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US Global Investors’ Tim Steinle on Why Refiners Are in a “Sweet Spot”

The fracking boom has meant a lot to the American economy, both in terms of new jobs in the energy sector, and cheap natural gas and crude oil. So how does an investor play these changes? The

The fracking boom has meant a lot to the American economy, both in terms of new jobs in the energy sector, and cheap natural gas and crude oil. So how does an investor play these changes? The answer may not be as obvious as immediately appears.

That’s why spoke with Tim Steinle, a fund manager with US Global Investors, about how refiners and chemical companies are benefiting from rock-bottom natural gas prices and the spread between West Texas Intermediate (WTI) and Brent Crude.

EQ: What do you think investors need to understand about the energy sector moving forward? Can we expect more big gains, or is this a wave that you think as cresting?

Tim Steinle: If you look at the bull market of the last five years, Energy has actually underperformed. The S&P 500 is up 136 percent in that time, ex dividends, and energy’s up only 100 percent. On a relative basis, it’s behind almost 40 percent.

So there are several things we have to mention. One is that from the top-down perspective the macro is still positive for cyclicals overall, which energy is one of. There are curbs in quantitative easing, but the easing is still in progress. That’s why you can see energy beginning to close the performance gap with equities more recently.

Then you have to look at relative valuation, too. You have a good forward P/E for the energy sector, which is only 14 relative to the market average of 16. So energy’s not that expensive either. We’re really witnessing, especially in North America, a technological revolution. The U.S. has become a global leader in gas production, which is great for energy independence and the competitiveness of new industries in the U.S. That’s set to continue.

EQ: Speaking of natural gas prices, what sort of businesses are experiencing peripheral benefits from the current, low natural gas prices?

Tim Steinle: Chemical companies are one area. Globally, chemical industries have actually underperformed over the last 12 to 24 months, whereas in the U.S. they have a strong run. That’s because the feed stock, the natural gas that they use is much cheaper here. The natural gas is cheaper at something like $4 per MMBtu here versus $8 to $10 in Europe and $13 or $15 in Asia. So a clear advantage in chemicals.

EQ: Domestic refiners have some ways to get around the export ban on oil and gas. What can you tell me about refiners and why you see so much opportunity in that segment?

Tim Steinle: Refiners are in a very sweet spot. Over the last ten years or so they’ve done this huge capex cycle adding capacity to process sour crudes and comply with more stringent EPA requirements. They’ve done all that, and now we have this domestic gusher of sweet crude in the mid-continent. Over the last couple years it’s found its way to the Gulf Coast, where there’s a lot of refining capacity. So they’re in a sweet spot because they have this tremendous advantage and flexibility in picking the crude slates. You have a WTI to Brent spread anywhere between $5 to $10, and it was even higher than that last year. Which means European refiners are simply not competitive, they’re shedding capacity because North American refineries enjoying the benefit of cheaper feed stock.

There was never a ban on exporting refined products. The ban was on purely exporting crude, which refiners are not subject to. They have historically done arbitrage, especially in diesel markets. They would ship diesel fuel, jet fuel, and arbitrage it between North America and Europe. Now they have a clear advantage exporting diesel to Europe because of the cheaper WTI. So there’s this tremendous flexibility that the Gulf Coast refiners have both in terms of exporting refined products and then in accessing cheaper crude.

Another element, if you look domestically, because of improving fuel efficiency on our car fleet, we have no increase in domestic consumption, but yet we see the refining capacity increasing while crude runs are rising. You see, refineries are not just one simple unit. There are multiple units. You start with the crude unit and then further down the flow chart you have hydrotreaters and hydrocrackers, those are designed to process crudes further. Those are more expensive units to add.

That’s what I was talking about earlier with refiners adding capacity over the last ten years. Those are very expensive machines and very complicated processes. The crude unit runs are higher today, because they essentially can take the crude and process it and it doesn’t necessarily have to be very deep processing. But then countries in Latin American can accept that sort of product that may not find a place domestically.

So all of those cracking operations were very profitable for refiners. To trade the refiners, you look at the crack spreads. You look at the difference between prices of products and the price of crude. Crude is their feed stock, but their products are in a global market. That global market price is determined by the floor set by Brent, because Brent is the global benchmark. So that goes back to that difference between WTI and Brent.

There is one final point that makes domestics refiners more attractive than ever before in their history.  This one has to do not with petroleum, but with financial engineering.  Hungry for yield investors are chasing MLPs for their stable dividend streams, and refiners responded to that demand by spinning off their midstream operations as MLPs.  If refiners trade at 5 times EBITDA, their MLPs trade at 15 times, which allows them order to finance maintenance and expansion of their midstream operations. 


Tim Steinle joined U.S. Global Investors in November 2008. Mr. Steinle is co-portfolio manager of the Emerging Europe Fund ($EUROX).

Mr. Steinle was formerly a risk manager for Valero Energy Corporation from 2001 through 2008. He also managed the development of fixed-income and foreign exchange trading systems at Enron Capital & Trade and served as an analyst at Procter & Gamble for three years.

Mr. Steinle earned an MBA in Computational Finance at the University of Texas at Austin in 1996. He completed his undergraduate studies in Electrical Engineering at the Azeri Petroleum Institute in Baku and is a native Russian speaker. Mr. Steinle is a member of the CFA Society of San Antonio.

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