Oil Prices and Refiner Stocks

Despite recent intraday volatility, prices for oil (and gasoline) look sticky in expensive territory above $120, while showing signs of potential backtracking off the recent $130 to $140 range. "The Greek" says that barring Israeli bombardment of Iran, oil should move into a lower trading range soon. We think it may be time to consider buying refiners, partly as a result.

The Energy Information Administration released its weekly Petroleum Status Report this morning, adding the fresh data to a stack of reports and news flow that have flooded the market over recent weeks. However, the sudden abundance of information has only added to volatility, rather than clarifying where oil and distillate prices should trend. Also, recently aggressive analyst forecasts have distorted organic price trend.

More importantly, oil would seem to have become comfortable in its recent range above $130. Still, it's hard to ignore the tone of the data and news flow of late. The data is singing a song for lower near-term oil prices, and the volatility is indicative of a commodity that is uncomfortable where it is. So, as information is digested, we expect prices to back up some (read decline toward $120), but only until Iran.

Even the Arabs Don't Like It

Saudi Arabia's recent commitment to boost production was just one, though very important event. Also this week, Kuwait's oil minister suggested oil's natural price should now be $100. So, there seems to be some honest concern in the Middle East that higher pricing will not serve demand well.

Demand destruction is clearly apparent, as the American Petroleum Institute said gasoline demand fell 1.4% in May. The fact that decline in demand has not occurred in any similar period (1st five months of year) since 1991 tells you that we've reached that critical threshold where gasoline and energy usage will decrease. This should help to stabilize pricing and to promote alternative energy technologies.

Petroleum Status Report

Today's report from the EIA showed a lighter inventory draw than in recent weeks, and below forecast as well. However, the market was initially more concerned with an unexpected draw in gasoline inventory. We believe the 1.2 million barrel apparently illogical draw from gasoline inventory is partly the result of refiner efforts to improve margin.

Consider Refiners

Capacity has been reduced, as refiners had been losing money on rising oil prices that had not been matched by gasoline. Now that gas is upward of $4, refiner margins are improving. Thus, it may be time to consider the refinery stocks like Valero (NYSE: VLO), Tesoro (NYSE: TSO) and Sunoco (NYSE: SUN), all of which are down 40% or more over the last 12 months.

Caveat

We expect an Iran event over the next three months, and that will increase oil prices and undo everything we just suggested.

Please see our disclosure at the Wall Street Greek website. Article also interests AMEX: DIA, AMEX: SPY, AMEX: DOG, AMEX: SDS, AMEX: QLD, Nasdaq: QQQQ.