The Commodity Investor Q&A
With Matt Badiali
March 19 , 2008
Q: I always see stories about China's big increase in auto use and fuel consumption... Where will the country get the oil it needs? – S.H.
A: Anywhere it can. That includes all the places U.S. companies are not allowed to go. In fact, according to the Mining Journal, China recently signed more than $100 billion worth of energy deals with Iran.
In addition, Chinese companies aren't afraid of Africa. I read recently that China will try to supply 40% of its oil and gas imports from Africa in the next five to 10 years. Angola is already its largest source of foreign oil. Chinese companies have invested $30 billion in Africa's oil and gas industry so far.
Much of this investment is in countries that are considered unsavory by American voters and investors. Remember when Warren Buffett was called out last year for his investment in PetroChina? Protesters said he should divest his shares because PetroChina does business in the Sudan. The authoritarian Chinese government doesn't entertain that kind of shareholder complaint.
To me, that means long-term oil assets are going to become increasingly valuable. China is far, far behind the U.S. in oil consumption per person, and it's playing catch up. This competition will be unlike anything we have seen in the past... The days of cheap oil and gas are behind us, and investors would do well to look for undiscovered ways to profit.
Q: Refiners aren't making any money right now... Why is this a good time to buy? – M.B.
A: Yes, I believe there is an investment opportunity in refiners right now. And yes, the share prices of these companies have been killed recently, along with their earnings.
That's because the price of refined products versus the price of oil is way down. This ratio is simply the price a refiner can get for its finished product (output) versus the price it has to pay for oil (input). A low ratio means refiners aren't making a whole lot of profit.
In this table, you can see this ratio in terms of gasoline, diesel, and heating oil...
|
Highest Ratio |
Lowest Ratio |
Average Ratio |
Current Ratio |
Diesel |
82% |
-1% |
19% |
33% |
Gasoline |
83% |
-4% |
24% |
-1% |
Heating Oil |
118% |
-7% |
17% |
28% |
Gas & heating oil data from 1988 to present, diesel from 1993 to present |
|
What I'm showing you is the margin you would receive for a barrel of refined product over a barrel of West Texas Intermediate (WTI) oil. For example, a barrel (42 gallons) of gasoline is worth less than a barrel of WTI right now! That means refiners must find discounted, low-quality oil to make any margin at all.
As you can see, the refiners must be making up some profits on heating oil and diesel fuel. But I think the margins on gasoline, and therefore the earnings of the refiners, are about to get better.
Analysts told Oil and Gas Investor that they expect the spot price of gasoline to hit $3.10 per gallon this summer. After transportation costs and taxes are figured in, that'll equate to $4 per gallon at the pump. If oil just moves sideways, I think steady demand from drivers will keep fuel prices high.
Given this situation and the washed out shares prices in the sector, I think we're due for a rally. However, if you speculate on refiners, mind your trailing stops because it's a volatile sector.
Good investing,
Matt Badiali
