(Oil refiners story, updated with latest data on crude stockpiles, gasoline consumption, OPEC position, and to clarify that Dahlman Rose ratings)NEW YORK ( TheStreet) -- Oil refiner stocks have been among the biggest gainers in 2011, and given the gains, a volatile trade in this energy sector niche remains likely. Some of the biggest U.S. refiners sold off early this week, led by Holly Corporation ( HOC), Frontier Oil ( FTO), Tesoro Energy ( TSO) and Western Refining ( WNR). Western Refining led the decline among refiners, down 13% in the first two days of the week, though the refiner halted its losing ways on Wednesday. Trading volume in shares of Western Refining was twice its average volume, at over eight million shares traded on Tuesday, as profit-taking in the big gaining refinery stocks represented at least a portion of the selling action. Frontier, Holly and Tesoro were all down by more than 4% on Tuesday, but reversed course in Wednesday trading, as the spread between the West Texas Intermediate and Brent crude again widened, one day after the spread had narrowed to less than $10. The lack of resolution to the Libyan civil war continues to dominate oil trading. New OPEC commentary on Wednesday that it saw no immediate need to add to crude oil supply, a reversal from commentary on Tuesday, lifted Brent crude, while a larger than estimated stockpile of U.S. crude in Cushing, Oklahoma sent the WTI oil price lower. It would be easy to make the case that the 40% gain in Western Refining shares year-to-date is reason alone for a pullback, according to analysts in the sector, and that would go for many of the refiner stocks, up in a range between 20% and 40% this year. Yet the damage in the past few days among refining stocks, and the slight rebound on Wednesday, haven't been meted out equally, and all refining stocks are not created equally either. Whereas the rising oil prices are good for the energy sector, the oil prices trend is not inherently good for refiners, with the spread between crude oil prices and the prices on refined petroleum products the key metric for these companies. Yet just as a broad decline in energy can't explain the refiner trade, the crack spread -- as the spread between crude oil and refined petroleum products is known -- is also too simple a way to look at the refiner stocks. "These are not hot stocks anymore, so maybe expectations need to be adjusted. From that standpoint it's more challenging, but there is nothing I see that will cripple this group," said Dahlman Rose analyst Sam Margolin. In any event, given the 2011 rally in refiner stocks and the recent pressure on some of the refining companies, led by Western Refining, here are a few key themes and issues to focus on in monitoring the refiner stock group.
If saying that rising crude oil prices are bad for refiners is too pat, focusing on the advantage for refiners that benefit from the spread between WTI and Brent crude is a crucial way to view refiner stocks. The spread has finally come in under $10, but Sam Margolin of Dahlman Rose says there is a sustainable $6 to $8 in the spread between WTI and Brent crude that isn't linked to day-to-day headlines from the Middle East and Northern Africa. The wide spread between North Sea Brent crude and West TexasIntermediate crude has been as much as $17 recently, but historically, the spread is usually within a dollar or two. On Tuesday, the spread continued to narrow as Brent crude decline by almost four times as much as WTI light sweet crude, with OPEC commentary that it might add more light sweet crude production coveted by European refiners hit hard by the Libyan oil production shutdowns.
SUN - Get Report), can be traded based on its lack of exposure to cheaper WTI crude oil prices. It's not the only reason that the Argus Research analyst rates Sunoco at underperform, but Sunoco's exposure to international crude supply pushes up prices and cuts into refining margins relative to U.S. based refiners that are focused on WTI supply. Dahlman's Margolin isn't bearish on Sunoco, but concedes that two factors make a refining stock most susceptible to a short-term correction: not being able to take advantage of the spread between WTI and Brent crude, or rallying to an extent greater that peers. In the former case, Sunoco's lack of exposure to WTI could be a negative trading trigger, even though the Margolin makes the case that Sunoco has several other units that remain profitable regardless of the spread between WTI and Brent and for this reason, the stock is range bound. In the latter case, Western Refining is susceptible solely based on its rally, and that seemed to be in evidence this week. "If you are Holy and you have access to Cushing
With all the focus on the premium in Brent crude versus WTI, analysts say some investors might be missing a spread that's as crucial: light sweet crude versus heavy crude. As the WTI-Brent crude premium narrows, there's room left for refiners to exploit the divergence in the pricing between lighter and heavier crude and the potential margin erosion stemming from reliance on harder to refine heavy crude. "You can make the case that the light-heavy crude dynamic is more sustainable than the WTI-Brent divergence," Dahlman Rose's Margolin said. "It's being overlooked now and the discount between lower quality heavier crude and light sweet crude will widen with record levels of consumption." In addition, any incremental barrels of oil coming from the OPEC heavier crude supply as a result of extended production disruptions in Northern Africa or the Middle East can increase this divergence from refiners based on their mix. "For a company like Valero, with significant complexity in their system, it's just as important as the WTI-Brent spread and they can maximize the heavier crude input," Margolin said. Valero is notable for its capabilities for refining what is known as sour crude, like heavy crude another alternative to light sweet, and defined by having a higher sulfur content than light sweet crude. Weiss at Argus Research noted that Sunoco, on the other hand, is more limited in terms of its reliance on light sweet crude as the WTI-Brent gap narrows. Taking Sunoco as an example, with Libyan barrels lost, there are fewer light, sweet barrels on the market. Most light, sweet crude comes to the East Coast from North Africa (e.g., Nigeria). If Europe is short light, sweet crude, it's more likely to get it from North Africa. North Africa is going to require a higher price to send it to the U.S. due to increased shipping costs. Even if this doesn't happen, with less light, sweet crude on the market, prices should rise and differentials between high and low quality crudes should widen. Operating under the assumption that most supply that is brought on to replace what's lost from Libya is lower quality (likely sour), "This environment is bad for Sunoco, as it can't easily benefit from the market changes and is more likely to be hurt by them," Argus Weiss said. Weiss noted in his recent research report on Sunoco, "all of Sunoco's Northeast crudes are priced off of Brent, leaving the company's Northeast refining assets in a particularly vulnerable position, as it will pay relatively more for feedstock than those peers that can acquire cheaper crudes." The Argus Research analyst added that Valero's refineries have a higher complexity, meaning they can process lower quality crudes (heavy, sour), and as more lower quality crude comes on the market, differentials are likely to widen (greater supply to a fixed market in terms of capacity results in lower prices).
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