Phillips 66, it would seem, has struck gold in New Jersey.


At the time of publication, the author had no investments in companies mentioned here.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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