Can it be that only eight weeks have gone by since we included three refiners among our top five Best Buys? Yes, it can, even if eight weeks can seem like an eternity in energy investing.

Since that call, many of the refining stocks in our portfolios set new record highs, only to get whacked hard in August’s market turmoil.

We now believe there’s worse to come, which is why we’re urging subscribers to dramatically reduce exposure to this sector.

For much of the year to date, refining margins have been abnormally high, boosted by a combination of heavily discounted domestic crude and near-record gasoline demand as a consequence of lower pump prices.

More recently, the margins (known in the industry as crack spreads) have regressed, hardly unexpected with the summer driving season now over. And while share prices have pulled back as well, they haven’t pulled back enough given the rising risks of a refining slump.

This volatile industry suffers more than its fair share of those, and the next one could be worse than the stretch between May and October of last year that saw Valero (NYSE: VLO) drop 25% and Marathon Petroleum (NYSE: MPC) 21%, peak-to-trough.

Then, the problem was triple-digit crude and sluggish fuel demand dampened by the high prices. Now crude is cheap and gasoline demand high, but both of those trends are getting long in the tooth. And the refiners have far more to lose this time around once those tailwinds reverse.

No one, of course, knows exactly when that might happen. But it’s only a matter of time, for a couple of reasons. One is that crude won’t stay at $45 much longer in the absence of a global recession that’s not in the cards – that price is just too low to produce satisfy the ongoing growth in demand for long.

The other threat is from heavy Middle East and Asian investment in new refineries, which are already dampening the boom in U.S. fuel exports over recent years. U.S. refineries ran all-out this spring and summer to process discounted crude — as did many of their overseas rivals. The result is that some of the recent crude glut has been transformed into a surplus of diesel now selling below the price of gasoline. And while gasoline demand has been running at record levels in the U.S., it can’t be expected to keep growing now that lower fuel prices are no longer a novelty.

Valero has returned 67% for the Growth Portfolio in less than two years, and our recommendations of Marathon and Tesoro in 2013 have also proven rewarding. Alon USA Energy (NYSE: ALJ) is up 34% since we recommended it as part of the Aggressive Portfolio in March.


But the trends responsible for this outperformance are under growing strain as oil producers retrench, automakers continue to improve their vehicles’ fuel efficiency and new overseas refineries compete aggressively for market share.

Refiner share prices owe a lot to the events of the past year. And yet as shale drillers have proven over that span, investing in energy stocks based on the fundamentals that soon may not apply can be very, very costly.

Refiners stocks won’t necessarily suffer an implosion of shale proportions: that’s the worst-case scenario and hardly the most likely. But it’s difficult now to see where the additional upside will come from, given the likelihood of more expensive crude and an increasingly competitive refining market that’s unlikely to sustain its recent growth rate.

As a result, we’re recommending the sale of Alon USA Energy (NYSE: ALJ), CVR Refining (NYSE: CVRR), Western Refining (NYSE: WNR), Delek Holdings (NYSE: DK), HollyFrontier (NYSE: HFC), Marathon Petroleum (NYSE: MPC) and Tesoro (NYSE: TSO).

We’re also advising selling half of your position in Valero (VLO). This is the only refiner we’re keeping in the portfolio, because Valero’s scale and balance sheet should cushion its decline when the downturn comes.

That’s still one more refining stock than was included in The Energy Strategist portfolios three years ago, and the decision to exit a group that’s done so much for performance has been very difficult, made more so by our bullishness on the refining stocks earlier this year.

But we can only take what the market gives us, and if one keeps demanding what is not forthcoming eventually the market will take its revenge.

We’re paid to analyze the energy sector with an eye not just on the present day but on how the future will diverge from expectations, because that’s what moves share prices.

And our sense is that expectations for the sector are increasingly based on favorable but unfortunately unsustainable recent trends. We expect to revisit many of the recommendations we’re exiting today at significantly lower prices down the road.

We’ve continuing to recommend additional exposure to refining via the refinery logistics MLP Delek Logistics Partners (NYSE: DKL), which remains a Best Buy. Its income stream is not dependent on its sponsor’s margins, only on its continued growth, which in Delek’s case looks likely.

Our abbreviated (and re-ranked) Best Buys list now looks like this:

1. Energy Transfer Equity (NYSE: ETE)
2. UGI (NYSE: UGI)
3. EQT (NYSE: EQT)
4. Magellan Midstream Partners (NYSE: MMP)
5. Enterprise Products Partners (NYSE: EPD)
6. Delek Logistics Partners (NYSE: DKL)
7. DHT Holdings (NYSE: DHT)
8. EuroNav (NYSE: EURN)
9. Cabot Oil & Gas (NYSE: COG)
10. SunEdison (NYSE: SUNE)

SunEdison’s now bringing up the rear as a direct consequence of the dramatic recent plunge in its share price (see ), which has made the stock inherently more risky and, obviously, much more volatile. But as its continued presence on this list implies, we think there’s big upside to the current price for speculators who can stomach the churning.

We expect to add more upstream picks to the Best Buys list in the weeks and months ahead. But first we need to see a meaningful upturn in the price as the market’s focus shifts from past oversupply to the coming declines in shale output.