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Shorting US Refiners in a Pair Trade

March 3, 2016

For US refiners, the times are changing. They were big winners – and a big winning theme for MRP –  in the early days of the fracking revolution. Now the tables have turned and MRP recommends shorting the US refiners in a pair trade with a suitable offsetting long, such as a broader energy ETF. If the market continues to rally, such a pair trade can be profitable if the refiners stocks in a short basket go up less than the long position.

The surge in US oil shale production swamped the country's energy infrastructure and led to a disconnect between US and global oil markets. The gap between global Brent and West Texas benchmarks, for instance, was as much as $44 and averaged $13 from 2011 through 2015. US refiners minted coin by buying oil at prices well below their competitors. Other beneficiaries included pipeline construction, oil by rail, chemical companies and other users of cheaper oil. MRP renewed a recommendation to be long the group on March 2, 2015.

Late last year, the Brent premium began to narrow as energy infrastructure was built out, the US shifted policy to allow more oil exports, and the global drop in oil prices all came together and put an end to the party for refiners; MRP closed the recommendation to be long on October 29, 2015.

GLOBAL OIL PRICES RECONVERGE, ENDING THE PARTY FOR US REFINERS

 Source: Bloomberg, McAlinden Research

The Brent premium is now down to just a few dollars and even turned negative for a few days earlier in the year. As today's Daily Intelligence Briefing shows, the pressures continue to build and margins are squeezed. MRP is recommending a short position in a basket of US refiners. The table below lists the securities from the S&P 1500 Oil & Gas Refining and Marketing Index, with an equal-weighted basket depicted in the upper left chart. As with any short position, the risk of a broad market rally can be hedged with an offsetting long position, such as the S&P 500 Energy Index as shown in the chart in the bottom left.


 Source: Bloomberg, McAlinden Research
 
Last updated March 3, 2016
 
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Warren Hatch, PhD, CFA
Portfolio Management and Global Investment Strategy
McAlinden Research Partners

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