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dexion10 (27.67)

SHORT THE REFINER RALLY - I'VE LOST HOPE FOR 90% OF THE INDUSTRY

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August 08, 2008 – Comments (11) | RELATED TICKERS: TSO , WNR , VLO

I saw a post earlier today by goldminingXpert encouraging people to buy a refiner WNR.

I too used to be a bull on the refiners but the investment thesis is broken. There is no reason to expect these businesses to return to their recent profitability - in fact they are all going to return to their prior multi-decade trend of creating no value at all. 

This industry will not be healthy again until some of the poorest refining assets are shuttered and capacity is reduced... WNR and TSO have some of the poorest assets so I'd worry about bankruptcy in both cases... longer term this should benefit VLO, FTO, HOC - as they have some of the best assets - and they will survive the cycle. 

 Reasons to Short Refiners AFTER a sustained rally higher:

+ New U.S. capacity will destroy margins

+ New Foreign capacity will destroy export markets (diesel)

+ High debt in a time of rising corporate refinance charges 

+ Lower U.S. demand further destroys capacity. 

 

The fundamental causes are gone and they are not returning. While crack spreads (margins) may widen in the short term there will be a lasting margin compression for the industry

 I implore the author to do so more research here - this is a  super dangerous trade to put on. I'll explain below... but quickly here are the bullet points

I've done lots of research on this industry for months and the only stocks I'd own in this space are VLO, FTO, HOC, MRO - and I wouldn't own any of them in the near term except FTO because I believe they'll be bought and they have premium assets and no net debt.

Most of the other independents are in jeopardy of going bankrupt... they are high cost producers in a shrinking market.  Their replacement cost doesn't even matter because in some cases the capacity isn't even needed over the long-term. 

I won't despute that you can own all of these stocks for a trade 

Refining is a pretty miserable business it has been for decades... if you look at all the refininers charts they were flat lines below $10 $20 for over a decade... that tells you that these businesses didn't increase intrinsic value ... they were just barely servicing large debt loads with skinny profit margins.

 

Refiners are doomed here is why:


Remember the only reason these refining stocks popped the last few years was that oil refining capacity was tight and these guys had wider margins (crack spreads).

Now we have negative trends and secular changes that are going to challenge this industry for years until the weakest refiners like WNR TSO ALJ are put out of business. 

 

++ DEMAND SHOWS NEGATIVE GROWTH

Now we no longer have tight capacity because the U.S. population is driving less and switching to fuel efficient cars. 

 U.S. CAPACITY

Did you know that there is more U.S. Refining capacity coming online via upgrades from other major refiners like Marathon Oil and Valero. 

 

++ CAPACITY

New refineries are coming online overseas so export markets for diesel which have been propping up U.S. refiners will no longer be as viable and pricing will be destroyed... Additionally some of the new Asian refineries are more modern than many of our U.S. facilities so they are more efficient at refining gas for lower prices.

 

11 Comments – Post Your Own

#1) On August 08, 2008 at 9:28 AM, RVAspeculator (29.20) wrote:

Long term you are VERY correct, short term this pop may continue.

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#2) On August 08, 2008 at 9:57 AM, goldminingXpert (29.46) wrote:

it's a trade, not a buy and hold. As a trade, WNR will work out well--long-term, you are right it will fail.

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#3) On August 08, 2008 at 10:01 AM, dwot (47.53) wrote:

The debt bothered me on the WNR.  If they sell an asset, as they plan, and it makes a decent dent in the debt they might be ok, but the debt to what their actual profit was from the brief look I had was very scary for this company.  It is the type of thing that puts them at risk to go under.  I have no idea about what they could get for the asset they want to sell.

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#4) On August 08, 2008 at 10:03 AM, dwot (47.53) wrote:

Good post, from what I understand in Canada we have not enough refineries.

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#5) On August 08, 2008 at 11:06 AM, dexion10 (27.67) wrote:

Thanks for the comments everyone. 

I do agree with goldmining expert that refiners can be a trade.

I'd only roll with FTO VLO or HOC... becaue the risk reward is much better when your dealing with premium assets and better balance sheets.

FTO is highly profitable in comparison to others.

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#6) On August 09, 2008 at 12:38 AM, AnomaLee (28.64) wrote:

I agree with refiners as a trade, but I want to mention something else about refiners.

If the dollar continues to rally vs the Euro(as I'd expect) that lessens their nomimanl profitability from exports.

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#7) On August 09, 2008 at 4:20 PM, anchak (99.84) wrote:

Good post...especially coming from you...since we know you follow this space.

But the question is at hwat point int time do you renege on the short-term up trade ( in my case to recuperate losses) and go short - if at all?

Because general perception would be that with oil price dropping margins have a chance of improving and also there will a slight pick-up in demand. However, I think , this time people are serious about the fuel efficiency migration - there will slow and steady destruction in demand - Emerging economies will keep it up - but that's an anomalistic force working against the broader trend

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#8) On August 10, 2008 at 10:27 PM, dexion10 (27.67) wrote:

anchak - for now you can let your refiners run... over the near term there is a good long trade... as soon as it ends though go short the weakest links in the system...  the independent refiners with high cost assets that weren't upgraded for light sweet crude refining.

TSO WNR seem like the weak links. Let them rally hard and be marry...  but when the rally ends short them or pair trade them against FTO, VLO, or HOC.

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#9) On August 25, 2008 at 9:52 PM, TDRH (99.65) wrote:

I have seen a lot of arguements against the refiners and yours is one of the best.   My initial thought was that they would rebound eventually, but the higher price of oil decreases demand, and closes the spread. 

At the lower valuations though I would think that the assets of the smaller/weaker refiners you mention might be attractive for consolidation.   Not something you want to use as an investment premise, but still a possibility.

I still like Valero as well, it specializes in some of the heavier crude from Venezuela and other markets, and can be quite profitable if and when the price of oil rebounds. 

All in all though your position is strong and well thought out.

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#10) On August 25, 2008 at 9:53 PM, TDRH (99.65) wrote:

I have seen a lot of arguements against the refiners and yours is one of the best.   My initial thought was that they would rebound eventually, but the higher price of oil decreases demand, and closes the spread. 

At the lower valuations though I would think that the assets of the smaller/weaker refiners you mention might be attractive for consolidation.   Not something you want to use as an investment premise, but still a possibility.

I still like Valero as well, it specializes in some of the heavier crude from Venezuela and other markets, and can be quite profitable if and when the price of oil rebounds. 

All in all though your position is strong and well thought out.

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#11) On August 26, 2008 at 6:10 PM, dexion10 (27.67) wrote:

Thanks TDRH... - btw I'm glad you got the gist of my blog because it looks like I screwed up the editing and it was a bit out of order.

 

I think VLO is one of the only refiners worth owning but the risk reward isn't that good... FTO would be the refiner for me to own but it's hard to figure where the bottom is because we may just have to see some pain (some real blood from weak competitors) before the cycle turns and consolidation begins. 

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