Tesoro shares have taken a big hit on the doubly bad news, which begs us to take a fresh look at this very volatile sector inside of the energy space: where it's going and whether Tesoro's bad fortune might make for an interesting investment opportunity.
The refiners were one of my top stock sector picks for 2010, although I chose
as my specific best. Going into 2010, there were indications that the refining space had been oversold and that the group's fundamentals were about to improve.
Sell Valero, Buy Tesoro
Refiners are a relatively easy sector to at least understand. They take a raw product, crude oil, and manufacture a finished product -- mostly gasoline and heating oil. In contrast to most other manufacturers, however, the price that they can charge for their finished product is not up to them.
Both gasoline and heating oil are market priced, as is the crude oil that they use. One analogy I've used to describe this is if
were forced to buy corn on open markets but limited in the price it could charge for corn flakes. Its profit margins would be entirely out of their control.
So it has been with the refiners. The measurement of refinery margins is known as a "crack" spread, the price differential between crude oil and refined products. Those margins have been miserable for the last two years.
In response, refiners have been forced to make draconian changes in their business models, cutting staff, pushing back maintenance scheduling and in some cases, closing refineries entirely.
I saw this trend in late 2009 and posited that these cutbacks were going to result in fundamental shortages of refined products in the spring of 2010 that would not only drive margins higher and help the stocks, but also enflame the buying frenzy into crude oil, pushing a barrel of oil up to and perhaps past $100.
So far, some of this has come true. Refinery utilization numbers, a measure of how hard the refiners are working and how much product they're pumping, has been at historic lows for this time of year. This, however, has caused only a frustratingly moderate increase in crack spreads and a moderate increase in share prices, although my top stock Valero is up more than 22% for the year.
That's nothing, though. I was looking for a double on these this year. Tesoro has lagged Valero and the other refiners horribly. It has put off maintenance runs which some blame for the fatal fire at its Anacortes refinery that killed five. It also received that downgrade from Deutsche, which caused a 6% decline in the stock on Monday and leaving it unchanged for the year. There are no more refineries being built in the U.S., however, and Tesoro's Western portfolio of refining assets are irreplaceable. I see this as an opportunity to buy their stock very cheaply.
Even if you don't believe in the refinery story going forward, as I do, Valero and Tesoro have had very good historical correlation -- almost 85%, compared with other refiners like
. A hedge fund play would just buy Tesoro here while selling Valero, looking to take advantage of the dislocated spread.
I prefer to just buy the stock. I've rolled out of my Valero position and "traded" it for exposure in Tesoro. I still am a believer that the shortages in gasoline are coming, right at the middle of the summer when the market will be most vulnerable as the recovery in the domestic economy really hits its stride. Even pushing out the margins a little should have an overwhelmingly positive effect on the stock, which is trading about $13.50, but don't drool at this too much. It traded as high as $65 in late 2007.
Can it get back there ever again? That would require a real "crack squeeze," where margins get really wide for a long time. It's happened before, not so long ago. And some of the symptoms of a squeeze are definitely in place. I think that possibility makes having one of the refiners in your portfolio a must, and Tesoro is the one on sale this week.
At the time of publication, Dicker was long Tesoro.
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 degree from the State University of New York at Stony Brook in 1982.