The situation for oil refiners in mid-2007 was just too good. Their profits were far too large. I didn’t think the stocks could go any higher. Here’s why…

A refinery converts crude oil into usable products like diesel and gasoline. Its profits come from the “crack spread,” which is the difference between the cost of oil and the price of gas or diesel. The best situation for these companies arises when the crack spread is large and they can sell their product for a high amount relative to crude oil. This situation arose in mid-2007…

Between February 20 and March 28, the average price of unleaded gasoline rose 49.4%, but the price of crude oil only rose 21.1%. This led to huge profit margins for the oil refiners… profit margins that seemed likely to persist.

You see, demand for petroleum products was growing, and no new refineries were being built. The last new refinery in the United States was constructed in 1976. Major hurdles prevent the construction of new refineries: financing a new project, getting permits, dealing with the environmental concerns.

And refineries experienced more than 30 unplanned outages in the U.S. in April 2007. Because of these outages, 400,000 fewer barrels of oil were being processed into gasoline each day, driving gas prices higher.

———- Advertisement ———-
What are you doing on Thursday, June 12th?

This is the last day to take full advantage of what millionaire S&A analyst Jeff Clark describes as: “The Single Best Income Strategy Ever Created.”

Free report explains the urgent details. Click here.
————————————

This is why most people thought I was crazy when I made a bearish call on refiners in a June 2007 issue of the S&A Digest. Investors were making money on refiners hand over fist, and the stocks were priced as if the good times would continue forever. Refiners were the darlings of Wall Street.

I disagreed…

Refinery outages are temporary problems, and simple economics says demand will moderate as prices increase. Less demand from consumers, along with the same level of gasoline production, leads to lower gas prices. So I knew these margins had to shrink.

As it turns out, I was right. By last month, refiners’ profit margins had disappeared… and with them went the refiners’ stock prices. An index of the four largest refiners fell by half.

Today, however, we are in the opposite situation. The price of oil has outrun the price of gasoline, and oil refiners’ margins are terrible.

The following chart shows my crack-spread indicator (a ratio of the price of gasoline to the price of oil) compared to an index of oil refining stocks. If the gray line is above zero, the crack spread is above its average level. If it is below zero, it’s below average.

As you can see, the crack spread has risen substantially from its March low.

Oil refiners are cheap, they are rallying, and investment banks are upgrading the stocks. Unfortunately, there is no refiner ETF. But here’s a look at the four largest U.S. refiners…

As you can see, all of these stocks are extremely cheap right now. And I believe the worst is now over for oil refiners. The situation is going from bad to less bad. The last time oil refiners were in this situation, the refiner index rallied by 40% in the following six months.

Good investing,

Ian

Source: A Six Month Trade for 40%

This fund is full of the world’s largest construction and engineering firms, heavy-equipment makers, and building-material producers. Fluor, which we featured last week, is a large weighting. Also included is Valmont (utility poles and irrigation equipment), Tetra Tech (water), and Terex (excavators and cranes).

The PKB soared from mid-2006 to mid-2007. Infrastructure investors gained 50% in just 12 months. The soaring turned to sinking last year as the credit crisis hammered shares related to global growth. The PKB is now holding steady around $18. So… has infrastructure put in its low?

Our guess is yes. U.S. infrastructure has earned a widely publicized “F” grade. The blossoming BRIC nations require bridges, roads, refineries, pipelines, and ports to continue growing. The Middle East is bathing in cash and needs to upgrade its ability to pump and process crude oil. This industry has an unimaginable amount of money headed toward it… think $41 trillion. We’re placing this trend in the “no brainer” category.

Source: The Infrastructure Correction Is Over

Crude surged after the Energy Information Administration came in with some inventory surprises.

In its weekly stockpile report, the EIA said that crude was down 3.2 million barrels for the week ended April 4. That stunned analysts, whose consensus was for a 2.7 million barrel build.

“The hefty fall in crude oil stockpiles was a major shock for a market which was expecting the opposite,” wrote Martin Slaney, of GFT Global Markets U.K. “As we head into driving season in the U.S. the tumbling inventories data is particularly significant.”

Meanwhile, U.S. gasoline supplies fell 3.4 million barrels, while distillate supplies dropped 3.7 million barrels. Analysts had been anticipating declines of 2.3 million barrels for gasoline and 1.3 million barrels for distillates. Also, refineries operated at 83% of capacity last week, up from the previous week’s 82.4%.