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Gasoline Prices to Jump 15% (at least) in May

The Cushing Landlock

By

It doesn't please me in the least to tell you this. But gasoline prices are about to move higher by as much as 15% to 20%. I'm not saying this because of any mysterious patterns on the oil price chart...

And the reason has nothing to do with how much oil is being produced, or how much Americans are driving their cars...

No, the reason that gasoline prices about to go higher has to do with the fact that America's oil production is landlocked. The primary oil hub for the U.S. is located in Cushing, Oklahoma – hundreds of miles from any port.

There are two benchmarks for crude oil prices: West Texas Intermediate Crude (WTI) and Brent Sea Crude. WTI used to be the global benchmark, back when Texas was the world's biggest crude oil field. Then, as oil production grew around the world, the price of Brent Sea crude became important, too.

As you can see from the following chart, WTI and Brent prices have been roughly the same for years. But at the end of 2010, the prices started to diverge. Brent crude suddenly became more valuable than West Texas crude, even though it's not as “sweet.”

Brent vs. WTI Spread

There's a very simple reason why Brent Sea crude prices are so much higher than West Texas prices. It's not demand, it's supply. American oil production is stuck in America. It's landlocked in Cushing, Oklahoma.

Why?

Because there is precious little pipeline capacity to take American oil to export terminals and thereby take advantage of the Brent price. Just about all of our oil goes to Cushing, Oklahoma and gets transported around the U.S.

If you follow the weekly oil inventory numbers, you know that, even though the amount of oil (supply) stored at Cushing fluctuates, there's always millions of barrels on hand.

The latest inventory numbers show that 41.18 million barrels of oil are in storage. And supplies have risen 22.9 million barrels in just the last month.

As for gasoline inventories, we have around 221 million barrels, while we're using around 8.74 million barrels a day. The U.S. is, quite literally, awash in both oil and gasoline.

The Cushing Landlock (not a wrasslin' move)

With so much oil and gasoline on hand, I'm sure many Americans wonder why gas prices still hover around $4 a gallon. It's a valid question, but you really only have to look as far as the margins at the nation's refineries to get an answer.

Valero (NYSE: VLO) is making $0.016 for every dollar's worth of gas they sell. That's it. They aren't even getting their 2 cents worth of profit. Tesoro (NYSE: TSO) isn't much better, with $0.018 per dollar in net profit.

The explosion in U.S. oil production has been a mixed blessing. Unemployment rates are virtually zero in oil areas like North Dakota's Bakken. But Bakken oil companies are forced to take below-market prices for their oil due to the lack of adequate transportation infrastructure. In an extreme example from early February, Bakken oil hit $71 a barrel at Minnesota's Clearbrook terminal as supply overwhelmed pipeline capacity.

It's strange, because Bakken shale oil is very high quality, light, sweet crude. It's much more desirable than the heavy oil coming out of Canada's oil sands.

If only oil from the Bakken and other U.S. fields could access the global market and the $118 per barrel that Brent crude is fetching...

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Where There's a Will, There's Seaway

The Seaway oil pipeline is owned by Enbridge (NYSE: ENB) and Enterprise Products Partners (NYSE: EPD). It carries imported oil from Freeport, Texas to Cushing, Oklahoma. At least it will for the next 3 weeks.

On May 17, the Seaway pipeline will reverse its flow. In less than a month, 150,000 barrels of American oil will flow from Cushing to Freeport's refineries and export facilities. By 2013, as much as 400,000 barrels of U.S. oil will have access to the global market and the Brent crude price.

This means the gap between the U.S. oil benchmark WTI (currently $102) and the foreign Brent crude oil benchmark (currently $117) is going to close. WTI prices could make a quick 15% move higher as U.S. oil gets more access to international prices.

Now, I'm not a politician. I can't tell you why we haven't figured out a way to keep U.S. oil here at home and ease the price at the pump. I can't explain how it makes sense to import oil and then export gasoline.

However, I am an investor. And I can tell you that U.S. oil companies will make a lot more money when the price of WTI surges higher. That $71 a barrel for Bakken oil could jump to $100... or higher.

One of my favorite Bakken oil companies is hitting its first year of solid profitability this year. Profits in the current quarter will be 1,300% more than the same quarter last year. For the whole of 2012, profits will be up 700%.

Big Numbers, Big Profits

Those are big numbers, but not surprising as the company goes from being barely profitable to solidly profitable. But earnings will rise 50% a year for the next 5 years. Now that's impressive growth.

Yet there's something that's even more impressive. The forward P/E for the next 12 months is 6.

That's right, 6! Project that out over 24 months and you get a P/E of 3 for 2013.

Exxon and its paltry 7% growth trades with a forward P/E of 9.

You're not going to double your money in 2 years with Exxon. But with this Bakken oil beauty, you could get a triple. Or more.

That's because, in the last quarter, this company had an average sale price (asp) of $85 a barrel due to the hedges it uses. (And for the record, hedges are good because they lock in a sale price and give the company some accounting certainty.) If oil prices run higher, this company will lock in a better sale price. Maybe 20% better. Maybe 30%.

I can also tell you that a jump in average sale price has an exponential effect on earnings. That's because you take no additional costs to sell at a higher price. If $85 a barrel gets you $4 million in net earnings, then $100 a barrel will get you $19 million in earnings.

So, the reversal of flow for the Seaway pipeline is a big catalyst for domestic oil stocks, especially those in North Dakota's Bakken.

Good investing, 

Briton L. Ryle
Analyst, Wealth Daily 

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