5 Fine Refinery Stocks

Surprisingly, the finer stocks in energy right now are the refineries. U.S. oil and gas refineries are experiencing a reversal in fortune after skyrocketing crude oil prices scorched margins this summer.

Refineries' margins, which result from purchasing crude oil from companies such as BP (NYSE:BP), converting it into gasoline, and then selling it to consumers, are coming back. Refining margins -- the difference between crude oil cost and gasoline price -- were up more than $12 a barrel as of Tuesday, from $0.02 at the beginning of the year, according to The Wall Street Journal. Tesoro (NYSE:TSO), the third largest refinery in the U.S., said this week that it expects fourth-quarter earnings to trump analysts' forecasts, since margins improved in the quarter.

Margins have widened across the spectrum of refineries since the cost of crude oil has come down, and the profit made from the sale of gasoline has increased markedly after supplies have tightened due to reduced production from unplanned refinery maintenance. U.S. demand for crude oil declined in 2008 to the lowest level in five years, as the recession curtailed demand for energy. The price of a barrel of light sweet crude is currently trading in the mid-40s, down from a high of $147 a barrel back in July.

Meanwhile, as consumers have cut back on driving, refineries have cut production by 2% according to the American Petroleum Institute. This has caused declines in supply and slight increases in gas prices. Gas prices averaged $1.68 for the month of December and are up 6% since to $1.78, as of Jan. 12, according to the Energy Information Administration (EIA). The EIA predicts gas prices will average $1.87 for 2009.

Follow the money trail
Improved margins account for a lot. The oil and gas refining industry group is up 12.4% over the past three months, outperforming 90% of all sectors. To follow the money and uncover refining companies that are the cream of the crop, I put the Motley Fool's CAPS screening tool to work. I searched for companies in the energy sector with:

• CAPS ratings of four and five stars, the highest ratings from our CAPS community. During the first 20 months for which we have data, four-and-five-star companies have outperformed the market, with average annualized gains of 7% and 12%, respectively.
• Return on equities of 15% or greater to ensure efficient companies.
• Market caps of $500 million or greater.
• Within the search results I looked for refineries in particular.

After running the scan, here's what I found:

*All numbers from Motley Fool CAPS. TTM = trailing 12 months.

While the outlook for refineries has improved, that doesn't mean it's time to jump in feet first and buy these stocks. Forming a watch list of refineries to see if margins are sustainable is the best move right now. Margins are coming back, and when the global economy stabilizes, refineries could be a good investment niche within energy, as long as oil doesn't soar too high. Also, gasoline-powered vehicles will still outnumber energy-friendly vehicles in the near- to mid-term, which will also bode well for refineries. The price and demand for gasoline should be used as a guide to the success of refineries.

Also remember that using the screener is a great way to identify winning companies, but that this should only be the first step in your due diligence. As always, remain mindful of the stock's valuation, fundamentals, and growth prospects.

Start refining your portfolio at Motley Fool CAPS today! Let the collective wisdom of our 125,000 member-strong investment community help you make better investing decisions.

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