CNBC Guest Blog

Published: Tuesday, 20 Oct 2009 | 9:40 AM ET

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Stephen Schork
Editor of
"The Schork Report"

Energy prices were strong on Monday… spot crude oil in New York ticked ever so closer to $80, while oil in London took out last summer’s 77.71 high print. Meantime, natural gas futures in New York faded initial weakness, but then rallied hard. Thus, at this point there is no real point in stepping in front of the NYMEX/ICE freight train.

Last Thursday, analysts at Morgan Stanley named Sunoco

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[SUN  Loading...      ()   ] as their top pick in the refining industry, leading shares to shoot up 9.5% to $32.61 by Friday.

Their analysis must have come as a surprise to the analysts at Moody’s who lowered Sunoco’s rating on October 7th from “Stable” to “Negative”, not to mention the 400 workers recently furloughed at Sunoco’s Eagle Point refinery in New Jersey after the company idled the facility there indefinitely.

Regardless, major refiners felt the knock on goodwill, with Valero Energy

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[VLO  Loading...      ()   ] rising 7% and Tesoro Corp.

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[TSO  Loading...      ()   ] rising 8.6%.

Moving beyond the equities markets, does Morgan Stanley’s analysis imply that crack margins will improve, leading to better returns for refiners?

Or is a buy signal on Sunoco simply due to better cash management and balance sheet magic, exemplified by shutting in their NJ refinery?

According to Bloomberg’s article,

“Refiners will increase in value as diesel demand strengthens and production cuts reduce supplies…

…Sunoco is likely to bounce back most quickly on the strength of its non-refining businesses.”

Sunoco equity purchased on the strength of the first statement could be on shaky ground.

Diesel demand has been middling for the last two years and shows little signs of a recovery in the short or long term. Diesel demand for September 2009 was 3.66 MMbbl/d, just 2.1% lower than the 3.73 MMbbl/d value for September 2007, a time when exports, rural driving for leisure and urban driving for industry were booming. If anything, diesel demand has held up well in comparison to industrial production, but expecting a recovery when we’re practically already at 2007 levels is myopically optimistic.

According to our analysis here at The Schork Report, the second argument, that Sunoco might be a good buy due to its non-refining business holds more water. In the short term, the 321 crack margin (the so-called “refiner’s crack”) has a third quarter average (2003 to 2007) of $6.99, and as of the end of last week it was at $5.31. That means we could see further strength for refiners as units enter turnaround season, especially if analyst predictions for a harsh winter hold true. Sunoco’s prices regressed on the crack margin alone would imply a stock price of $33.63, slightly above last week’s closing price. Thus, with Sunoco trading down below $30 prior to the Morgan report, it appeared the stock was undervalued, relative to the crack market.

However, the market is now in the process of arbing that differential out. Anyway, indefinitely idling its NJ refinery will also lead to $250 million in savings for the year. It is no coincidence that Valero Energy, whose price rose 7% on Friday, also announced plans to lay off 100 workers, or 20% of the workforce, at its Paulsboro refinery in NJ.

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Stephen Schork is the Editor of, "The Schork Report" and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.

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