The sweet spot of the North American shale boom has moved on from the rock formations thousands of feet beneath the Earth to the refinery towers and stacks looming above it.

Refiners are feasting on a record domestic crude glut that’s rapidly filling up limited storage capacity, while selling to consumers who are driving and flying more in response to the energy discounts.

This glut has, for the moment, capped the recent bounce in the price of domestic crude, oil’s first sign of life since the autumn crash.

The benchmark West Texas Intermediate (black line, left-hand scale below) is still more than $5 a barrel cheaper than during the panic of mid-December. Meanwhile, wholesale gasoline (blue line, right-hand scale) is up 10% or so over the same span after a sharp move higher over the last month.


U.S. gasoline demand has been running 3% to 6% above year-ago levels since December. Even more encouragingly for refiners, domestic distillate demand (mostly for diesel, which last month earned them three times the per-gallon margin of gasoline) was recently up 11% year-over-year.


Source: U.S. Energy Information Administration 

This has translated into dramatic outperformance for the six refining stocks in The Energy Strategist portfolios over the last six weeks. Since Jan. 14, they’re all up in the range of 37% to 42%, while the broad Energy Select Sector SPDR ETF (NYSE: XLE) has gained not quite 8% over the same span.


Even refiners who reported disappointing quarterly results, like HollyFrontier (NYSE: HFC) and CVR Refining (NYSE: CVRR), have done well. Meanwhile industry leaders generally exceeded expectations and the year-ago numbers, as detailed in the next article.

And then there was Western Refining (NYSE: WNR), which made an extra $200 million in the just-reported fourth quarter as input costs at its two directly owned refineries slid much more sharply than product sales, which were aided by fatter markups at Western’s 261 filling stations.

Gross margin per throughput barrel just about tripled year-over-year. And it’s risen sharply from those levels so far this year. In addition to the supply and demand factors noted above, fuel prices have been propped up by a strike now affecting 12 U.S. refineries. In the near future Western should also benefit from last week’s blast at ExxonMobil’s (NYSE: XOM) southern California refinery, which has sent crack spreads there sharply higher in a disruption likely to ripple into Western’s turf in Arizona.

Western has an enterprise value of  $5.3 billion, and returned $553 million to shareholders last year via share repurchases and regular and special dividends, all without appreciably increasing its debt. Western partially financed this largesse by selling logistics assets into an affiliated master limited partnership. The MLP trades at a dramatically higher valuation that the parent’s EV/trailing EBITDA of 4.8.

Given the overwhelming likelihood that much of the current windfall will end up in shareholders’ pockets soon enough, we’re upgrading WNR to a Buy below $57.

We’re also on recent record recommending continued buying of CVRR below $26 despite its stumble late last year.

There are undoubted risks to the current refiner party, including higher crude prices that sap demand, weaker economic growth that saps demand, efforts to undo the ban on exports of U.S. crude and competition from new Asian refineries. But none of these factors are likely to prove as decisive as the continued availability of cheap domestic crude in a period of growing U.S. and global demand.

With that in mind, we’re also upgrading Valero Energy (NYSE: VLO), Marathon Petroleum (NYSE: MPC), Tesoro (NYSE: TSO) and HollyFrontier (NYSE: HFC) in our portfolios. Buy VLO below $70, MPC below $118, TSO below $105 and HFC below $50.

In addition, we’re adding two more refiners to the mix. Delek Holdings (NYSE: DK) is the sponsor of the Delek Logistics Partners (NYSE: DKL) MLP we first recommend late last year. Like Western, it’s enjoying fatter margins and reduced costs at its two refineries in Eldorado, Arkansas and Tyler, Texas. The company is has almost no net debt and continued upside from the current expansion of the Tyler plant, growth of its local crude gathering capabilities, asset dropdowns to the MLP and pipeline access to discounted crude from the Permian basin.


Source: Delek Holdings presentation

Perhaps most attractive of all is Delek’s significant retail operation, with 366 stores located mostly in Tennessee, Alabama and Georgia. Same-store sales are up 9% year-over-year so far this quarter.

With a big capital projects out of the way and rapid profit growth supporting a new $125 million share repurchase authorization for 2014, the path of least resistance for the share price is higher. We’re adding Delek to our Growth Portfolio. Buy DK below $44.

Our other new recommendation is Alon USA Energy (NYSE: ALJ), one of the cheapest refiners out there, befitting its lack of scale and diversification. Alon operates a refinery in Big Spring, Texas in the heart of the Permian Basin via a majority-owned MLP , Alon USA Partners (NYSE: ALDW).

ALJ also operates a light sweet crude residual cracking refinery in Krotz Spring, Louisiana, a 296-store chain of filling stations located mostly in Texas and 10 asphalt terminals across Western U.S. that make it a leading supplier in the region.

The stock is up a relatively modest 10% year-to-date and could chase its sector higher. We’re adding Alon USA to the Aggressive Portfolio. Buy ALJ below $16.