Refinery Stocks: Crack Spread Error!

On June 21, I posted about the end of the rally for refinery stocks. The post coincided with the tail end drop in the two listed refinery stocks, PetronM & Hengyuan. Subsequently, both stocks recovered.

Chart 1: PetronM & Hengyuan's daily chart as at July 12, 2017 (Source: Shareinvestor.com)

For the next 2 weeks, I went back & checked on the chart for RBOB Gasoline Crack Spread Futures, Continuous Contract #1 at quandl.com (here) and I was perplexed by the recovery in our refinery stocks while the crack spread was still hooking down. After closer examination, I discovered that the chart on quandl.com was not updated. I was misled by the refreshed date (denoted as A) and data time period (denoted as B). In actual fact, the data points on the chart stopped somewhere in early March (look closely at the box denoted as C).


Screenshot of chart from quandl.com

That mistake prompted me to search for a new source of chart for crack spread. I found it at cmegroup.com (here) for the crack spread futures traded on NYMEX. The current weekly chart is given here. If you look at the chart below, you can see clearly that the crack spread futures recovered substantially in the past 3 weeks. That accounts for the recovery in the share prices of PetronM & Hengyuan.


Chart 2: Crack spread futures as at Jul 9, 2017 (Source: CMEGroup)

When I put the charts for crack spread futures and WTIC next to each other, I discovered the close correlation between crude oil prices and crack spread futures. How do refinery companies make abnormal profit?


Chart 3: WTIC & Crack spread futures as at Jul 9, 2017 (Source: Stockcharts.com & CMEGroup)

I found this comment in Quora to explain the outsize profit for refinery stocks:

Fuel prices tend to rise immediately upon news of higher oil prices, but refineries have often hedged against oil price rises and carry significant inventory.  During periods of rising prices, you can see modest increases in refinery profitability due to more valuable inventory and the positive effects of hedges made during low price periods.

The truly good times for refineries come when prices fall.  Margins explode because fuel prices will fall much more slowly than crude prices, and refineries delay their product price falls as much as possible in order to maximize profits.  This is common on the retail side of fuels as well, where a period of falling prices is often the only time retail fuel stations make better than break even on fuel.

Now we know better. So, the next time crude oil prices drop, you should consider buying refinery stocks.

Refinery Stocks Coming Under Selling Pressure

In May, PetronM and Hengyuan rallied strongly to their high. Since then, they have been sliding. Most investors would think that the reason for this is the drop in crude oil price. That's not quite right. 

 
Chart 1: PetronM's monthly chart as at Jun 21, 2017_10.00am (Source: ShareInvestor,com)

 
Chart 2: Hengyuan's monthly chart as at Jun 21, 2017_10.00am (Source: ShareInvestor,com)

I had posted before that the earnings of refinery companies depend on crack spread, which is the differential between the price of crude oil and petroleum products extracted from it. To give you an idea how that impact the earnings of these companies, I have created a graph comparing their earnings for the period Mar 2014 to Mar 2017 with the crack spread for that period. As you can see the earnings dropped whenever crack spread dropped. 


Chart 3: Crack Spread (Front Month) and PetronM & Hengyuan's profits for Mar 2014-Mar2017 (Source of Chart: Quandl)

Now, crack spread is again dropping. The smart money is again selling these stocks since they have rallied so sharply in May. If you have good paper profit sitting in these stocks, you should consider SELLING INTO STRENGTH.

Note:

I hereby confirm that I do not have any direct interest in the security or securities mentioned in this post. However, I could have an indirect interest in the security or securities mentioned as some of my clients may have an interest in the acquisition or disposal of the aforementioned security or securities. As investor, you should fully research any security before making an investment decision