Prices at the gas pump are going through the roof, and the summer driving season is still months away. You might be thinking you can still get in on some of the profits by investing in oil refiners, the companies that sell high-priced gasoline. Think again. In this volatile, cyclical business, you've probably missed your chance.
Sure, it's hard not to be tempted by refining stocks. Coming off a great year in 2003, U.S. refiners are entering another. Consider the whopping profits enjoyed by the biggest independent refiner, Valero Energy (NYSE:VLO). Analysts expect $6.30 in earnings per share from Valero in 2004, up from $5.08 last year. Then there's Frontier Oil (NYSE:FTO): Its earnings are expected to leap this year from $0.50 to $1.45. Integrated oil players like ExxonMobil (NYSE:XOM) and ChevronTexaco (NYSE:CVX) are making big gains from their refinery assets.
The typically low-return refining business is hot, spurred by a strengthened economy and changes to gasoline specifications, a combination that has tightened supply and boosted the refining spread above historical levels. Demand for gasoline is so darn high that prices have been going up faster than crude oil prices. That makes for big profits.
But the big money is not necessarily here to stay. Refiners' profits are closely tied to swings in gasoline inventories. Where you see a short supply of gasoline, you'll see acceleration in refiners' earnings, for sure. But an unexpected leap in inventories can swiftly erase any gains. An unseasonably warm winter or even the hint of an economic downturn can throw margins back into the red. Besides, it doesn't take long before high pump prices actually hurt refiners by dampening demand.
Today's high profit margins could be just a blip. In its March presentation to analysts, ExxonMobil described a "clear downward trend" in refining margins in real terms since 1988, with inflation and other cost pressures squeezing the business, in addition to the cost of meeting regulations.
Refining stocks have jumped 20% to 25% this year, on top of an 80% gain in 2003. Valuations at Valero Energy, Frontier, Marathon (NYSE:MRO), and Premcor (NYSE:PCO) are stretching, if not topping, their historical trading ranges. There isn't much room for margin slippage.
Look back over the long term and you'll see that refining is a tough business where single-digit returns are the norm. In refining, short-term investment opportunities come and go. The latest one has probably gone.
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Fool contributor Ben McClure hails from the Great White North. Ben doesn't own any shares mentioned here.
