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My first purchase of small oil refiner Western Refining
The spread between prices of Brent oil and West Texas Intermediate, or WTI, oil is about $20 per barrel (Brent being more expensive) and is expected to stay there for at least the next year or two. In fact, it recently hit a record of $23 per barrel. One analyst thinks it could go as high as $50 per barrel by next spring.
This is a catalyst for Western Refining shares because Western Refining doesn't buy oil tied to the Brent price; it uses oil tied to the WTI price. However, it sells its refined products -- gasoline, diesel, aviation fuel, etc. -- at prices determined by the more expensive Brent price. And that means more profit for Western Refining. Do I have to draw it out further? With more profit, a higher share price should follow.
Western Refining, CVR Energy
Why and how long?
There are two questions investors need to answer, then. First, why is there such a disparity between the two oil prices when the historical difference has been just a few dollars and with WTI usually being more expensive? Second, how long will this price difference last?
The reason for the disparity comes down to Economics 101 -- supply and demand. There's too much oil coming to Cushing, Okla., where WTI oil is delivered. There is a lack, right now, of ways to move that oil toward refineries on the Gulf of Mexico and the East Coast. Plus, Brent oil's supply is being crimped with the civil war going on in Libya.
The inability to move the oil from Cushing to Gulf Coast refineries is expected to last for up to a couple of years, but it could be longer. The TransCanada
Rail is an alternative, but there's a lack of tanker rail cars, and refineries on the Gulf Coast aren't really set up to receive oil that way, though companies are working on those problems. A new rail terminal at Port Arthur, Texas, for example, should be completed by mid-2012.
Even if oil can be moved out of Cushing, will that be enough to close the spread? Some don't think so because of increased production from oil shale fields such as Bakken in North Dakota, which is contributing to the oversupply at Cushing in the first place.
Of the three refiners benefiting from the Brent/WTI spread I called out above, Western Refining has the lowest growth expectations priced in, as shown below.
TTM Free Cash Flow
|CVR Energy||$138 million||18.5% / 9.3% / 0%|
|HollyFrontier||$248 million||17.3% / 8.6% / 0%|
|Western Refining||$207 million||5.7% / 2.8% / 0%|
Source: Capital IQ, a division of Standard & Poor's, and author calculations. TTM = trailing 12 months.
*Shown as annual growth of FCF for first five years, next five years, and terminal growth, discounted at 15%, where the predicted price of the DCF model equals the last closing price.
As you can see, the market is expecting little growth from Western Refining, especially when compared with the other two. If Western Refining actually had priced-in expectations of 18%/9%/0% (splitting the difference), it would be priced at $37, some 83% higher than it is now.
Tomorrow, I'll purchase another $350 of Western Refining to increase the position in my Messed-Up Expectations portfolio to a mid-level 4%.
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