As we’ve explained this week, the energy supply chain is a robust source of income and appreciation upside for investors. Recently, we’ve explained the first two portions of the supply chain (the Upstream and the Midstream). Today, we want to discuss the critical part of the supply chain that caters to the strong consumer demand in the oil markets.
Once oil producers extract crude and gas from the ground, they move it through pipelines, trucks and other transportation segments to the “Downstream” elements. These include the refining of crude oil, the distribution of fuels, and the marketing and retailing of gasoline and other byproducts for consumers and businesses.
Let’s dig into the various options investors have when exploring the downstream.
The most important part of this ecosystem is the refining network. In the United States, the bulk of refining capacity happens along the Gulf Coast (PADD 3), where numerous refining centers convert crude oil into petroleum products like gasoline, diesel, jet fuel and petrochemicals.
The five refineries with the largest amount of capacity are based in Louisiana and Texas. The Motiva Enterprises refinery in Port Arthur, Texas, can refine up to 607,000 barrels of oil daily.
Six refineries (including two owned by Exxon Mobil Corp. (NYSE: XOM) and two owned by Marathon Petroleum Corp. (NYSE: MPC) have a capacity north of 400,000 barrels per day in these two states.
Unfortunately, refining capacity in the United States has slumped significantly over the last few decades. The U.S. hasn’t built a sizable refinery since 1977. In 1982, the U.S. had 27 refineries on the East Coast that could refine roughly 1.8 million barrels daily. Forty years later, that capacity dropped to 800,000 barrels at seven facilities.
In addition to stricter environmental rules impacting margins and operations, the Jones Act has reduced America’s ability to transport fuels between various domestic ports due to strict policies. The Jones Act originally aimed to protect the domestic maritime industry and ensure a strong U.S. merchant marine.
However, the act has led to higher transportation costs because fuels can only be transported between domestic ports with Jones-Act-compliant ships, of which there remains a shortage. This further strains the U.S. refinery network and has driven U.S. refiners to sell refined products to South America and Central America.
Who are The Big Players?
The obvious answer to refinery capacity in the U.S. is the large, multinational players like Exxon, which have large facilities on the Gulf Coast. But another major player that stands out is Valero Energy Corp. (NYSE: VLO).
Based in San Antonio, Texas, Valero was founded in 1980. It has grown to become one of the largest refining companies in the United States and operates refineries across North America. Valero primarily focuses on refining crude oil into a wide range of petroleum products, including gasoline, diesel, jet fuel and petrochemicals.
Valero owns and operates a network of refineries with a combined processing capacity of over 3 million barrels of crude oil daily. Its refineries are strategically located across the U.S. Gulf Coast, the U.S. Mid-Continent, and the U.S. West Coast, as well as in Canada and the United Kingdom.
Valero is a stock that trades at rather interesting swings over the last 18 months. When our Energy sector signal turns positive, it’s been a good time to buy Valero. And when it turns negative, we take profits or cut losses and get out of the way.
That said, given the severity of the refining challenges in the U.S. and the ongoing demand for diesel in the U.S. supply chain, Valero is a very intriguing long-term play for investors looking to take advantage of the ongoing Energy Supercycle.
The stock trades at just 4.4 times earnings, maintains a price-to-free cash flow under 4, and offers an attractive dividend for investors. We see in the chart above that shares do get stretched in periods of extreme frenzy around energy speculation, but the stock has remained in a clear uptrend over the last 23 months, and we look for that pattern to continue due to the historical blundering around U.S. energy policies.
*This is for informational and educational purposes only. There is an inherent risk in trading, so trade at your own risk.
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Market Momentum is GREEN
A big squeeze is in effect, but inflows remain strong. We project that this situation is very similar to the 2018 fourth quarter. Be cautious, but it’s a good time to trade. Keep your stops tight and don’t take any unnecessary risk into the fourth quarter.
*This is for informational and educational purposes only. There is inherent risk in trading, so trade at your own risk.