Three Stocks to Profit From Surging U.S. Oil Inventories
“Jody, where can a person invest his money and be guaranteed to make 50% in the next six months?”
No. The question above isn’t from our reader mailbag. Instead, this is the recurring dialogue between me and my cousin Brad at family gatherings.
Below, I’ll share my typical response. I’ll also share three tickers that provide a decent shot at a 50% gain without taking on much risk.
The question above is one I mentally prepare myself for each time my family gets together. Here’s my response and the ensuing back-and-forth…
Me: “There is no place that you can invest your money and be guaranteed to make 50% in the next six months. I don’t believe that I or anyone has the ability to predict even which way the entire market will move over a short of time period. Even Warren Buffett says that he has no clue how the market will move over a calendar year.”
Cousin Brad: “Yes, yes, that is what you always say. But seriously, where can a person make 50% in the next six months?”
Me: “It isn’t guaranteed, but I hear the lottery is a source of the windfall profits that you seek.”
This particular family member knows about my obsession with investing. I’m not joking about this. We seriously have a conversation along these lines at every holiday and birthday gathering.
I think he believes that I am holding out on him. That I’m keeping the really good ideas for myself. Or perhaps he thinks it is rather pathetic that someone who spends as much time on investing as I do can’t make 50% every six months.
Of course, I’m not holding out on him, and I believe that even aiming to make those kinds of returns in a short period of time can cause an investor to take unnecessary risks.
That being said, I do believe I’m aware of a group of companies that are very well positioned for the next six months. I believe these companies should generate unusually strong cash flows in the next couple of quarters, which should also result in good stock price performance.
For decades there was virtually no difference in the daily price of West Texas Intermediate or Brent crude oil. Historically WTI actually traded at a slight premium to Brent because it is a higher-quality crude.
Source of chart data: Energy Information Administration website
The chart above tracks the differential between WTI and Brent from 1990 through the end of 2010. As you can see, the differential stayed very close to $0 over this time, which means there was little difference between the two prices.
With the United States historically importing far more oil than it produced, the price for American oil was set by the global market.
Then, in 2011 fast-growing North Dakota oil production overwhelmed the pipeline capacity available to move that oil from the wellhead to refineries or other end-users. That meant that too much oil was getting stuck in one location, Cushing, Oklahoma, which is where WTI is priced.
Bloated Cushing inventories put major pressure on WTI pricing. Oil produced here in North America that was shipped to Cushing received a lower price than similar quality oil produced globally.
Differentials blew out massively from any historical precedent, with WTI trading for an incredible $30 less than Brent at one point in late 2011.
Since then, those differentials have gradually shrunk. The rail industry moved quickly to add capacity to ship hundreds of thousands of barrels to end destinations, and the reversal of the Seaway pipeline was added to get oil from Cushing to the Gulf Coast. It took a while, but the industry adapted.
For most of 2014, WTI traded reasonably close to Brent.
But recently, those differentials have started blowing out again. At the close of trading last week, the differential between WTI and Brent was nearly $10, with Brent sitting near $62 and WTI near $52.
The reason for the surge in the differential this time is again soaring North American oil inventories. This time, though, it isn’t a case of not being able to get the oil out of Cushing. It is a case of arbitrageurs around the world shipping their oil to North America (both Cushing and the Gulf Coast) for storage.
Over the past six months, there has been more oil produced globally than consumed. That extra oil needs a home, and the most obvious place for it is onshore in the United States, which is really the only place with sufficient available storage. Land storage costs are only 30 cents per barrel per month, which is much lower than the dollar per month it costs to store oil offshore on a tanker.
As long as daily global oil production exceeds consumption, these inventories are going to increase. That is going to keep WTI at a price lower than Brent.
Buy low and sell high. Yep, that is a simple recipe for making money.
For North American refiners, that is what their near-term prospects look like.
These companies have input oil costs based off of WTI, but sell refined oil-based products (gasoline, jet fuel, kerosene, etc.) priced off of Brent.
With WTI/Brent differentials widening and expected to stay under pressure for the next six months, North American refiners could very well post some better-than-expected cash flows.
I would view this as a fairly short-term opportunity — which is great news for my cousin, or anyone looking for short-term gains.
The best way to play this short-term opportunity is with a handful of well-positioned refiners.
I would suggest owning the refiners that have the most exposure to these widening differentials (WTI/Brent and LLS/Brent). LLS is Light Louisiana Sweet, which is priced at the Gulf Coast, where inventories will also be growing.
That makes Marathon Petroleum (MPC), Phillips 66 (PSX) and Valero Energy (VLO) the best companies to take a closer look at. These companies have the most exposure to Gulf Coast and Cushing input pricing.
Remember, this is a short-term play. I expect to see American oil production level off by the middle of this year and perhaps even start to decline. Inventories will also start to come down as we hit driving season.
But if you’re looking to play a little-known opportunity in American oil, now’s your chance.
P.S. Ever wonder how you can make a lot of money from oil without owning a well? Or whether or not you should buy gold and silver? Or is fracking just a flash in the pan? Get insight, insider scoops and actionable investment tips twice a week with Daily Resource Hunter? Just click here for a FREE subscription!