The star stocks and stellar returns of the US refining industry (Part 3 of 7)
The refining industry’s profitability is broadly determined by the difference between the revenue it earns from selling refined products and its input costs. This cost is driven by price of the crude oil it uses. The industry’s revenues are determined by the prices of the fuels like gasoline, diesel, and jet-fuel that it produces.
The difference between revenue and cost is called the “crack spread.” The spread is fundamental to the refining industry’s profitability. Read Market Realist’s 101 on crack spreads .
The wider the crack spread (or refining margin) for a refinery, the more profitable it would be compared to a peer, everything else being equal.
As you can see in the graph above, not only has refining companies’ profitability picked up substantially in the last five years, but North American refiners’ overall profitability is higher than the rest of the world’s. These refiners include Valero Energy (VLO), Phillips 66 (PSX), and Marathon Petroleum (MPC).
European refiners, for example, haven’t fared as well lately. This difficulty is due to narrower refining margins resulting from expensive crude supplies and weak fuel demand in Europe.
U.S. refiners have been enjoying higher profitability for three reasons:
- American refiners are more “advanced.” They can process more difficult (cheaper) crudes and also produce more profitable products.
- Because of the recent shale boom, U.S. refiners get the benefit of cheaper natural gas to fuel their refining units.
- Again because of the shale boom—and effectively a ban on exports—American refineries have access to cheaper crude compared to refiners elsewhere. Meanwhile, they still get international prices for their refined products. This is because refined products can be freely exported.
The PowerShares Dynamic Energy Exploration & Production Portfolio ETF (PXE) and the Energy Select Sector SPDR Fund (XLE) ETF would also be good ways for you to gain diversified exposure to refining companies. But XLE isn’t as heavily weighted towards independent refiners as PXE.
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