Refining Stocks In Sweet Spot: Oppenheimer

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According to a May 26th report from Oppenheimer Equity Research, refiners are in an ideal position given low natural gas prices, industry fundamentals and a wide crude differential. Oppenheimer analysts Fadel Gheit and Luis Amadeo, who have been mostly bearish on the sector, say that’s why they’re raising their ratings pretty much across the board for U.S. refining stocks.

Details on Oppenheimer upgrade of refining stocks

In the introduction to their report Gheit and Amadeo note: “We are raising our rating on HollyFrontier, Marathon Petroleum, Phillips 66, and Tesoro to Outperform and reiterating our Outperform rating on Valero Energy (raising PT to $70 from $65), as we believe favorable industry fundamentals and company actions will continue to support higher valuation. We believe the stock performance will continue to reflect wide crude differential, low natural gas prices, growing refined product exports, improved petroleum demand outlook, and continued MLP growth.”

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They also point out that even given the strong stock performance of refiners over the last few years, “valuations remain attractive, and financial flexibility has improved with declining stay-in-business spending and rising growth investments in crude flexibility, product exports, and MLP growth.” Over time, this will permit refiners to shrink debt, boost dividends and repurchase shares.

Gheit and Amadeo specifically mention wide crude differentials, low-price natural gas and increasing exports as three positives for refining stocks:

Wide Crude Differentials

The analysts anticipate that the Brent-WTI differential will remain in the $4-$8 range, which together with steadily improving logistics gives a major competitive advantage to U.S. refiners with who have the flexibility to take advantage of many crude sourcing options. They also point out that increasing global tensions sends the Brent crude price up, while greater domestic oil production brings the WTI crude price up. By the same token, removing the export ban could increase the WTI price and narrow the differential.
Refining Stocks

Inexpensive Natural Gas

Keep in mind that the refining industry is a huge consumer of natural gas both as a fuel and as a raw material to produce refined products. U.S. natural gas is  significantly less expensive than oil, which gives U.S. refiners a notable cost advantage. The Oppenheimer team also highlights that even if natural gas prices increase, domestic production will increase and keep natural gas prices under $4/mcf.
Refining Stocks

Increasing Exports

The Oppenheimer analysts note that the U.S. went from the largest importer of gasoline and other refined products only three years ago to the world’s largest exporter of refined products today. This total reversal came about as a result of wide crude differentials, very low natural gas costs and higher run rates, which has further increased the cost advantage of U.S. refiners. They argue that this means large refined product producers Valero Energy, Phillips 66 and Marathon Petroleum can all compete favorably with local refiners in both Latin America and Europe.

Refining Stocks