Record-High Gasoline Never a Better Buy, Say Citigroup, FBR
By Jordan Burke
March 24 (Bloomberg) -- Gasoline that's going for a record $3.29 a gallon at the pump is actually cheap, the way Citigroup Inc. and Friedman Billings Ramsey & Co. look at it.
A barrel of wholesale gasoline fetched 50.4 cents less than crude oil last week, marking only the fifth time in 20 years that the refined version sold at a lower price, New York Mercantile Exchange data show. Investors who sell the raw material to buy gasoline or related products may return about 20 percent by June because the differential is going to go up, estimates from the banks show.
Gasoline may rise as the U.S. summer travel season increases demand and oil refiners limit production, according to Doug Leggate, a Citigroup analyst, and Eitan Bernstein, an FBR analyst. A rally would help restore profit margins at the two largest U.S. refiners, Valero Energy Corp. and ConocoPhillips, after crude's surge this year erased a premium that reached an all-time high of $37.48 a barrel 10 months ago.
``The gasoline margin will widen out from where it is,'' said Bill Kleese, chief executive officer of San Antonio-based Valero, whose 15 U.S. refineries from Delaware to California process one of the every seven barrels nationwide. Inventories of gasoline are going to come down, and demand for the fuel is going to go up, he said.
Wholesale gasoline futures rose 5.2 percent this year to $2.6051 a gallon ($109.41 a barrel) on the Nymex, after touching a record $2.7286 on March 12. Demand during the past five years has gained an average 4.2 percent from the first week in April to the first week in July, according to the U.S. Energy Department, and refineries are operating at 83.8 percent of capacity right now, 2.8 percentage points below the five-year average for this time of year.
Crack Spreads
Investors typically speculate on refinery profits by betting on the differential between crude prices and futures on gasoline and heating oil, another derivative of crude. Traders call it the 3-2-1 ``crack spread,'' referring to the term in chemistry for separating the components of oil.
Leggate of New York-based Citigroup said the profit from turning three barrels of oil into two barrels of gasoline and one of heating oil will probably increase to an average of $14.50 in the second quarter, meaning a 19 percent return for investors who bought the June crack spread at $12.235 on March 20. FBR's Bernstein, based in Arlington, Virginia, said the spread will average $12 to $14.50 this year, as much as 42 percent higher than the $10.237 average so far.
Volatile Prices
The 3-2-1 spread during the past month widened to a high for the year of $14.726 on Feb. 21 before sinking to $7.395 on March 17. On the same day, the straight gasoline-to-crude spread dipped below zero. Even after a rebound in both later in the week, the 3-2-1 spread is 61 percent lower than last year's record of $30.479 in April. In the past five years, it has widened an average of 10 percent between April and June.
``From current depressed levels, we find it difficult to believe that it can get much worse,'' Leggate said in a March 17 report. ``There is reasonable basis to expect some level of margin recovery over the next few months.''
Valero's fourth-quarter profit fell 49 percent to $567 million, with margins averaging $9.20 a barrel, down from $10.53 in the same period a year earlier.
San Antonio, Texas-based Valero has fallen 29 percent to $49.51 in New York Stock Exchange composite trading this year, and will likely rise to $74 within 12 months, said Leggate, who has a ``buy'' rating on the stock. FBR's Bernstein is targeting $83, and has an ``outperform'' on the shares. Houston-based ConocoPhillips is down 15 percent to $74.83, and will probably advance to $97 within a year, Leggate said, recommending investors hold the stock. Bernstein doesn't cover ConocoPhillips.
Rising Inventories
Gasoline inventories rose for 18 consecutive weeks to a 15- year high of 236 million barrels, the Energy Department reported March 12. Higher retail prices and a slowing economy reduced consumption while refineries that were answering greater demand for diesel and heating oil created gasoline as a byproduct. The average pump price is up 28 percent from a year ago and reached a record on March 15, according to the American Automobile Association.
Francisco Blanch, who heads global commodities research in London at Merrill Lynch & Co., forecast about a month ago that the 3-2-1 spread would reach $18.89 in the third quarter. Now he's not so sure.
``Everything that we knew about crack spreads has fallen apart with the gasoline supply glut and the shortage of diesel,'' Blanch said in an interview March 20. ``I have been a bit reluctant to make calls on this thing. It's so volatile.''
Refinery Shutdowns
Margins surged last year as refiners including ConocoPhillips and Philadelphia-based Sunoco Inc. were forced to shut units for repairs.
Prospects for more interruptions and higher demand mean even higher crude futures won't be able to stop the 3-2-1 spread from widening to at least $17 by August, said William Adams, a managing director at JKV Global, a Chicago-based trading firm. Crude futures have risen 14 percent to $101.84 since Feb. 1, touching a record $110.33 on March 13.
``When we add to that actual demand and add to that any potential supply chain breakdown, we could see gasoline prices move higher regardless of any crude supply we have on hand,'' Adams said.
To contact the reporter on this story: Jordan Burke in New York at jburke29@bloomberg.net
Last Updated: March 23, 2008 20:01 EDT
Market Data 
Markets 
AI
