Special Energy Indicator Points Toward Higher Gas Prices and a Potential 467% Profit Play

Keith Fitz-Gerald — Fri, 13 Jun 2008 12:02:46 +0000

Here at Money Morning over the past six months, we’ve talked a great deal about oil and gasoline prices. We’ve offered our predictions about how high those prices were going, and have detailed a number of investment opportunities – chosen as much for their margins of safety as for their profit potential.

This time we’re going to detail three energy stocks with the potential for double-digit – or even triple-digit – profit gains. Admittedly, these are longer-shot, speculative plays. But we used a special energy indicator to help ferret out these energy plays.

This indicator is known as the “crack spread.”

In case you’ve never heard the term before, the crack spread is the difference between the price of crude oil and the value of the petroleum products that refiners can make from it. The crack spread can widen or narrow over time, depending upon various combinations of supply and demand.

If the spread is positive, that means the price of the products that result from the refining process – gasoline, diesel fuel, aviation fuel, heating oil, kerosene and asphalt, to name a few – is greater than the cost of the crude oil needed to make them. But if the spread is negative, it suggests that the cost of crude is higher than the end-game value of its derivatives.

Right now, the crack spread is narrowing. In fact, it has been for some time as governments around the world and gasoline companies actually try to hold down the pain motorists feel at the pump.

Granted, governments and major oil players make for strange bedfellows. But they have a common interest right now: Both are trying to prevent “demand destruction,” the plunge in oil demand that would result if millions of motorists – fed up with high oil and gasoline prices – just stopped driving. Governments want to prevent an economic collapse, while the integrated oil companies simply want to avoid being branded as the “bad boys” of the soaring-oil-price era – making it much easier for the incoming presidential administration to slap the entire sector with an “excess-profits tax” (something that’s already being discussed by Washington insiders).

But we can also see another scenario, one that’s very different. Peering into our crystal ball, we can see a situation in which the crack spread begins to widen, and gasoline prices run away anyway – eventually reaching $7 or even $9 a gallon.

For motorists, the pain would be excruciating. For investors, however, there’s a chance for double or even triple-digit profit gains.

Let me explain…

The Subsidy Gambit

It turns out that a number of Asian governments – most notably Taiwan, Malaysia and China, for instance – are actually reducing or eliminating fuel subsidies designed to shield their consumers from crude oil’s relentless march. Ostensibly, this is designed to control demand, but history suggests this will merely give those with the money access to increasingly large supplies that they’ll gobble up. In other words, we believe that demand may be growing fast enough to override the prices that governments around the world still believe to be inelastic.

Combine that possible new reality with the fact that a developing Asia accounts for as much as 70% of the increase in global oil consumption, this end of subsidies would probably hammer worldwide markets, including our own.

Given that Asia represents a mere 20% of current global usage, Asia’s growth is critical to how the rest of the world uses and prices petroleum-related products – particularly gasoline. Incidentally, this stands in stark contrast to how Japan and much of Europe do things where high taxes on fuel and transportation are used to blunt demand.

The economic forces that will be unleashed when these subsidies are removed have the potential to make the Great Tunguska Blast that took place 100 years ago this month look like a wet firecracker.

Indonesia, for instance, spends nearly 20% of its budget to underwrite fuel costs and has telegraphed a 30% hike in fuel prices when those subsidies are removed. It’s much the same story in China, India and the Philippines, where separate figures for fuel subsidies are hard to come by, but where it’s safe to say that the net effect of these price controls have contributed to artificially low prices and artificially high levels of demand.

In China, where the government caps gasoline prices, for instance, motorists pay about half of what their U.S. counterparts pay. All in all, governments around the world will spend about $100 billion on oil subsidies this year – meaning about half the world’s population is benefiting from “cut-rate” petroleum prices. This year, those folks will account for all of the growth in global oil demand, equal to an additional 1 million barrels of oil per day, says Deutsche Bank AG (DB).

Now, pressure is escalating globally for countries to end the subsidies the world economy can ill-afford. The International Monetary Fund (IMF), for instance, is “calling on governments to let consumers face market prices in order to kick-start conservation and reduce official spending,” says The Christian Science Monitor.

As I hinted earlier, this change has the potential to jam a lot of consumers personally. But it would allow world markets to function as, well, markets. And that, in turn, would afford investors one of the biggest turnaround opportunities available in the energy sector today. The reason: As the subsidy removals, pricing changes and demand shifts work their way through the global economy, the crack spread would widen again… and fast.

And the biggest beneficiaries could well be the oil refiners, which have seen their profits get zapped along with crack spreads in the past year.

The Best Way to Play the Shift From Subsidies

If there is a sector turnaround, the upside could be huge. And the three firms in line to benefit are Western Refining Inc., Valero Energy Corp. and Holly Corp. Let’s take a closer look at each of the three:

Western Refining Inc. (WNR): The El Paso, Tex.-based Western is an independent crude-oil refiner that owns and operates four refineries, and that also owns and runs 155 retail service stations and convenience stores in the Southwest. Although Western’s shares rose 77 cents each, or nearly 7.1%, to close at $11.66 yesterday (Thursday), the stock is down 82% from its 52-week high of $66.13. Independent researcher Soleil Securities Group Inc., this week initiated coverage of Western with a “Sell” rating and a target price of $8, contending that the company is highly leveraged and has seen its shares suffer in concert with its peers as part of a general sector downturn. That underscores the sentiment these companies face. But a return to its 52-week high would represent a 467% gain.

The Only Three Moves That Will Stop the Oil Price Advance

Keith Fitz-Gerald — Thu, 22 May 2008 12:42:39 +0000

An Open Letter to Congress: First there was the trillion-dollar pork fest for energy. Then there was the decision to go with corn-based ethanol.

Now, Congress has voted to stop adding oil to the national Strategic Petroleum Reserve (which was created in the 1970s to smooth out pricing disruptions and supply problems).

Talk about missing the point!

Sure you could argue that by putting less into the strategic reserves we could take some of the pressure off price… and by implication help bring it down from its record level at more than $130 a barrel.

I mean it sure sounds good in theory, especially in an election year. But in reality the strategic petroleum reserves would last only 2 months, even if we cut off all imports tomorrow. So there’s simply not enough volume to make a dent in recent price hikes.

Nor can we drill or refine our way out of this mess, as President George Bush seems to favor. In a recent interview with Yahoo! News, the president suggested both as alternatives when in reality we can do neither.

For one thing, refiners are the ultimate middlemen and they’re pinched at these prices. They simply can’t make money as they try to refine an increasingly expensive product and sell it to users who are chaffing at $4 a gallon. That’s why stocks like Western Refining Inc. (WNR), Tesoro Corp. (TSO), and Valero Energy Corp. (VLO), for example, have fallen by nearly 30-40% in recent months. Their margins get worse with each up-tick in oil prices from here on out now that we’ve reached a point where high prices are beginning to dampen demand.

For another, drilling and refining our way out of this assumes we have oil to begin with… we don’t. And even if we turn the Alaskan Tundra into Swiss cheese, the demand reduction we’re seeing here in the United States is being dramatically offset by developing countries that are guzzling gasoline at unprecedented rates.

In fact, those are precisely the reasons that I’ve been predicting for years that oil prices were headed skyward and why I’ve just recently boosted my target price for crude oil to $225 a barrel.

For what it’s worth, here’s my simple three-step plan.

Encourage people to use less. This is not rocket science, guys, and I have no idea why our leadership can’t understand this but apparently logic doesn’t apply inside the Beltway. Our current fuel standards literally date to the 1970s and pre-date the emergence of both mini-vans and gas guzzling SUVs. They average 25 mpg when we all know damn well that manufacturers around the world are fully capable of building 40-50 mpg cars and are doing so for other markets like Europe and Asia where…taa daa…they sell a ton of small, zippy, gas-efficient vehicles.
Create incentives for this to happen. Instead of providing pork laden tax breaks to the oil industry and stimulus packages that are simply nothing more than a glorified handout, why not shift the money to the consumers who need it? Seems to me that once people figure out they have a meaningful and lasting way of saving money, they’ll not only make it happen, but line up immediately to get started.
Reward those that develop alternatives. We have some of the best brains in the world in places like Silicon Valley and our University System. The fact that they’re not working overtime on this issue suggests to me that they’re not being prodded in the right place. We would easily jump start this process and conservation by rewarding alternative development and usage.

Call me crazy, but there’s a reason why they call it “supply and demand.”

The bottom line is that if we demand less, prices will come down.

Source: The Only Three Moves That Will Stop the Oil Price Advance

Contrarian Stock Market Investing News - Featuring Bargain Stocks » WNR

Special Energy Indicator Points Toward Higher Gas Prices and a Potential 467% Profit Play

The Subsidy Gambit

The Best Way to Play the Shift From Subsidies

The Only Three Moves That Will Stop the Oil Price Advance