Don't let it get away!
Keep track of the stocks that matter to you.
Help yourself with the Fool's FREE and easy new watchlist service today.
This article is part of our Rising Star Portfolios series.
The more I read about gasoline refiner Western Refining (NYSE: WNR ) , the more I like what I'm finding. In the article outlining reasons I picked it for my Rising Star portfolio, Messed-Up Expectations, I highlighted the improving margins contrasted with the poor expectations for free cash flow growth priced in by the market.
Today I'm going to expand upon two other reasons contributing to my purchase decision that you should consider.
Reason No. 1: Brent/WTI spread
Since the end of last year, the price difference between Brent North Sea crude oil and Western Texas Intermediate (WTI) oil, which is delivered to Cushing, Okla., has grown dramatically. Historically, the price difference has been only a few dollars, but since last December, it's expanded to as much as $20 per barrel.
There's been a fair amount of speculation on the reasons for this difference. Contributing factors seem to include disturbance in the Middle East and North Africa, most recently the Libyan civil war, driving up the price of Brent oil and an oversupply of crude oil being produced in the middle of the U.S. relative to storage capacity, holding WTI price down. Another factor is said to be the lack of pipeline capacity to move the cheaper WTI oil to the Gulf Coast, in part due to ConocoPhillips' (NYSE: COP ) -- part-owner of the Seaway pipeline between the Gulf and Cushing -- decision to run oil through the pipeline from the Gulf inland.
While alternate methods of moving WTI oil to the Gulf exist, such as trains, the infrastructure to offload the oil at the destination isn't completely in place. Further, using trains to move oil around means those tracks would be used less to move other goods around, such as food.
The recent move by the International Energy Agency to release 60 million barrels over 30 days will help lower the price of Brent oil in the short term, but in the longer term closing this gap will require a more permanent solution. Dahlman Rose & Co. analyst Sam Margolin said, "It's a small amount of oil the IEA is going to release and it makes for a nice headline but it doesn't change the fundamental picture. Nobody thought the $20 spread was going to last but it's still looking pretty healthy."
And therein lies the opportunity for Western Refining. Western doesn't need to buy Brent oil. Instead, it uses the cheaper oil produced in the midcontinent with prices tied to the WTI price. In the first quarter, this led to better margins and helped swing the company from a loss last year to a profit this year.
Other refiners, including Holly (NYSE: HOC ) and Frontier Oil (NYSE: FTO ) , will also benefit from using WTI or WTI-linked crudes. However, several, including Valero (NYSE: VLO ) and Tesoro (NYSE: TSO ) , are significantly exposed to the higher Brent prices.
Reason No. 2: A wider crack spread
The crack spread is the difference between the cost of crude oil per barrel and what the refiner can get for the products it makes from the oil. It's called the crack spread because refining oil into gasoline, diesel fuel, heating oil, etc. is referred to as "cracking."
For the first quarter, Western Refining had a crack spread of $18.28 per barrel, or $0.43 per gallon. In April, the spread had widened to $25.67 per barrel. A level of about $20 per barrel is expected going well into 2012 based on a continued significant Brent / WTI spread and higher demand for gasoline, according to management.
The U.S. Energy Information Administration (EIA) agrees. In EIA's June 7 report, it expects distillate fuel (such as motor gasoline) consumption to increase both this year and next, with motor gasoline being the fastest-growing category next year. It expects average U.S. retail prices for regular-grade gasoline to be $3.60 per gallon this year and $3.67 next year, up from $2.78 per gallon in 2010. The increase is due to higher average cost of crude oil and an increase in refinery margin. That margin was an average of $0.34 per gallon last year, but is expected to be $0.47 per gallon this year before moderating a bit to $0.44 next year.
Likely to buy again
I'm probably going to wait to hear how the second quarter went when management discusses results at the beginning of August before buying a second round of shares for the MUE port. I just want to make sure that the thesis is continuing to hold steady -- including improving margins -- and get more comfortable with the company.
Add Western Refining to My Watchlist and come discuss the company and the refining industry at the MUE discussion board. There I'd be happy to share tidbits such as how home heating oil and diesel fuel are pretty close to being the same thing, though I wouldn't put heating oil into a diesel car.
Get three more oil stock ideas by clicking here to download our free, new special oil report, "3 Stocks for $100 Oil."
This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios).