Refine Your Portfolio With This Energy Idea
Several oil names could greatly benefit from soaring Gulf differentials, but one company remains our favorite.
We think wide Gulf Coast differentials are sustainable through 2014 and could move much higher as an additional 1.4 million barrels per day of pipeline capacity begins delivering crude to the Gulf Coast. Much of the additional supply is likely to be light crude, for which there is little incremental demand. Considering this, combined with an inability to export excess supply, a build in inventory is likely to occur. Our analysis indicates that inventory levels could breach the November 2013 peak, when Light Louisiana Sweet/Brent widened to $14/bbl, by March and again later in the year. As a result, Gulf Coast light crude differentials could soar beyond the market’s current expectation of $8/bbl, much like the West Texas Intermediate/Brent differential did previously. In this scenario, Marathon Petroleum (MPC) and Valero (VLO) are best-positioned to benefit. While trading near our fair value estimates, neither stock is currently pricing in a blowout in Gulf Coast differentials. Tesoro (TSO) remains our preferred refiner, as it trades at the greatest discount to our fair value estimate and holds the greatest potential for earnings improvement under current market conditions.
Why Did Gulf Coast Differentials Widen in the Fourth Quarter?
Gulf Coast light and heavy crude differentials widened substantially in the fourth quarter as low capacity utilization and a heavy turnaround schedule created a build in inventory. Turnaround activity affected approximately 700 mb/d of capacity and drove utilization down to a low of 87% in October and 91% for the fourth quarter. While in line with historical averages for that time of the year, the abundance of domestic crude and already-reduced levels of imports resulted in a spike in inventories. As a result, LLS prices averaged almost $8/bbl less than Brent prices during the fourth quarter after trading at a premium for the first three quarters of the year. Further benefiting margins was the concurrent drawdown in product inventories, which resulted in strong product margins. As a result, Gulf Coast refiners processing LLS at times realized higher margins than Mid-Continent refiners processing WTI.
Allen Good does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.