Industrials have been my favorite sector for the fourth quarter of this year; my latest recommendati...
'Clean Up' with the Refining Resurgence
03/14/2013 7:45 am EST
Jason Burack of Personal Finance says a new age is dawning for oil refineries.
After years of struggling to make consistent profits and being dumped by integrated oil majors, US oil refiners are making a comeback—thanks to cheaper input costs, no new refining capacity in the US, and a large spread between West Texas Intermediate (WTI) and Brent crudes.
The US is now experiencing its fifth oil boom, because of unexpected production from shale plays like Bakken, Eagle Ford, Haynesville, and Marcellus. The latest oil boom will emphasize the importance of infrastructure, and will also allow American oil refiners to recover profit margins they have not enjoyed in years.
Oil refiners and pipelines will play a major role in this oil boom, because there is a big bottleneck of getting oil to the refiner by pipeline or rail, turning it into gasoline, and then getting the gasoline to a port city for export.
The challenge is getting landlocked oil from Oklahoma to port cities and Bakken and Canadian crude to East Coast refineries. But these infrastructure problems will soon be solved, and companies that produce shale oil will make hefty profits and stay in business.
For years, oil refiners have struggled to consistently profit from refining crude oil into gasoline and other petroleum products. Refining has been a hated, environmentally unfriendly, capital-intensive business, and has suffered from tremendous underinvestment for decades.
A number of East Coast refineries in the US have closed due to the difficulty being profitable. No new oil refinery has been built in the US since the 1970s.
Existing refineries have very expensive upgrade costs, and the EPA imposes onerous mandates, rules, and regulations that tremendously increase the cost of building a new refinery or expanding and upgrading an existing one. This red tape and Not in My Backyard (NIMBY) syndrome has created a good barrier of entry for the existing refineries, and this has prevented increased refining capacity from coming online in the US.
Consequently, refining is in short supply in the US, and the likelihood of massively increasing refining capacity anytime soon is minimal. The supply of gasoline depends far more on refining capacity than it does on crude prices. Refiners will have the ability to control the entire market over the next few years in ways they couldn’t imagine before.
An unexpected shale oil boom in North America has also created a very attractive opportunity for refiners to buy oil below the current spot price for WTI crude oil. American refiners can buy Canadian heavy oil or shale oil—which often sells for a discount to WTI—for $50 to $60 per barrel, then refine it into gasoline and export it to foreign markets for much higher prices.
Refiners have not seen spreads like these in a long time, especially since the spread between WTI and Brent is still close to a $20/bbl difference, and may not narrow as quickly as many experts think. And refiners should continue to make money even when the pipeline issues get solved, because those pipelines will bring them even more cheap supply without refining capacity increasing.
For more conservative investors, supermajors such as Chevron (CVX) have experienced big boosts to their profits from US refining operations. Chevron saw its refining profits globally swing from a loss of $61 million in the fourth quarter of 2011 to a profit of $925 million in the same quarter of 2012.
Driven by stronger margins, Chevron’s US downstream operations also earned $331 million in the quarter, a reversal of the $204 million loss in the year-earlier period, despite an 8% drop in refining capacity. So it's a good time to buy Chevron.
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