Buy Alon USA, HollyFrontier and Valero Despite Lower Oil Prices

NEW YORK ( TheStreet) -- Oil prices could be headed as low as $75 a barrel in the near term due to excessive supply, but investors should consider the recent selloff in energy stocks as a buying opportunity.

The current landscape is a perfect storm for most bears. But refiners are quickly reaching a tipping point that suggests a bottom is near. Key pure-play names include Alon USA (ALJ) , HollyFrontier (HFC) and Valero (VLO) . Wall Street may have fallen out of love with these names, but that doesn't mean you should.

VLO Chart

To understand why, let's examine the components that drive refinery profits.

Late 2013, and first quarter of 2014 (the latest numbers available), European and North American petroleum consumption is near or below the levels of 2010. A year marked as a slow climb out of the recession depths for some, but not all. The old Western economies counterbalance Asian demand growth, albeit as prices fall, expect demand to strengthen if history is our compass.

Because oil trades in dollars, a strengthening dollar requires more euros to buy the same amount of gas, diesel and crude oil. A weak Euro eelps explain in part why European demand is tempered lately, but the euro-dollar exchange rate average is about the same or more favorable for the euro now compared to 2010.

Looking back, the euro was stronger in 2012 than up to this point in 2014 on average. That leaves the last and most significant reason for falling crude, and why you want to take a closer look at refiners.

The current amount of supply available is staggering, and we have production from shale fracking to credit. North Dakota's raging oil boom may create more headlines, but Texas continues to lead in production. The massive Eagle Ford formation in Texas is a real game-changer because of its ease of transport to refineries based on its location, and because it's quick and easy to ramp up production.

As significant as fracking is to domestic supply, the amount of reserves in the Gulf is even greater. The potential could turn into realized sooner than you think. The Gulf oil is further down the road as it takes much longer to bring that oil to market. Fracking moves oil from the ground to the gas tank quickly.

The speed oil and natural gas can make it from the ground into the marketplace is why you should discount concerns over declining storage inventory levels. If an international event in the Middle East or Africa disrupts marketplace supplies, for example, an increase in domestic production can come online quickly to fill the gap. I will touch on this further, but for now, keep this concept on the back burner.

Falling crude prices have directly had an impact on the market's perception of refiners, but government reports fail to reinforce the refiner bear thesis. For the first half of 2014, refinery utilization rates are running well above average during the last 10 years. Every month during the second quarter of 2014 the utilization rate topped 90%, the first time since 2005.

VLO Operating Margin (TTM) Chart

The market hasn't fully caught up to the fact that a combination of high utilization rates and falling crude prices means that as demand for cheap energy grows, the relatively small amount of additional refinery capacity will expand margins. This is especially true for Alon USA, HollyFrontier, Valero and others.

Moving back to supply disruptions, geopolitical risk can positively impact refiners in the right locations. The three previously mentioned companies either completely or primarily operate within North America. As we've already witnessed, the spread between WTI and Brent has allowed U.S. refiners the ability to export refined products, including diesel, into the world market.

A supply disruption almost certainly opens up more opportunity for U.S.-based refiners. With all three companies' stock prices down significantly, it's a heads-you-win, tails-you-break-even type of play. The share price drop has priced in poor results, leaving a long position largely intact if nothing improves. However, if basic economic theory of "lower commodity prices equals greater demand" is valid, the refinery stocks could capture a significant lift in price.

For long-term investors willing to hold through skepticism, this is the value buy you're looking for. Alon USA has a current dividend yield of 1.9%, Valero's current yield is 2.2%, and HollyFrontier's yield is 2.8%. In other words, the companies will currently pay shareholders to wait for a bounce.

That's why in a falling oil price environment, investors can still make money in the energy sector if you're selective and don't take on a trader's mindset.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

Follow @RobertWeinstein


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

TheStreet Ratings team rates ALON USA ENERGY INC as a Hold with a ratings score of C. TheStreet Ratings Team has this to say about their recommendation:

"We rate ALON USA ENERGY INC (ALJ) a HOLD. The primary factors that have impacted our rating are mixed ? some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. The company's strengths can be seen in multiple areas, such as its revenue growth and solid stock price performance. However, as a counter to these strengths, we also find weaknesses including deteriorating net income, generally higher debt management risk and disappointing return on equity."

You can view the full analysis from the report here: ALJ Ratings Report

If you liked this article you might like

Changes in Renewable Fuel Regulations in 2017 Could Impact Your Energy Investments

Changes in Renewable Fuel Regulations in 2017 Could Impact Your Energy Investments

Tesoro Continues M&A Streak With $6.4 Billion Deal for Western Refining

Tesoro Continues M&A Streak With $6.4 Billion Deal for Western Refining

Bullish and Bearish Reversals in the Market

Bullish and Bearish Reversals in the Market

Energy Sector Down After the Energy Information Administration reported Oil Inventory Build-up

Energy Sector Down After the Energy Information Administration reported Oil Inventory Build-up

Bullish and Bearish Reversals for the Week

Bullish and Bearish Reversals for the Week