It is a well-known observation in the refining business that when oil prices rise, gasoline prices rise very quickly. When oil prices fall, gasoline prices don't follow nearly as quickly. This phenomenon is commonly referred to in the refining business as "rockets and feathers." Several studies have confirmed this effect.
The reason it happens is that when prices are climbing consumers will drive out of their way to save a nickel on a gallon of gasoline, but when prices are falling they do less comparison shopping. As a result, refiners and retailers are much slower to reduce prices as oil prices fall.
For refiners, the general rule of thumb is that when oil prices are falling refiners earn higher margins. This signals an occasional short-term profit opportunity for savvy investors who recognize when conditions are right, since this makes refiners a good short-term bet in a time of softening oil prices.
A look over the past month shows that refiners have indeed outperformed other energy sectors. Bellwether refiner Valero has seen its share price increase by 9 percent, while Tesoro's share price has risen by 7.6 percent. The fact that both have significant operations in California also helps, as the most recent gasoline crisis there should improve margins this quarter.
In comparison, over the past month ExxonMobil (NYSE: XOM) shares, for example, have lost 4 percent and Chesapeake Energy has fallen 15 percent. Pure refiners stand to benefit the most from softening oil prices. Integrated oil companies will show mixed results – better downstream performance but lower upstream performance. Pure oil producers will typically see the lowest performance if oil prices are softening.
The refining sector is not one that I typically recommend as a long-term holding in a portfolio. Refinery earnings are inconsistent, but during the right time of the cycle refining companies can be very profitable. However, over the next few years refineries that have access to disadvantaged feedstocks from the mid-continent region should consistently outperform those with less access to those crude oil supplies.
Investing in refiners is certainly not for everyone, but for those investors who like to take advantage of short-term trends, refiners offer opportunities for significant gains provided you know the right indicators for getting in and out of the companies.
– This article is a modified version of a story in Energy Trends Insider, a free subscriber-only newsletter that identifies and analyzes financial trends in the energy sector. It's published by Consumer Energy Report.