Investors with positions in refiners should tread carefully, as oil hovers around $100 per barrel. Geopolitical tensions in oil producing nations, coupled with growing global productivity growth, is driving energy prices toward levels not seen since June of 2008. While integrated oil stocks cash in on higher prices, refiners risk getting burned.
Geopolitical Uncertainty Drives Oil Prices Up
As long as instability emanates out of North Africa and the Middle East, oil prices will be supported. Libya accounts for about 2% of daily global oil production and exports roughly 1.2 million barrels a day. Meanwhile, unrest in Bahrain creates spillover fears for similar dissension in Saudi Arabia. The Saudis are the world's largest oil exporter, second largest oil producer, and they own 20% of the world's oil reserves. The potential for supply disruptions are bullish for energy prices. For related reading, see Oil And Gas Industry Primer
Refiners Crack Under The Spread
$100 oil does not bode well for one segment of the oil patch. Profit margins for refiners depend upon the crack spread. Refiners are companies who process crude oil into petroleum products including gasoline, kerosene, heating oil, aviation fuel and diesel that they then sell to consumers. The crack spread for refiners is the difference between the price paid for crude and the price of products that they sell. Refiners can only capitalize on advancing crude prices if gas and diesel rise at the same rate. The question is: What is the point at which prices at the pump will force consumers to retrench? (For more on this topic, check out How can I hedge against rising diesel prices?)
Thus far, consumers have been able to absorb higher oil prices, which have more than tripled from their 2009 low. From October 2009 until recently, oil traded in the sweet spot for refiners between $70 and $85 per barrel. Over the past year and a half, shares of Texas-based refiners Western Refining, Inc. (NYSE:WNR) and Frontier Oil Corporation (NYSE:FTO) have led the refinery rally, rising 173% and 113%, respectively.
Demand for refined products has risen along with crude, but oil is now approaching a breakpoint price for refiners. $100 per barrel of oil has translated into an across-the-board haircut for refiners. Since February 17, Valero Energy Corporation (NYSE:VLO) is down 7.5%, Tesoro Corporation (NYSE:TSO) has shed 5%, and Sunoco, Inc. (NYSE:SUN) has given up 3%. An added risk premium should be added to pure-play refiners while oil trades at or above $100 per barrel.
Investors can still get access to the space with Marathon Oil Corporation (NYSE:MRO), which is a more diversified refiner. By the end of June, Marathon plans to spin off its refinery operations into Marathon Petroleum Corporation. Marathon Oil, which will continue operating the exploration & production, oil sands mining, and integrated gas divisions, will benefit from higher prices.
Diversified Oil Powers Up
Meanwhile, integrated supermajors like Exxon Mobil Corporation (NYSE:XOM) and Chevron Corporation (NYSE:CVX) profit on increasing crude prices. So do shares of oil shale and oil sands producers, especially when crude hits $100 per barrel. One such producer, Chesapeake Energy (NYSE:CHK), has surged more than 12% since February 23.
The Bottom Line
Oil prices had been slowly advancing before the North Africa and Mideast impetus. Strong global demand, particularly from China, is still in place. Geopolitical uprisings will only serve to speed up the push toward prices where consumers must retrench. U.S. gas prices are at 2.5 year highs. If the national average creeps closer to $4 per gallon and consumer demand levels off, U.S. refiners will get squeezed. (For related reading, see Oil Service Stocks For Rising Oil Prices.)
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