From: Nicole Urken
Sent: Wednesday, September 5, 2012 10:29 AM
To: James Cramer
Subject: Refiners

To supplement HollyFrontier stats, astounding performance in the refiner group over the last year including Marathon Petroleum (MPC), Tesoro (TSO), Valero (VLO), and Western Refining (WNR)

From: James Cramer
Sent: Wednesday, September 5, 2012 10:31 AM
To: Nicole Urken
Subject: RE: Refiners

These have been remarkable—more than just a trade

From: Nicole Urken
Sent: Wednesday, September 5, 2012 10:32 AM
To: James Cramer
Subject: RE: Refiners

Yes, brent-WTI spread proving to be more than a short-term trend

On Mad Money, our previous negative stance on the refining companies, was predicated on a number of points: (1) A structural ‘goldilocks’ problem: Refiners benefit from higher oil prices, but when those prices are too high, it begins to crimp demand.  We worried that the price had to be ‘just right,’ leaving mama bear and papa bear in the dust.  (2)  The spread between West Texas Intermediate (WTI) crude traded at the NYMEX and Brent crude traded at the Intercontinental Exchange (ICE) that benefits the group would not last, (3) The choice for integrated oil companies to spin off  their downstream businesses from upstream reflected poor fundamentals for refining, and (4) Refineries are old with operational issues and also vulnerabilities to outside risk factors like extreme weather. Because of these reasons, we saw that the refiners represented a more risky cohort of the energy group that should be seen as trading mechanisms without lasting power.

(Read More: 2 'Terrific' Buying Opportunities.)

However, as the refiners have continued to surge, we took a closer look at industry dynamics with HollyFrontier President and CEO Mike Jennings last Wednesday. While we have emphasized how the continued boom in onshore shale plays—including Eagle Ford, the Bakken and the Permian Basin—has been aiding exploration and production companies like EOG Resources not to mention providing a solid demand environment for the pipeline master limited partnerships (MLPs), we failed recognize just how much the shale revolution was creating a long-term dynamic that is positive for the refiners as well.

So what’s the deal? And why do names like Holly Frontier remain a compelling investment here?

1. Demand for oil has proven to remain solid, even amidst anemic economic growth and a “new normal” of higher unemployment.
2. The disconnect between WTI prices and brent crude prices, benefitting margins and pushing up the refining stocks, is not a short-term phenomenon. Why? First, background: The input costs of a refinery is represented by the WTI price while the price charged at the pump is much better represented by the Brent price. The spread between the two has been experiencing new highs, because WTI (based on oil prices in Cushing, Oklahoma) has been depressed due to increasing oil production in the Bakken, Permian Basin, and Eagle Ford along with Canadian oil sands. Oil from these regions is flowing through pipelines into the middle of the country but can't easily reach the Gulf, Pacific or Atlantic coasts. All the trapped oil is giving mid-continent refiners a cheap crude source. We thought this was a short-lived phenomenon, as pipelines (such as the Seaway pipeline) were reversed and more infrastructure were built to move the oil.  However, the infrastructure is still years behind. And so refineries in the middle of the continent like HollyFrontier are buying the lower priced oil in the middle of the country and selling it at a higher price.
3. Ultimately, the large integrated companies that have split up their upstream exploration and production business from downstream refining and marketing businesses didn’t do so because the latter was a weak business but to enhance value of each segment. As we have seen Marathon’s refining business Marathon Petroleum Corp has performed very well since its debut, as has Conoco’s refining business Phillips 66.
4. While the aging of refineries does remain a concern, high quality names like HollyFrontier have maintained their facilities. Furthermore, the refining companies that are located in the middle of the country, like HFC, are better positioned that those on the coast. HFC is also benefiting from synergies from its merger of Holly and Frontier, helping with costs.
5. As an additional note, many of the refining companies have begun to offer dividends that gives them a bit of a defensive flare. For example, HollyFrontier has offered a “consistent” special dividend in addition to its regular dividend, bringing its effective yield up to over six percent.

The bottom line: The refiners do remain a compelling investment within the energy space, even after the run. They too benefit from the shale revolution that is boosting many members of the group.

Other Mad Money random musings:

• Breaking up ain't hard to do: We continue to talk break-up plays on Mad Money, most recently highlighting the sum-of-the-parts value of Hess and Manitowoc.  One point worth highlighting relating to this theme: AIG . There has been much attention on AIG this week after its very successful equity offering, reducing the government stake to just 15.9 percent.  Ultimately, this is a case study of a successful break-up story (albeit necessary) where its underlying assets were not being appropriately valued.  The company has gone from an overleveraged and highly complex diversified financial company to an organization mainly centered on core insurance markets, where it has significant strength and is a sweet spot of the cycle.
• Consumer discretionary remains strong: We got poor numbers from Burberry earlier this week, sparking fears about other retail names.  However, we have seen this story before at Burberry and its downside is case-specific. Keep your eyes on aspirational luxury names like Michael Kors and Coach that remain well positioned. (Related: 5 Stocks Set for Solid Earnings.)
• The bulls have been in the drivers’ seat of late—with positive news out in Europe (German Supreme court ruling) taking major fears off the front page, positive action at the Fed, and signs that China will continue to ease.  This makes the cyclical trade—mining, housing, financials, tech, materials and some industrials—most compelling right here.  Staples likely to suffer because of raw costs and defensive trades like big pharma are not in the sweet spot—higher beta healthcare that remains depressed like the HMOs look interesting here.  That said, it is key to remain diversified and don’t lose track of your defensive positions. Tidbits leading into earnings season.

Read on for Cramer's Top Dividend Stocks 2012

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