Cracking Cheap Oil Profits

With U.S. oil inventories at their highest levels in decades, crude prices have caught another leg down on the news that a framework nuclear deal has been reached. While the detailed agreement isn’t due until the end of June – and it is still possible that a final deal won’t be reached – it is basically expected to require Iran to dismantle most of its nuclear program and submit to inspections in exchange for an end to economic sanctions.

While the timing of the rollback of sanctions, which have crippled the country’s energy and financial sectors, is still an open question, the end of the embargos could bring a flood of Iranian oil. While the country is currently only producing a little more than 3 million barrels of oil per day, that production level could quickly rise if the country could legally access global oil markets. Not only would that bring in an estimated $1.6 billion a month in revenue, the end of sanctions would also allow the country access to updated drilling technology, possibly allowing for a production boost.

Unfortunately for oil speculators, though, bringing Iranian oil into a market already awash in American production is decidedly bearish for oil prices. While that’s bad news for exploration and production companies, it’s not universally bad news for the energy sector as a whole.

Refiners are specifically positioned to benefit from cheap oil, the feedstock for everything from gasoline to plastics. Their profits are largely driven by what is known as the crack spread, or the difference between the price of crude oil and the chemicals made for it. Thanks to cheap oil, that spread has been widening as companies are making more on each barrel of oil refined, particularly on the Gulf Coast, the western states and Europe.

Over at The Energy Strategist, our oil expert Robert Rapier follows these trends closely and currently rates Western Refining as one of his “top buys.”

A small company with only four refineries, you wouldn’t expect Western Refining (NYSE: WNR) to sit at the center of global oil politics . . . but it does. With its facilities in Texas and New Mexico, it has access to oil produced in the Permian Basin. That crude is incredibly cheap thanks to the glut of it on the market, even as the Western’s refined products are able to get premium pricing in the American Southwest. My virtue of geography, imported distillates like gasoline just aren’t cost effective in that part of the country, resulting in higher retail prices.

Those competitive advantages have allowed the refiner to be incredibly generous with its shareholders, repurchasing hundreds of millions of dollars’ worth of its shares and currently paying a $0.30 quarterly dividend. It’s also developed a history of paying sizable special dividends, most recently paying out $2.00 per share in November.

With 151 million barrels per day of refining capacity, Western is investing in upgrades to boost its capacity. It’s also taken a stake in a Minnesota-based refiner, providing additional capacity in geographically advantaged region. It spun its midstream assets out into Western Refining Logistics (NYSE: WNRL) back in 2013, allowing it make extremely cost effective investments in transportation infrastructure.

While planned pipeline development could eventually start dinging Western’s margins, allowing oil to flow more easily to other parts of the country and reducing the company’s cost advantage, it will be several years before much additional pipeline capacity comes online. In the meantime, the company can continue positioning itself to tap into closer sources of crude, such as it has done in El Paso to utilize local production.

In the meantime, oil prices will remain under pressure as the markets wait to see if a final bargain is struck on Iran. If that deal gets done, not only could nearly 3 million barrels of additional oil start coming to market, production would likely rise as the country gains access to more advanced technology.

That’s good news for Western Refining though, a relatively obscure operation sitting at the crossroads of the global oil market. Already up better than 20% so far in 2015, it should only keep rising from here. And it’s just one of Robert’s energy patch picks, with his portfolios full of sector plays for investors looking for either growth or income.