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Crude Oil and Oil Stocks Correct on July 19
Demand for crude oil and products is robust
Crack Spreads Rise Significantly Higher – Rising Profits for VLO
Higher lows and higher highs since March 2020
When it comes to fossil fuels, the US view is changing. On the day of his inauguration, January 20, 2021, U.S. President Joseph Biden canceled the Keystone XL pipeline project that carries petroleum from the oil sands in Alberta, Canada, to Steele City, Nebraska and on to the NYMEX delivery point in Cushing, Oklahoma. In May, the Biden administration banned drilling and fracking for oil and gas on federal lands in Alaska.
As the US seeks to tackle climate change on a greener path, the nation and the world continue to rely on petroleum-based fuels to power lives and businesses. In the coming years, increasing regulations will increase the costs of extracting oil and gas from the Earth's crust in the US. In addition, it returns the price power for energy commodities to the international cartel, OPEC, and its partner, the Russians.
As the US and Europe move towards decarbonisation, more than a third of the world's population lives in China and India, two countries that march to the beat of a different drummer. In addition, in the US, most cars, trucks, airplanes and other modes of transport continue to require petroleum-based fuels. Rising demand in the wake of the global pandemic and falling inventories under the Biden administration's green initiatives are optimistic for oil and gas prices. Anyone with any doubts should look at the price developments in the crude oil, coal and ethanol markets over the past year.
Nearby NYMEX crude oil futures recently traded at its highest price since 2014, at $76.98 a barrel. Natural gas rose to more than $4 per MMBtu last week, its highest price in July since 2014 and its highest level since late 2018, as the peak heating season kicked off. traded at the highest level since 2014 in recent weeks.
With increasing demand, oil refineries are making a profit. Valero Energy (NYSE:) is a leading US refinery. Shares of the company have fallen nearly $20 lower and are now trading about 22.8% below their June 3 level. At $65.54 per share on July 26, VLO is back in the buy zone (at time of publication, shares were only a few cents higher)
Its $3.92 dividend, or nearly 6% return, makes the stock an attractive bet as it pays an above-market interest rate for those waiting for capital gains.
Crude Oil and Oil adjusting inventories on July 19
Crude oil has a nasty habit of lowering an elevator shaft during corrections. The most glaring example came in the first half of 2020 when the price of the commodity evaporated and fell below zero on NYMEX futures and to its lowest level this century on the near futures contract.
Since April last year, the energy commodity has made higher lows and higher highs. Nearby NYMEX futures rose to their highest level since 2014 at $76.98 a barrel on June 6. The now active contract of the month of August reached $76.07 a barrel.
Source: CQG
The chart above shows the decline from its all-time high and the substantial drop on Monday, July 19, which took August WTI futures to a low of $65.01 on July 20, before returning to over $72 a barrel. . Crude oil fell alongside the stock market, giving oil-related stocks a double bearish sell bump.
Lately, oil-related stocks have outperformed crude oil. The highly liquid S&P 500 Energy Sector ETF (NYSE:) has a portfolio of stocks in the leading US oil and gas-related companies.
Source: bar chart
The chart shows that the XLE rose to a high of $56.65 on July 10 and fell to a low of $46.30 on July 19. The ETF fell lower on July 19 – the day the price of crude oil fell through the last elevator shaft.
Oil stocks fell 18.3% from its high, while NYMEX crude oil futures price fell 14.5% in August. Crude was trading at $72 a barrel on July 28, 10.8% above its recent low, while the XLE recovered 7.6% at $49.83. Oil-related stocks have lagged the price of crude oil, as they fell more during the correction and rose less during the recovery.
The XLE has a 3.12% exposure to Valero Energy. The company refines crude oil into transportation fuels and petrochemicals and produces biofuels in the US, Canada, UK and Ireland. The company's profile states that it operates through three segments: refining, renewable diesel and ethanol.
VLO has a market cap of $26.042 billion at $65.54 per share. The stock trades an average of 5.13 million shares per day. In 2021, VLO traded in a range of $54.84 to $84.95 per share. At Tuesday's closing price of $65.58, the stock was closer to its lowest than its high for the year. The share has also fallen since the beginning of June.
Three factors indicate that Valero is poised to move higher, making it a steal at the current price level.
1. Demand for crude oil and products is robust
Vaccines that create herd immunity to COVID-19 have caused a demand explosion as people return to work, vacation and travel the world. US oil and petroleum product inventory levels reflect strong demand for traditional fuels.
According to the Energy Information Agency, , , and stocks decreased from January 1 to July 16, 2021.
Source: EIA weekly data
Over the course of 2021, crude oil inventories decreased by 53.7 million barrels, gasoline inventories decreased by 100,000 barrels and distillate inventories increased by 10.7 million barrels. Daily crude oil production in the US has increased from 11 to 11.4 million barrels per day since the end of 2020, an increase of 3.6%. However, they remain 13% below the peak level of 13.1 mbpd in March 2020, despite strong demand.
Rising demand for gasoline, diesel and aviation fuels has pushed refining spreads higher in 2021.
2. Crack spreads have increased significantly, meaning profits for Valero have increased
Crack spreads reflect the economics of processing a barrel of crude oil into a barrel of gasoline or distillate products. The spreads are a real-time indicator of fuel demand and a barometer of profit for companies like Valero that process oil products. Rising crack spreads mean more profit for oil refineries.
RBOI vs WTI Crack Distributed monthly
Source: CQG
The monthly chart of the spread of the gasoline crack shows that it went from $10.81 at the end of 2020 to $23.81 per barrel on July 26. Gasoline is a seasonal fuel that tends to be the winter when drivers put few miles on their cars during the spring and summer months.
In the pandemic-ravaged 2020, the July gasoline burst spread was below the $14 a barrel level.
ULSD vs WTI Crack Monthly Distributed
Source: CQG
Despite the name, crack spreads are a proxy for distillates such as diesel and jet fuels. The distillate crack spread moved from $13.92 at the end of 2020 to $18.49 per barrel on July 26. In July 2020, the crack distribution of the distillate was below the $12.50 per barrel level.
Higher crack spreads translate into higher profits for VLO and other oil refineries. When it comes to biofuel, corn is the main input for ethanol production in the US. At the end of December 2020, the neighborhood was at the $4.8575 per bushel level, with ethanol futures nearing $1.433 per gallon wholesale.
At $5.4575 on July 26, corn was up 12.4%. Ethanol at $2.32, ethanol was 61.9% above the 2020 closing price. As input grew less percentage than output, refining the coarse grain into biofuel is an increasingly profitable business for VLO.
3. Higher lows and higher highs since March 2020
Valero may have pulled back from $84.95 to $65.54 per share, but the longer-term trend remains bullish.
Source: bar chart
Valero stock has made higher lows and higher highs since the stock bottomed out at $31 in March 2020. The stock hit a higher low of $35.44 in October 2020, which is the critical support level.
I expect strong demand for oil products and strength in spread narrowing to support equity gains. However, seasonality can mean that VLO can be sold in the coming months as winter approaches. I would be a tapering buyer of VLO from current levels, leaving plenty of room to add the price weakness in the volatile stock.
Meanwhile, Valero's dividend at the $3.92 level translates into a return above the market price of 5.98%. VLO pays shareholders to wait for capital growth.
The shift to a greener path for US energy means that regulation for all traditional energy companies will increase production costs and constrain parts of the business. However, US demand for crude oil and biofuels has risen as vaccinations create herd immunity to the worst effects of COVID-19.
It will take years, if not decades, to achieve lower emission standards and decarbonisation. In the meantime, the US remains addicted to petroleum-based fuels, which is bullish for Valero stocks at current price levels and below.
