We’ve recently been staring oil volatility in the face.
Crude oil prices have been in retreat over the past week, with a slump of nearly $6 in both the U.S. and London benchmarks.
The good news, however, is that the same can hardly be said for U.S. refined oil products.
Which means that we have moved into an environment favorable to the less-talked-about refining sector – which makes the companies involved in the sector very intriguing.
In fact, as you’ll see down below, I have two refining plays that you can capitalize this rising market with.
And we can attribute the bump in the refining market largely to the following three factors…
The Cost of Oil is Crucial
First, the spread between oil benchmarks West Texas Intermediate (WTI) and Brent continues to widen.
The difference between the price of Brent and WTI was over 14% as of 2:30 Monday afternoon, and the close of daily oil trading.
Which is a percentage not seen since early 2015.
This spread means it will be the processors that are capable of bridging the cost point components will generate the highest refinery margin.
This margin is where a refinery makes its money, and is the second factor of interest.
The refinery margin essentially comprises the inference between what it costs to produce a finished product – such as high-octane gasoline, low sulfur content heating oil or diesel, or high-grade jet fuel – and the first arms-length wholesale transaction.
The latter aspect is often referred to as the “rack price,” reflecting times past when trucks or train cars were maneuvered under a rack to receive product directly from the distillation process.
The main ingredient in determining the price remains the cost of crude oil, which reflects two of the pricing components: domestically available oil, and volume imported.
When it comes to U.S. refineries, one might assume that the largess provided by American shale and tight oil deposits would remove the need to import.
However, refiners still desire imports if the volume coming in is attractive from a cost consideration.
Crude movement into the U.S. is now primarily a factor influencing processing bottom lines; remember, the largest single component of those imports is coming from Canada.
That makes North American energy independence even more probable.
But there’s still one other factor in the refining sector that is even more crucial…
U.S. Refineries: They’re Going to be Big
For some time now, American refiners have led the world in the exports of finished oil products.
The reason is simple.
All oil products are value-added and sell on the international market at a premium to raw crude oil. Transitioning from the export of crude to the final product enhances revenue flow.
And the U.S. has a competitive advantage called the Nelson Complexity Index (NCI).
The NCI measures the ability of a refinery to process along a wide range of distillate categories. The lower the NCI, the more limited the refinery. Consequently, the greater the NCI, the greater the capital expenditure necessary for the refinery’s complexity.
Primarily, complexity considers the ability of a plant to produce both primary runs (straight from the crude) and secondary runs (requiring additional treatments).
Unless a plant is serving a wide market with sufficient demand across the board, the billions of dollars to enhance activity simply is not cost effective.
In general, U.S. refineries have higher NCI ratings and can combine raw material accessibility with a wider range of product. When a developed export infrastructure is added, a decided competitive advantage emerges.
And for all countries whose central budgets are dependent upon exports, that is a very important consideration.
Refiners elsewhere – especially in Europe and sections of Asia – have been either operating at a loss or have been restricted to servicing more limited local markets. Others, such as processing plants in Russia, and even Saudi Arabia, have attempted to ramp up oil product trade.
However, that is easier said than done.
Refineries in countries dependent on oil sales are often more limited in the range of oil they can process and the types of products produced.
For example, until recently, 42 of the 49 refineries in Russia could not even produce an upper-end product, and virtually none of them could even process many grades of crude.
All these factors combined lead me to giving you two ways to profit greatly from this bullish refining market…
Two Profit Recommendations
The first is Valero Energy (VLO).
Valero has been a staple in my premium Energy Advantage Portfolio with three distinct and currently operating introductions into the holdings.
Each of the three entries has provided a massive return since introduction of 220%, 471%, and 589% as of close yesterday.
Valero is the leading U.S. independent refiner with exceptionally high NCI ratings, and has the most detailed and established infrastructure of processing, pipelines, storage, and terminals. The company is also the leading exporter of American-produced oil products.
As the refining sector moves up, Valero has been leading the way: Its stock is up a very nice 4.2% for the week and 9.8% for the month.
The second recommendation is my preferred way to play the entire refinery space. The VanEck Vectors Oil Refiners ETF (CRAK) is an exchange-traded fund that allows you to invest in a broad refinery sector diversification by using a single investment.
CRAK tracks the Global Oil Refiners Index. The fund invests at least 80% in the stock of companies generating a least 50% of revenue from crude oil refining. And while it does include selected foreign refineries that issue depository receipts traded in the U.S., most of the ETF tracks U.S.-based companies.
CRAK is just beginning to move up, reflecting the overall sector improvement. The ETF should be down today, after a four-day rise of 4.6%, allowing for a better entry price.
These two picks are just the beginning of the increasing refining sector revival, and investors in the industry are sure to be seeing some impressive profits.
Source: Oil & Energy Investor