Gasoline Too Cheap?
Research for Online Investors

by John Dalt

2/3/10

Last week we covered a trading technique called ‘pair trading.’  We found a relationship we wanted to make you aware of. There may be an opportunity for a pair trade developing.

The major oil company’s quarterly reports have been disappointing.  We expected gross sales to be down and profits to be squeezed, after all we are dealing in $70 dollar oil not $120 dollar crude oil.  A big component of Exxon and Chevron’s profits are their refineries.  Refining margins have been tough because the ‘crack spread’ has been so thin.  We covered the ‘crack spread’ on Dec. 2, 2009

In plain language the refining business is tough, and has been for the 18 months. High gasoline prices suppressed demand and competition (foreign and domestic) has forced the margins to unsustainable levels. Operating a refinery is a high cost, low margin operation, even in good times. Now, margins are non-existent, but you cannot run a refinery at less than capacity. You cannot go to just one shift, they run 24/7 or they don’t run at all. In the last six months, refineries have been closing.

Gasoline usage historically increases in late spring, the “vacation effect.” Summer driving includes more miles, thus more demand. Also, refineries close in the spring for a ‘turn around’ to change over to refining summer blends of gasoline required by some states and localities to meet environmental standards. These are so called ‘boutique blends.’

Every refinery that closes for even a few days, takes their production off line while they change over to produce a different blend for the summer.  This can create an opportunity for enhanced margins for existing refiners.

Last year the summer driving season never materialized.  Demand never picked up as the public hunkered down because of resident fear from the credit crisis.  Will this year be different?  We will watch but wanted to make you aware of this possible opportunity.

Extremes are meant to correct!

UGA and USO are etfs that track gasoline and crude oil.  They do not perfectly reflect the commodity, so be careful and do more research before entering this trade.

If you decide to enter this 'pair trade', you would go long UGA and short USO.  This trade would seek to capitalize on a widening 'crack spread'  If both go up, gasoline would need to go up faster.  If both go down, gasoline would go down less.  If one stays static the other moves away from it.  All of these scenerios will result in profits for you on the 'pair trade.'

T he White House Budget projected the 2011 budget deficit at $1.3 trillion, an increase of $290 billion over the Congressional Budget Office (CBO) prediction just last week. Now, that is inflation! The TBT etf (inverse 20-year bond interest) is up over 2% in the last two days. Investors see the handwriting on the wall. How long before foreign buyers of treasury bonds will slow their purchases?  What is 1% on $12.3 trillion dollars?  For every 1% increase in interest rates, the U.S. deficit will increase $123 billion, per year!  It is not hard to imagine 4 or 5 percent increase in the next two years.  What is another half trillion, per year, between friends?

Toyota Motor Co. (TM) stock has lost 20% in the last two weeks, over $25 billion.  Ray LaHood quipped "My advice is if anybody owns one of these vehicles is to stop driving it and take it to a Toyota dealer because they believe they have the fix for it." He later retracted that statement, referring to it as a misstatement. How does a regulator keep clean hands, when it owns the main competitors?  Reuters has the story, "U.S. Steps up Pressure on Toyota."  We will watch for a bottom, probably in March or April, and then look for a value buy on TM.

Congress is working overtime on additional regulations for banks.  The president wants new regulations to prohibit banks from using their regulatory capital in their proprietary trading operations.  It is already illegal.   If you want to lose your bank charter, and see it sold to the highest bidder over the weekend, just use the bank’s capital to trade bonds or equities.  If you can’t stand the ‘mark to market’ on Friday night, you might get a surprise visit.

We admire Texas more each day.  Their legislature meets every other year.  I suppose this means their state legislators have to have gainful employment to make a living during the ‘off’ years.  This is good, not so much time to ‘drink the water’; more time to see what it is like to live under the laws you pass!

"The more corrupt the state, the more it legislates." – Tacitus

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

MarketToday Home Page

Back to Top