The Commodity Investor Q&A
With Matt Badiali
September 10, 2008
Q: What has the drop in oil done to the crack spread? Are refiners now making gobs of money since gas prices have not fallen as fast and as far as crude? – N.
A: I wouldn't say they are making gobs of money... Yes, refiners are much better off than they were. But that's not really saying much. Let me explain...
You can measure the crack spread by adding the cost of one barrel of diesel plus two barrels of gasoline and comparing it to three barrels of crude oil. It's an easy way to gauge refiners' profit margins.
According to my math, the average margin over the last 10 years is 20%. In the past 10 years, refiner margins only spiked down below 10% six times. In October 2007, the margins fell below 10% and stayed there for five months. In June 2008, the margins fell into the single digits and only just came back.
These companies are still not making a "normal" level of profits.
From an investors' prospective, refining seems like a bulletproof investment. These companies have a huge "moat" because you can't build new refiners. And they supply a necessary commodity – it's not as if you can turn to some other fuel for your car if the price goes up.
But Americans parked their cars when the price of gasoline hit $4 a gallon. So not only were refiners losing money on the margins, they sold fewer gallons.
For example, Sunoco – an average U.S. refiner – lost $91 million on its refining business during the first half of 2008. It earned $558 million in that same period in 2007. Shares of the company are down 46% from their 52-week high.
However, those shares are also up 35% since early July, when they bottomed. Barring another spike in the oil price, I think refiners' share prices will come up. But thousands of companies out there make much better margins than refiners. It's a cyclical business... and tough to make money on in the long term.
Q: What's happening to Suncor Energy? – A.H.
A: All the large oil companies hit a local share price high on or around May 20. That predated the top in the oil price by a month and a half... call it foreshadowing.
But Suncor, the poster child of Canada's oil sands boom, is off a bit more than its peers. I think it has a lot to do with lifting costs...
Company |
Share Price Decline |
Lifting Cost* |
Profit per Barrel* |
Finding & Developing Cost* |
ExxonMobil |
19% |
$5.61 |
$33.22 |
$9.21 |
Chevron |
21% |
$8.90 |
$41.27 |
$80.97 |
ConocoPhillips |
22% |
$8.14 |
$56.08 |
$14.17 |
Occidental |
26% |
$12.91 |
$51.13 |
$18.97 |
EnCana |
31% |
$7.86 |
$35.10 |
$12.03 |
Suncor |
36% |
$25.94 |
$40.20 |
$5.53 |
| *Data from Bloomberg for 2007. |
|
Lifting cost tells you how much a company pays to get its oil out of the ground. But Suncor's oil is actually "bitumen," a kind of oil mixed with water, sand, and clay.
The industry calls those "unconventional" reserves. That's a snub – it all winds up as gasoline anyway. But Suncor and EnCana (another oil sands company) need to process their bitumen to turn it into oil. So the market doesn't value it the same as conventional reserves.
On the other hand, Suncor spends less to find new reserves than any company in the industry. I think that should more than offset the discount for its bitumen. And Suncor is a gigantic oil company with enormous reserves. I've stood there and looked out over its mines. This is industry on a scale few people have ever seen.
The company has 2.6 billion barrels of oil in the ground. That means you get almost three barrels of oil per share. So you can buy all that oil for $15.79 per barrel.
It's true Suncor's stock has taken a beating. But I don't think there's anything wrong with the company. A bubble in the oil price made some traders crazy. Now they know oil isn't going to $500 per barrel, so they're selling out.
It was nonsense to begin with and, thankfully, it didn't last very long.
Now that it's over, we can go back to the fundamentals: What do you think Suncor's oil will be worth in five years? How about 10 years?
I think Suncor and the other tar sand companies will become more and more vital to the U.S. over time. Our usual suppliers like Nigeria and Mexico are having trouble with their plumbing. If we can't get oil from those countries, where will we go to get it? I think the answer is just north of the border. Seems like a smart investment to me.
Good investing,
Matt
Editor's Note: If you'd like to submit a question to the Commodity Investor Q&A, e-mail me here. Please keep in mind... I can't give personalized investment advice. 
