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Prices at the gas pump are headed toward record highs. So can investors still profit?
Shares of oil refining companies have soared by an average of 37% since January, and Tesoro (TSO, news, msgs) is leading with a whopping 68% jump. A unique convergence of factors has positioned the companies to exceed estimates when first-quarter earnings reports start rolling in later this month.
Refiners process crude oil into products such as gas, heating oil, kerosene and diesel fuel. The cheaper they can get the crude and the more they can charge for the refined products, such as gas, the better.
Thanks to a shortage of U.S. gas inventories and a relative decline in imports, prices are on the rise. Inventories dropped last month by nearly 5 million barrels, marking the eighth straight month of declines. Futures are currently trading at roughly $2.10 per barrel. That's below the $2.60 peak hit last May, but above prior expectations.
By contrast, crude prices are still well below last year's peak, even after the recent run-up in price attributed to the Iranian capture of 15 British sailors and marines. With crude currently at around $64 per barrel, refiners are positioned to benefit from historically high margins.
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A series of outages
A series of unexpected outages at refineries across the country has also contributed to the bullish environment. Capacity utilization rates were running at about 86% in March, the lowest level at this time of year since 2002. Normally, utilization rates heading into the busy summer travel season are running in the low 90% area. A recent fire at BP's (BP, news, msgs) refinery in Indiana and a February fire at Valero Energy's (VLO, news, msgs) refinery in Texas should help keep utilization rates a bit below normal for some time.However, as long as the margins are high enough you can expect other plants to find more capacity. Imports will also pour in to take advantage of the profit potential. Longer-term, there is a risk to U.S. refiners as India and China ramp up construction of refining plants.
Meanwhile, U.S. capacity is at least partially constrained by environmental regulations that make it extremely costly to build plants. The last new U.S. refinery was built more than 30 years ago, and the number of outages is likely to increase as the plants age. Refiners will be pressured to use some of the current profit windfall to update plants and create safer working environments. Such expenses are apt to weigh on future earnings.
Looking forward, year-over-year growth rates are expected to begin a two-year decline that will see earnings drop by an average of 16%. In other words, the good times are about to end as supply starts to catch up with demand and capital expenditures start to increase. That's bad news for industry shareholders, but good news for drivers hoping for gas prices to peak.
Use near-term share-price gains to exit the group. Stocks most vulnerable to considerable declines over the next six to nine months include Tesoro, Marathon Oil (MRO, news, msgs) and Hess (HES, news, msgs).
At the time of publication, Robert Walberg did not own or control shares of any company mentioned in this article. His clients owned shares of Valero Energy.
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