Inside the Madness

Don’t Play the Goldilocks Game with the Refining Stocks

Nicole Urken, Mad Money Research Director

From: Nicole Urken
Sent: Tuesday, January 10, 2012 5:44 PM
To: James Cramer
Subject: MPC

Marathon Petroleum announced the co expects to report a small loss for Q4 vs. $1.00 consensus estimates —Case in point why we warned against MPC (refiner) vs MRO (E&P). Q4 results were negatively impacted by increase in price of West Texas Intermediate (WTI) crude oil.

From: James Cramer
Sent: Tuesday, January 10, 2012 5:51 PM
To: Nicole Urken
Subject: Re: MPC

Refiners no good

Nicole Urken, Mad Money Research Director

From: Nicole Urken
Sent: Wednesday, January 11, 2012 5:16 PM
To: James Cramer
Subject: Re: MPC--CVX

More bad news on the downstream side at CVX:

Chevron expects Q4 EPS to be significantly below Q3 2011 results…while upstream earnings projected to be comparable with 3Q, downstream earnings in 4Q expected to be near breakeven. Lower margins and refinery input volumes, and the absence of an asset sale gain are expected to reduce downstream earnings significantly compared to 3Q results

From: James Cramer
Sent: Wednesday, January 11, 2012 5:48 PM
To: Nicole Urken
Subject: Re: MPC--CVX

Let’s take a look back at the sell block segments we’ve done on this group.

This week, the interim report from integrated oil name Chevron and the profit warning at Marathon Petroleum Corp —the fairly new refining spin-off from parent Marathon Oil Corp —are just the latest signals suggesting a tough quarter for downstream (or refining) earnings.

Frankly, these latest negative pre-announcements weren’t all that surprising, particularly after refiner Tesoro last week projected a fourth quarter loss, noting an “extremely weak margin environment.” On "Mad Money," we have placed these names in the dog house continually. Why? Because they are ultimately trading vehicles and extremely difficult to game.

After all, the refining business is all a margins game. At the end of the day, refiners make money based off of the spread between their input costs (they pay West Texas Intermediate prices for oil, traded at the NYMEX) and what they charge at the pump (based on Brent Crude prices, traded at the Intercontinental Exchange, ICE.  In 2011, the large spread between WTI and Brent was not typical—with WTI artificially held down by a supply glut in Cushing, Oklahoma, among other factors.  As this spread continues to narrow—as it has been over the past several months (since its highs in the early fall)—refining margins will continue to be pressured which, consequently, will place downward pressure on the underlying stock prices. Plus, the refining business is a game of Goldilocks, as we’ve explained on "Mad Money": The companies need the price of oil to be not too high, not too low, but JUST right.  After all, while higher oil prices can mean refiners can charge more at the pump, once that price hits $4 a gallon for gasoline, that starts to affect the demand side of the equation, affecting driving habits.

Ultimately, refining is just a very tough business…and it certainly is not a growth area—that’s exactly why so many of the big integrated oils like Marathon and Conoco are splitting off or moving away from it.  (Marathon spun off its refiner in July of last year;  Conoco announced a plan to spin off its downstream biz back in July). Both of these companies want to focus instead on their growth business—exploration & production (E&P) which will be rewarded with a higher multiple.  Even refiner Sunoco has been getting rid of many of its refineries in order to focus on the highest quality assets.

Given a bottoming in WTI (particularly following the announcement of the Seaway pipeline reversal, easing some of the supply glut issues in Oklahoma), a relative narrowing of the spread does not bode well for the refiners in 2012.  And more pain can remain ahead, even after the latest sell-off in the group.

Most importantly, though, the refiners are just not the cohort you want to be in within oil stocks, even if you are bullish on Brent prices moving up.

For those that argue Brent will continue to rise (based on Europe concerns being contained, the possibility that China starts massively easing, continued signs of robust worldwide demand, and Iran supply shortages courtesy of international tensions), there are better ways to play the upside: The oil services companies with international leverage.  First, oil services companies will benefit the most when oil companies are flush with cash and the price of oil is high… because they will spend more (and thus help the oil services names). We are in a situation now where oil companies have both the ability and incentive to spend money in order to find new sources of crude and get more out of their existing finds. While North America shale play upside has driven servicers over the last year, the next leg of growth will be international.  Plus, the international oil-levered names aren’t as exposed to potential effect of reduced rig counts from still-low natural gas prices. Among the best situated is Schlumberger , where international markets account for 80 percent of total revenue.  Another key play? Weatherford .  While its high cost structure and less consistent earnings results may keep you up at night, this name—with a strong international footprint—has even stronger potential upside and operating leverage. Particularly if it gets under $14/share, it’s a screaming buy.


The bottom line: If you believe Brent in on its way up, don’t play Goldilocks with the refiners, even after the pullback—That game is just too hard. And you don’t want to take papa bear’s chair anyway. Instead, you should go with internationally-levered oil services names, like Schlumberger or Weatherford.

"Inside the Madness" appears twice a week at

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