WSJ, for the VLO buffs:
HEARD ON THE STREET
Refining Stocks
Still Have Plenty
Of Fuel for Now
By JEFFREY BALL
January 29, 2007; Page C1
With President Bush calling for significantly slowing the growth in gasoline consumption in the next decade, stocks of some companies that refine crude oil into gasoline slipped temporarily last week, a sign that some investors are reassessing growth prospects for the refiners.
That long-term concern may have overshadowed a near-term opportunity. There are good reasons to conclude refiners of crude are poised for a nice seasonal stock pop as the high-demand summer driving season approaches.
In his State of the Union speech last week, Mr. Bush urged a big increase in alternative fuels such as ethanol and a potential toughening of federal automotive-fuel-economy standards. Both measures, he said, are intended to hold the growth in gasoline consumption to 20% below its projected level in 2017.
The market reacted immediately. As word of the president's energy proposals surfaced Tuesday, hours before the actual speech, the stocks of some producers of corn-based ethanol inched up -- and those of some refiners inched down.
Time will tell whether Mr. Bush's proposals will meaningfully slow the growth in America's gasoline use. It would take real technological breakthroughs for the U.S. to produce the volume of ethanol the president outlined, requiring the country to move beyond corn, the current feedstock for U.S. ethanol, and use "cellulosic" materials such as switchgrass and wood chips, which are far more plentiful, to make the fuel.
Cellulosic ethanol is largely experimental; how many years it would take to reduce its cost to a competitive level is an open question. (See Commodities Report, page C3, on ethanol's wide range of costs.)
If the president's policies to curb the growth in U.S. gasoline use succeed, "the impact on refining would be drastic," Deutsche Bank AG oil analyst Paul Sankey wrote in a research note last week following the president's address.
Whatever happens during the next decade, however, the nuts-and-bolts realities of the U.S. refining industry suggest investors may do well in the next several months by investing in refiners of old-fashioned crude oil.
Right now, largely because of a warmer-than-expected winter that has curbed demand for heating oil, another product of the refining process, oil refiners' margins are low. Analysts expect some of the same pressures that last summer pushed up U.S. gasoline prices -- and refiners' margins -- will be repeated as the summer driving season approaches.
Margins will "stabilize and start going back up in the spring," said John Parry, a senior oil analyst at John S. Herold.
The energy-research company is bullish on refiners Tesoro Corp., which will report fourth-quarter earnings today, and Sunoco Inc. and Valero Energy Corp., both of which will report this week. Although Herold doesn't rate those stocks, it has what Mr. Parry calls an "inferred buy" on them, because the stocks are trading below what Herold regards as their value based on their average margins over the past three years. Herold has recommended investors buy ConocoPhillips, an integrated oil company with a significant refining business.
Mr. Parry owns stock in Tesoro, Sunoco, Valero and ConocoPhillips, among other oil companies. Herold doesn't own shares in the companies, but it has done business with ConocoPhillips in the past year.
[Oil and Gas Stocks]
The underlying reason for the near-term bullishness on refiners, Mr. Parry and other analysts said, are government regulations pushing refiners to blend into gasoline the same brew President Bush touted as an antidote to high pump prices: ethanol.
Regulations in parts of the country with particularly dirty air require special blending agents be added to gasoline to reduce the air pollution produced when the gasoline is burned in cars and trucks. Historically, the chief blending agent was methyl tertiary butyl ether, or MTBE. Because of concerns that MTBE contaminates groundwater, the government effectively has prodded refiners to phase it out, and now refiners typically use ethanol as a substitute.
Particularly in summer, ethanol is harder to blend into gasoline than MTBE is. Mixing in ethanol requires adding other chemicals that are in short supply in the U.S. That raises pump prices -- and refiners' margins.
Doug Leggate, a Citigroup Inc. oil analyst, predicted Tesoro will be the first beneficiary of the seasonal bump, because it does much of its business on the warm West Coast. Tesoro's shares already have risen markedly this month. Next up for real gains, Mr. Leggate said, are Valero, focused on the Gulf Coast, and Sunoco, based on the East Coast. Sunoco has the most "upside potential," he said.
Mr. Leggate has "buy" ratings on Tesoro, Valero and Sunoco. He has a "hold" on ConocoPhillips, generally because of the company's exposure to the upstream oil business, which Mr. Leggate has regarded as less promising than the refining business. Mr. Leggate doesn't own shares in any of these companies, but Citigroup owns Sunoco shares and does business with Sunoco, Tesoro and Valero, among other oil companies.
Aronson+Johnson+Ortiz LP, a quantitative money-management firm in Philadelphia with holdings of about $28 billion under management, has raised its holdings in refiners including Tesoro and Sunoco. During last year's third quarter, the most recent period for which statistics are available, it raised its holdings in Tesoro to 227,900 shares, up 202,300 shares, and it raised its holdings in Sunoco to 1.19 million shares, up 849,700 shares, according to FactSet Research Systems Inc.
Within the energy sector, "the refiners are looking more attractive because of their value tilt," said Stefani Cranston, a portfolio manager at the firm.
Deutsche Bank's Mr. Sankey is bearish. In addition to his long-term concerns about the threat ethanol poses to gasoline consumption, he notes that one big factor boosting refiners' margins last year was lingering refinery damage from the 2005 Gulf Coast hurricanes. Most of that is fixed.
Mr. Sankey -- who has "hold" ratings on most of refiners, including Sunoco, Tesoro and Valero -- doesn't personally own any of the stocks, but Deutsche Bank does, and it provides investment-banking services to many refiners.
Some refiners have said they are worried by Mr. Bush's ethanol push and are reconsidering plans to expand their gasoline production as a result. Adding less supply could have the effect of keeping gasoline prices higher.
Because "the mandatory nature and scope" of the president's proposals "give us serious pause," Marathon Oil Corp., an oil company with a big refining business, said in a statement following Mr. Bush's speech, "we must now re-evaluate our long-term investment program," especially prior plans to expand refinery capacity.
Write to Jeffrey Ball at jeffrey.ball@wsj.com1 |
