Monday, November 5, 2007

Time to Get Back in Refiners? Adding to Frontier Oil (FTO) and Starting Tesoro (TSO)

I have mentioned repeatedly how curious it is that the refiners have not raised prices in the face of a massive rise in crude oil - this has destroyed their margins. In fact this is the reason the big majors are seeing some profits squeezed - they are benefitting from the rise in crude but being hurt by the lack of profitability in their refining operations. However, just from anecdotal evidence (prices at the pump up $0.20 in last 3-4 days) plus a quick look at the refining margins chart, see here - shows margins are finally expanding. If you are new to this area, please click on the label for Frontier Oil at the bottom of this listing and read up on 'crack spreads' - essentially the variance between crude oil prices and gasoline prices - it is not quite so simple because we have sour crude, light crude etc, but I digress.

I am going to get back into this sector (which is not 1 of the typical secular plays, but more of a medium term trading sector), with 2 stocks.
  1. I am adding back to my Frontier Oil (FTO) position. I added 300 shares this morning in the mid $45s to my existing 150 shares; this is an addition of just under $13.7K and makes Frontier a 1.7% position. Frontier Oil has been my favorite in the group as its refineries are the best positioned geographically in the country and it's chart has held up much better than most of the other names in the sector. In fact it's been sitting above its 20 day moving average the past 8 sessions in a very choppy market. That bodes well. I had cut this position on the spike off the Kerkorian stake in fellow refiner Tesoro, but instead of pulling back Frontier has simply held its ground.
  2. I am beginning a new position in Tesoro (TSO) off the Kerkorian bid and improving margins in the sector. Tesoro spiked from $57 to $66 on the news of the Kerkorian stake (at $64 mind you) - since then Tesoro reported an awful quarter (no surprise) and has given back the entire gain and today has fallen to $56, which also happens to be its 20 day moving average. How convenient. So I am getting a better price than before the Kerkorian bid was announced. I've initiated this position with a 450 share buy in the $56 range. This is a substantial starting position of $25.5K, or a 2.2% position.
I've been struck by the lack of movement in gas prices this fall as crude pushed up relentlessly. Gas should be nearer to $3.75-$4.00 nationally if basic supply/demand was in play, so I've postulated that either this is signaling crude is poised to drop or something else was going on (pressure not to raise prices?) Some of these refineries have been pushing out product at near losses. For example in Hawaii, Tesoro's spreads were $0.11. Yes 11 cents. These companies were enjoying spreads in the mid to upper $20s range earlier this year. Very strange times. If crude simply falls (which is going to be hard with the dollar crumbling) to mid $80s, this will provide a serious boon to these companies. Tesoro's own economist is saying (granted there is bias) that crude should be trading in the $60s... but with all this liquidity in the system (thanks Ben!) hedge funds need to speculate on something and commodities (and the dollar) seem to be the place they are going with their new found dollars. Two very crowded trades - short dollar/long crude. While I agree in the long run these are correct calls, even a near term correction in these areas would cause a lot of people pain. And again the market likes to do what most people least expect. So this sort of counter move would benefit the refiners in a large way.

Again, unlike most stocks in the portfolio which are long term secular trends, the refiners are more of a 'trade' a few times a year type of position - when crack spreads are high you sell, when they are low you buy. It appears we might have put in a bottom of late; investors seem to be focusing on last quarter's earnings and yes the prospect of higher oil remains, but margins seem to be improving so we'll try becoming more constructive on this sector.

Long Frontier Oil, Tesoro in fund; no personal position

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