Home Trading ETFs Is It Time To Buy Refiners? – VanEck Vectors Oil Refiners ETF (NYSEARCA:CRAK)

Is It Time To Buy Refiners? – VanEck Vectors Oil Refiners ETF (NYSEARCA:CRAK)

by TradingETFs.com
QuandaryFX


For those who have invested in the refining sector through the VanEck Vectors Oil Refiners ETF (CRAK), you’ve been in for a bit of a turbulent ride these past few months. Since the refining and energy industry peaked around October of last year, CRAK’s shares have fallen by 15%, with a max loss of around 26% seen near the end of last year. Even though shares have been recovering since the beginning of this year, in this piece I am going to make the case that it is not yet time to buy CRAK and that investors should steer clear of this instrument.

When examining an ETF, it always makes sense to open the hood and look at what it actually holds. CRAK holds a basket of refineries, with no individual refinery making up more than 10% of the holdings. The fund rebalances holdings periodically to roughly track the market capitalization of its holdings, which means in the long run CRAK gives a pretty good and broad view of the refining sector.

When it comes to performance, the fund has been crushed versus the S&P 500 since the recent volatility in the energy industry began.

And while CRAK has been gaining as of late, when comparing its gains to the S&P 500, it can pretty easily be seen that nothing has really changed and the upside we’ve seen has basically just been market drift.

In this piece, I am going to dig into fundamentals of the refining industry and explain what is happening, why it is happening, and how long this problem is likely to remain. As I stated in the beginning, my basic advice remains: stay away from refineries. As you will see in a few minutes, the refining industry is oversupplied, which explains the ongoing losses seen in the sector and in the ETF.

When you examine the refining sector, a quick run-through of the supply and demand balances for the products can give a pretty good view as to what is happening and why. Before jumping into that, however, let’s take a quick look at what refineries across North America produce.

As you can see in the chart above, the lion’s share (almost 70%) of the production created by refineries boils down to two things: gasoline and distillate. These two products and their respective markets represent the vast majority of earnings volatilities at the standard refinery. Other products are created in the refining process, but in comparison, they represent small fractions of the overall slate.

Gasoline is the largest product and market which most refineries are exposed to. If you’ve been following gasoline inventories, you can quickly understand why refineries have been in the tanks. Gasoline is massively oversupplied:

While recent weeks have seen a decrease in inventories back into their 5-year range, gasoline stocks still remain very elevated when compared to their 5-year average. Simply said, refineries have overproduced gasoline. The market is trying to clear in a few different ways, but the most significant of these ways is exports. Exports have been strong this year, and recent weeks have probed new multi-year high territory.

Imports are still within historical ranges, but we did see a bit of relief earlier this year with a downtick in barrels brought into the country.

When it comes to gasoline stocks, however, the devil is in the details. First, the largest demand centers for gasoline are generally PADD I and PADD III. While the inventory balance does show inventories pulling towards the 5-year average, PADD I and PADD III are giving entirely different stories. First, PADD I is signaling that we are undersupplied in that region.

While PADD III is screaming a massive and unabated oversupply situation.

This difference in supply and demand situations is exactly why we have seen a recent decoupling in the local gas cracks for those regions.

New York Harbor’s gas crack has been strong and is showing recovery, while the U.S. Gulf Coast remains weak. For the refining industry at large, the better and more representative benchmark is the Gulf Coast. The reason, of course, is that a large majority of refining capacity is located in the Gulf Coast. For example, while overall refining runs are strong at around 16 MMBD…

… PADD III makes up over half of those runs:

Given the share of refining runs in PADD III and the ongoing inventory situation of largely untouched stocks in the Gulf Coast refining complex, the gas crack in that region is likely to remain short for the time being.

On the distillate side, the picture is actually pretty good. Inventories have been weak and declining when taken as a whole.

This decrease in inventories has been consistent across both PADD I and PADD III. As of late, imports have been decreasing and exports have been rising, lending additional tightness to the balance.

Given the fundamental picture of distillate in North America, the trend is consistent: distillate cracks are strong and continue to gain in strength.

It’s safe to say distillate is what’s saving the refining industry from falling off a cliff right now. The distillate markets are tight and distillate cracks are strong. The only catch here is this: distillate only represents about 20% of the overall refining slate for the industry. This means that just a small fraction of the production slate of the refinery is accounting for a huge share of positive earnings. As you can see in the following chart, the more representative 321 crack remains suppressed for the Gulf Coast but has been showing some strength for the northeast.

As we previously discussed, however, most of the refining capacity is along the Gulf Coast, which means that the gains from the higher cracks in the northeast will likely not move the needle too much for holders of CRAK.

The fundamentals of the refining industry are bearish. These fundamentals are why CRAK has underperformed the S&P 500 by 10% and why that differential continues to widen. And unfortunately, these fundamentals have not changed. The same catalysts present at the beginning of the price decline remain present now. For this reason, I suggest that investors exit their positions in CRAK. The primary money maker of the industry it holds is oversupplied, and many refineries have flirted with run-cut territory this year.

Perhaps the bright side of this analysis is this: the refining industry is cyclical. The summer months are typically when refineries make their year, and while cracks have been hit hard this year, the recent trend is at least in line with general seasonal directions. The refining industry is generally strongest during the summer driving seasons, and cracks normally peak around that time as you can see in the following chart.

In light of these fundamentals, I believe that if you are still bullish on CRAK after this analysis, you should consider reentering your position around the beginning of driving season (May) and holding through the end (August-September). Historically, these are the strongest times of the year for the crack, and any gains we will see will likely come during these months. Until then, I suggest staying away from CRAK and the oversupplied refining market.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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