November was a busy month in general for oil and gas companies. Between the election of Donald Trump and OPEC's announcement of a production cut, oil and gas stocks were in a frenzy. Interestingly, independent refiners saw large gains this past month. Typically, rising oil prices mean smaller profits, yet these independent refiners all gained more than 10% this past month.
|Company||Price Change (11/1-11/30)|
|CVR Refining (NYSE:CVRR)||15.6%|
|Delek US Holdings (NYSE:DK)||26.2%|
|Alon USA Energy (NYSE:ALJ)||22.1%|
The reason why these companies share prices gained so much isn't quite as obvious as it might seem.
One thing to remember when it comes to refining companies is that they don't typically do well when oil prices rise. The price of refined products typically lags behind that of crude oil, so rapid rises in crude normally narrow the price spread between the two and refining margins shrink. So this past month would normally be a tough time for refiners when oil prices have jumped from around $40-$42 per barrel to above $50 a barrel.
Thing is, the price jump for these stocks had little to do with the price of oil, but rather something else that a Trump presidency could potentially lead to: the lifting of Environmental Protection Agency (EPA) regulations on ethanol.
As it stands today, a certain amount of ethanol needs to be added to the pool of motor gasoline based on set volumes from the EPA. Companies that produce ethanol also produce what are known as Renewable Identification Numbers (RINs), which was a method the EPA had designed to keep track of total ethanol produced. For those companies that didn't produce ethanol themselves, they need to buy these RINs from either companies that manufactured ethanol or those that blended it into gasoline.
In theory, it makes sense as it would encourage the development of ethanol and let the market dictate pricing. The problem, though, is that there is a massive lack of oversight, it is an extremely opaque market, and it is rife with speculation and fraud.
For independent refiners such as CVR Refining, HollyFrontier, Delek, and Alon that don't have blending or retail assets that can help generate RINs, they have been stuck paying very high prices for RINs lately and it has deeply impacted their businesses. CVR Refining CEO Jack Lipinski has stood on his soapbox multiple times during recent conference calls to talk about why this has been such an issue for independent refiners.
So, there is hope that a Trump presidency will rectify this. One goal Trump stated a few times throughout his campaign was that he will get rid of regulations that hurt business, and one government agency that he routinely pointed out was the EPA.
One of the weird ironies of this plot is that most independent refiners don't want the ethanol rules completely scrapped. Rather, they are looking for a more transparent market for RINs and some tweaks to the laws for how RINs are sold and traded. This, they believe, will prevent overly burdensome costs on refiners without blending or retail assets.
If this were to happen in the future, then it would certainly give each of these companies a decent boost as it reduces operating costs. This, however, is a situation that has yet to happen, and the rapid rise in crude oil prices is likely to affect these companies' profits in the coming quarters. So investors jumping in on the news on what could happen with Trump as president need to keep in mind that it could be a while before these changes happen, if they actually happen at all. There are reasons to buy a quality independent refiner that runs an efficient operation and keeps costs low, but betting on a potential legislation change isn't the way to do it.
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