Tesoro's Run is Done
Kirk is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
One of the hardest lessons for investors to learn is that sometimes a stock that is running up does not mean it is a buy. No doubt, positive stock price momentum is often a signal that a company is just beginning to recognize its potential. Other times though, a good stock price run is just a rebound from an oversold period. Tesoro Corporation's (NYSE: TSO) recent run is probably an example of this.
Don't get me wrong, I like Tesoro as a company, particularly for a trade here and there (yes, I'm guilty of that), I said as much in February, however, the bottom line is that the company has little ability to grow profits longer term in an exceptional way. That doesn't mean the company is in any danger of going out of business. What it does mean is that earnings will have flat period and be generally slower growing for a very long time.
Refining is a very capital intensive business, so even when things are going good, as they are at the moment for Tesoro, there are always big expenses right around the corner. Also, the oil markets correct for prices on a fairly regular basis, so even when margins expand short-term, reversion to the mean over time is almost a certainty. We have seen this repeatedly.
Tesoro's quarterly profits surged by 78% in the last quarter due to a wide spread on Williston Basin oil to West Texas. This was caused by the combination of a shortage of transportation capacity, pipelines and refiners in the Williston accompanied by a surge in oil production among Bakken producers (which I have talked about here, here and here).
Having a wide spread between Williston and WTI crude allows Tesoro to capture much of that spread as profit for their Mandan facility which is running full tilt due to the massive new supply of Bakken oil. Tesoro's completion of a 10,000 BOE/d expansion of its North Dakota refinery should allow it more incremental gains in revenue. However, there are several reasons that margins will narrow over time.
First among those reasons is that transportation capacity for oil is increasing. As the ability of producers to move oil out of North Dakota increases, the spread which Tesoro is benefitting from will decrease. Berkshire Hathaway's (NYSE: BRK-A) (NYSE: BRK-B) Burlington Northern Santa Fe is putting tens of millions into expanding rail in North Dakota as are several other companies. The state of North Dakota is even encouraging rail development as a means to alleviate costly highway repairs necessitated by oil trucking.
In addition, six pipelines are being built or considered in order to transport oil out of the Williston to other refiners, thus creating a more efficient market. ONEOK Partners, as one example, is allocating $2.5 billion to expand pipeline capacity.
Ultimately, the Keystone XL pipeline from Canada will also be built alleviating strain on Enbridge's (NYSE: ENB) pipeline network which will open another option for Williston producers. Enbridge's pipeline network is the largest in America, however, its line from Canada through North Dakota is full of Canadian heavy sour crude which prevents it from transporting the light sweet crude of North Dakota. Rerouting millions of barrels of Canadian oil through a new pipeline would allow more Williston oil to reach Gulf Coast refiners and, even eastern refiners who are far under capacity due to a shortage of incoming crude, in a cost efficient manner. Once those new pipeline routes open up, Tesoro loses a significant pricing advantage that it now enjoys.
In addition, three new refineries have been approved in North Dakota, including one that is already under construction. Williston refining capacity will roughly double when all three projects are complete. This will further allow the spread between Williston and WTI oil to narrow, reducing the margin for Tesoro's Mandan, North Dakota refinery.
Ultimately, Tesoro will do fine, however, the outsize profits right now due to a wide Williston to WTI spread will dissipate over time. Don't get caught when margins contract and Tesoro shares flatten out or worse. There are better places for your oil money.
Kirk Spano and clients of Bluemound Asset Management, LLC have no positions in any of the stocks mentioned above. Neither Kirk nor Bluemound clients plan any transactions in the next 3 trading days in the mentioned company's securities. Opinions subject to change at any time without notice. Follow Kirk on Twitter @GALPinvesting, GALP is Growth At Low Prices, for new columns, important financial news and weekly stock picks.
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