Profit From Higher Gas Prices

05/07/2008 12:00 am EST

Focus: STOCKS

Curtis Hesler

Editor, Professional Timing Service

Gasoline prices may be a hot-button issue on the campaign trail, but Curtis Hesler, editor of Professional Timing Service, finds a way investors can make money from it.

I have been forecasting $1,600 gold and $160.00 crude oil for some time.but consider $6.25 gasoline.

In mid-April when gasoline was $2.80 a gallon and crude was $110.00 a barrel, refiners were losing about 5% on gasoline production. They typically will make a 25% profit. That means with crude at $110.00, gasoline should be selling for $3.68 to give the refiners that 25% profit. So, [with crude at $120 a barrel], we might conclude gasoline needs to be 9% higher than our $3.68 figure-or about $4.00 a gallon-to return to typical profit margins.

Adding another 50 to 70 cents a gallon tax makes it quite likely that gasoline at the pump is going to go over $4.00 this summer, even if the price of crude corrects back to major support at $100 a barrel.  Factor in the added cost of regional blends and, in all likelihood, we will see prices move to $6.25 by the time the next decade is under way.

There is not much you can do about rising energy costs. World crude production is peaking, and there is a need to see another five million barrels a day per year come on line in order to make up for depletion. That is a lot, and we need it now-not five years from now. Alternatives are nice, but they will not be enough.

Nevertheless, the technical picture looks a bit overbought on a short-term basis. Normally, there is a seasonal pause in crude prices from mid-May through July, after which seasonal strength typically carries prices to new highs in October.

Currently, the refiners are the low-hanging fruit, and you have to love the fact that this critical industry is virtually competition-proof because it is so fraught with regulation. Valero (NYSE: VLO) is [below] our buy price of $51.50, and it has been trading under that for the last month. (It closed below $48 Tuesday-Editor.)

Valero has the unique aspect of being able to utilize sour crude that they purchase for $10.00 to $20.00 less than the light sweet crude that most other refiners have to use. Valero is also adept at producing smaller runs of regional boutique blends.

The stock is off from highs around $78 last year. That weakness is due to the profitability issue we are talking about as well as concern over the economy and possible declining demand. They also operate a string of gas stations-more appropriately called convenience stores-which some fear may become a drag on the company.

I don't really think that the retail operations are going to make that much difference on their bottom line. The big money is in refining product and making a profit at wholesale, not retail, sales.

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