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.

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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%

No one can say for certain, of course.

But whether prices continue to rise or not, there are plenty of opportunities out there for investors looking to capitalize on the world’s long-term needs for oil. Some believe the meteoric rise in oil we’ve seen over the last three years is a temporary phenomenon. T. Boone Pickens isn’t one of them.

The long-time oilman, and current chairman of BP Capital Management, was recently asked in a 60 Minutes interview when he thought we’d see $1.50 a gallon at the pump again. “We won’t ever see $1.50 a gallon again,” said Pickens. “No, that’s gone.”

It’s tough to disagree. On the demand side, citizens of the wealthy West aren’t using any less oil, nor are the up-and-coming Tigers of the East.

On the supply side, just look at many of the world’s biggest exporters: Iran, Nigeria, Venezuela, Saudi Arabia and Russia. It’s a virtual rogues’ gallery, filled with nations that represent tyranny, corruption or instability.

Fortunately, the world’s single-largest oil deposit sits right here in North America. Time magazine calls it “Canada’s biggest buried treasure.” It’s an area with up to 2.5 trillion barrels of oil, locked in Alberta sand. That’s eight times the total reserves of Saudi Arabia, enough to satisfy the world’s demand for petroleum for the next century.

This is easily the world’s most exciting energy story.

And one publicly traded company is supremely positioned to earn billions from this region in the months ahead.

The Competition For Oil Is Heating Up

In May, the International Energy Agency (IEA) revised upwards its estimate of world oil demand, squashing hopes that a significant decline in oil prices is imminent.

Demand growth this year is running at its fastest level in 24 years. Last year, world oil use was estimated at 82.6 million barrels a day. The United States burns a quarter of that. But competition for oil is heating up.

Emerging markets – and particularly giants like China and India – are rapidly industrializing. According to the U.S. Energy Information Agency, world demand for oil is expected to increase 54% over the next 25 years.

Unfortunately, American oil production has been on the downswing since 1970. And many of the world’s major oil suppliers are either indifferent or downright hostile to U.S. interests. Where can Americans look for a steady, reliable source of black gold?

How about 900 miles north of Montana, in Alberta, Canada?

Jed Clampett Never Imagined…

Alberta’s oil sands are the largest known reserve of oil on earth, containing between 1.7 and 2.5 trillion barrels. (Saudi Arabia, by comparison, has only 262 billion barrels of proven reserves. In fact, all OPEC nations combined have less than 900 billion barrels.)

For decades, these sands weren’t even considered part of the world’s oil reserves because the oil there wasn’t economically extractible at prevailing prices using then-current technology.

But times have changed… And the new gold rush is on.

In Alberta’s oil sands, energy companies don’t drill for oil. They dig it up. After excavation, giant trucks three stories high – carrying up to 400 tons of oil sands – carry it off to a processing plant.

There, the sands are heated in a cell where the oil comes to the top of the water and the sand drops to the bottom. This oil froth is then sent to an upgrader and eventually to a refiner. Is this oil really as good as the stuff coming from Saudi Arabia?

Actually, it’s better. According to Clive Matter, Chief of Shell Canada, this oil is “absolutely as good as it gets. In fact, it even trades at a premium because it’s high-quality crude oil.”

And here’s the kicker: Exploration of Alberta’s oil sands is virtually risk-free. You can’t drill a dry hole here. There’s no drilling at all. It’s a mining operation – and the reserves are thoroughly outlined. So what you really need is a company with plenty of machinery, money and manpower to dig it up and process it as quickly as possible.

That’s why you should own Suncor Energy (NYSE: SU).

The Blue Chip Oil Sands Play

There are dozens of small companies flocking to Alberta for a piece of the action. But in this capital-intensive business, why gamble on the small fry? We suggest you opt for the undisputed blue chip play: Suncor.

Based in Calgary, Suncor is an integrated energy company. It extracts and upgrades oil through its oil sands operations near Fort McMurray, Alberta. Its operations throughout Western Canada produce natural gas.

It operates a refining and marketing business in Ontario, with retail distribution under the Sunoco brand. And it has operations in the United States and retails its products under the Phillips 66 brand. It also manufactures the gasoline additive ethanol.