No Short-Term Relief At The Pump

Close your eyes and imagine a world where gas prices jump 30 cents, overnight.

If you were paying $3.50 yesterday, today you’re paying $3.80 – a jump of 8% overnight.

It’s a crappy scenario to be sure, but it’s happening at pumps across California as I type.

What’s the story with rising gasoline prices? Should you expect this nasty trend to hit a fillin’ station near you?  Let’s take a look at the crude spot and how to position yourself for a new trend at the pump…

“California gasoline prices to surge” exclaims a headline from the LA Times.

The article comes on the heels of massive fire that shut down a 110-year-old refinery in California. The refinery accounted for nearly 15% of the state’s fuel-making capacity, the Times reports.

What’s worse for residents of California, this refinery was one of a handful of plants capable of producing the state’s unique blend of gasoline.

“Wholesale fuel traders reacted immediately by driving up spot prices more than 30 cents a gallon” the LA Times says. “Most gasoline stations don’t pay the spot price, instead getting their fuel under long-term contracts, but the spot price is a strong indicator of where retail prices are headed.”

As a reader of Daily Resource Hunter I’m sure you realize this is an isolated event that will affect only drivers in California. But, as you’ll see, there’s another nasty trend that could keep short-term prices at a pump near you higher than usual.

Yup. I’m talking about our good friend crude oil.

Prices for the black gooey stuff are up over 16% in a little over a month. As we know, this is a major factor in determining the price we pay at the pump.

So what does our crude crystal ball tell us will happen in the next couple months? Well, if history is any indication I’d say we’re headed higher in the short-term.

Take a look at this simple price chart for the Nymex December crude futures contract:

As you can see the price of crude has entered into a distinct trading pattern bouncing between $80-110.

Each time prices hit the lower $80-boundary (most likely pertaining to a physical breakeven costs to produce crude) prices bounce higher. On the converse, each time prices hit the upper $110-boundary (most likely a price at which demand starts to slow) prices begin to fall.

Let me be the first to tell you that this chart could be our new crude reality. With more production coming online domestically it’s going to be hard for prices to bust through the $110 mark. But with breakeven costs for new “tight” oil supplies in mind and latent crude demand that develops when prices fall, I doubt we’ll see a price shock that keeps us below that $80 threshold.

Hey, I don’t make the charts. I just listen to them.

Crude oil is a physical market and price action can tell us a lot more than the latest story in the print pages of the Wall Street Journal. That’s why it’s important to keep the chart above in mind. Until that trading range is broken I’d expect prices to continue oscillating in a $30 range.

Furthermore, if we start seeing an ease in Middle East tensions we may even see that range tighten up to what Byron King calls a “fair” price for Brent crude around $90-100 (which means American-based WTI would trade around $80-90/bbl.)

So what’s our plan to profit from this crude oil price cycle?

Well, first there’s a new opportunity that I want to bring to your attention.

For a long-time now we’ve considered refiners down-and-out. Indeed, with margins tightening and trending downward, refiners were getting squeezed from all sides.

But recently refiners have bucked the trend.

With a glut of cheap oil in the U.S. (well, cheaper than world oil prices), refiners are able to use the cheap crude along with cheap natural gas to blend and produce gasoline. Accordingly, these refiners can sell that “cheap” gasoline on the world market – creating a sizeable arbitrage opportunity.

A quick look at refiners Valero (VLO: NYSE) and Phillips 66 (PSX: NYSE) shows that over the past three months each company is up approximately 30%. If you’re starting to buy into this continued crude cycle idea – like the chart above is portending – now may be the time to take a peek at neglected refiners.

Beyond the budding opportunity with refiners, though, there are still ways to play this crude cycle – and since the refiners are only paying an average of a 2% dividend, there may be better income-generating way to play this trend as well.

Let’s stick with the basics and profit from companies that benefit from oil prices over $80. More importantly, with cash as our guide, let’s look for those companies that share the benefits with shareholders through dividend payments.

The key to this investment philosophy is simple. As long as consumers keep using gasoline (which we know is happening through EIA inventory data released this morning and refiner-related gasoline export data) companies that find, transport and process crude oil in the U.S. will be staying very busy…and in many cases very profitable.

That’s all for today.

Keep your boots muddy,

Matt Insley

No Short-Term Relief At The Pump was originally featured in The Daily Resource Hunter. Check out the newest Daily Resource Hunter research video “The Price of Gas Explained”.

Article Title originally appeared in the Daily Resource Hunter (www.dailyresourcehunter.com) At the Daily Resource Hunter our approach to research is different. With our boots on the ground, we travel the world looking for the most lucrative resource opportunities and deliver them to you in a daily email newsletter. For more information visit us at www.dailyresourcehunter.com)