Hot Returns from Freezing Winter

01/03/2011 1:39 pm EST

Focus: STOCKS

Jon Markman

Editor, Trader's Advantage

Oil refining stocks are warming up nicely as cold weather pumps up fuel demand, writes John Markman, editor of Trader’s Advantage.

Early indications suggested this would be one of the coldest winters on record. And that has certainly turned out to be the case, as unseasonably frigid air and snow has blanketed Europe and the East Coast of the US, ruining crops, shutting down transportation, and impeding retail sales. This is a big, big deal. Late in 2010, the chill spread out over Asia, and even Australia.

I recommended buying every kind of energy stock and fund on this news, ranging from coal miners to oilfield service providers and crude producers, and fortunately they have all been advancing nicely.

Now I just want to suggest that this is not time to be complacent about the cold weather and the potential for energy positions. It’s a theme that is quite likely to persist for months, as the cold fronts show no sign of abating and they come at a time when inventories of coal, diesel and heating oil have been tight. There’s plenty of natural gas, which is good, but the heavy fuels that power big furnaces and trucks are growing increasingly scarce.

In the US, the average price for a gallon of diesel recently rose 1.7 cents to $3.248 at the pump. Diesel in the US is about 52 cents a gallon higher than a year ago.

Heating oil, which is another distillate, is also escalating in price. The US Heating Oil Fund (NYSE: UHN) is an exchange traded fund that attempts to track the price of heating oil, and doesn’t do it very well due to contango issues [having to pay up as its futures contracts are rolled over—Editor]. It has been basing for two years, and looks ready to break out. I don’t recommend buying this because the SPDR S&P Oil & Gas Equipment & Services Fund (NYSE: XES) that we already own actually outperforms the raw material. But it’s still worth observing how these prices are moving higher in a steadfast way.

The refiners that are responsible for “cracking” crude oil into all of its various distillates—gasoline, heating fuel, jet fuel, diesel, asphalt, and the like—are also starting to make a great comeback. The refiners have been absolutely dead money for two years after a hellacious decline stemming from oversupply, the recession, and regulation.



Click to Enlarge

But once they get going, you will be stunned to see how well they can perform. In the chart above you can see the relative performance of a small-cap, a mid-cap and a large-cap: Western Refining (NYSE: WNR), the black line; Holly (NYSE: HOC), the green line; and Valero Energy (NYSE: VLO), the purple line. Their market caps are $900 million, $2 billion, and $13 billion respectively. Another leading mid-cap is Tesoro (NYSE: TSO), at $2 billion. I think the refiners are going to be a great play over the next six months, and you should take advantage.

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