profit pump drying up?

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Are Oil Refiners Out of Fuel?

Although the energy sector has been volatile, oil refiners’ stocks have been on fire in the last year or so.

2011 spinoff Marathon Petroleum (NYSE:MPC) has doubled in the last 12 months vs. a measly 4% rise for its sister company Marathon Oil (NYSE:MRO), which engages mainly in exploration and production. Same for Phillips 66 (NYSE:PSX), up almost 100% since its April 2012 spinoff, while returns at exploration and production stock ConocoPhillips (NYSE:COP) have basically tracked the market with a 13% gain.

Refiner Tesoro Corp (NYSE:TSO) is another doubler in the past year, and Valero (NYSE:VLO) is “only” up about 70%.

The reason for the oil refiners’ run is the odd spread between Brent and West Texas Intermediate crude oil prices. U.S. refiners have been getting a discount on WTI of as much as $20 over the last several months, but gasoline has remained costly because pump prices are tied to Brent.

It’s an odd situation, but the result is that input costs were way down while sale prices remained high — resulting in very nice margins for refiners.

But now the Brent premium is the narrowest since July, and there is some fear that the shrinking margins will send investors out of these plays. It’s not that refiners are going bankrupt now, just that the big payday might be over.

A bigger concern for traders, however, should be the momentum-driven rally, as these picks could swing dangerously the other way once sentiment shifts. Speculators got in for the short-term opportunity, and a mass exodus from this fashionable trade could hold back the picks.

The fundamentals are starting to deteriorate now that the growth is behind us, and year-over-year comparisons are getting harder, with refinery stocks including Tesoro, Valero and PSX all forecasting a 2013 that will feature lower earnings than fiscal 2012.

My advice would be to hold refiners if you’ve got them in your portfolio, but start getting cautious. If you have a doubler, I would seriously consider taking partial profits off the table and selling a portion of the position, too; a 100% run is a lot to let ride.

New money is probably better served sitting this one out for now, considering the meteoric run for the sector and the threat of narrowing Brent-WTI spreads.

However, it’s worth noting that the valuations are attractive — especially for recent spinoffs like Phillips 66 and MPC that are benefiting from their newfound independence. Most refiners including Phillips, MPC, Valero and Tesoro have forward price-to-earnings ratios of less than 10.

So on a pullback? Who knows — it might be hard to pass up one of these picks if the forward earnings multiples get down into the range of 6 or 7, with a nearly 2% dividend as a sweetener.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing he did not own a position in any of the stocks named here.

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