Answers to Your Questions

by | published July 6th, 2010

I have finally had time to begin reading the mail. Plenty has piled up!

I will be answering what I can here; our rules prevent me from answering E-mails directly. And I can’t provide personalized investment advice.

A number of readers have also asked for my take on particular stocks. Once again, if I end up doing that, it will be posted here for all to read. (If you have a question yourself, just send it to

Now, let’s dig in…

Q: Just read “India’s New Oil Decision: What You Need to Know” (July 2nd, 2010). Many thanks for your excellent analysis. The main contention in India is that when crude price per barrel doubles, prices at the gas station should not rise by more than 50% (because other costs, like refining, transportation, and distribution, do not change overnight). What is the unit cost to refine a barrel of oil… and what relationship would a rise there have to prices at the pump? ~ Ramarao B.

A: The refinery margin, as it is called, is the Holy Grail for refiners. This is the difference between processing costs for crude oil, going in one end of the refinery, and the rack price, the price charged to jobbers picking up distilled products (like gasoline) for wholesale distribution, coming out the other.

Unfortunately, that margin is not made public. It is considered proprietary information. The figures are averaged, and you can find those released from a number of sources, including the refiners’ own quarterly reports. Yet those published numbers usually do not reflect what the refiners are actually making. Independents are coming out of a horrible period, in which the margins were beaten down by economic problems and declines in overall driving. Those vertically integrated oil companies – which own fields, refineries, and distribution networks – generally fare better. After all, they would not charge themselves full market rates for the crude.

Now, a refiner will tell you that the price of that crude oil is the single biggest component in determining the reference cost. That is true… but it is the refinery margin that provides the primary source of profit.

So to answer Ramarao’s two questions…

First, throughout the summer, I expect the refinery margin to run about $12 on average per barrel of crude oil (about a 15% profit per barrel), with overall refinery capacity at about 80%. The real return, however, is greater than that, after you factor in the crack spread – the differentials among prices for various types of oil products (gasoline, diesel, jet fuel, heating oil) – and the results of hyrocracking. This little joy of nature results when larger hydrocarbon molecules are broken down into smaller ones – with results of between 114% and 118% of the original crude volume actually coming out of the process. This is added product that can be sold for full retail price but does not require any additional crude oil to be sourced.

Second, on average over the past decade, a $1 rise in crude oil prices per barrel has resulted in a 1.4-cent rise at the pump for gasoline (although this has accelerated of late). And no, it does not work in the other direction. During the price collapse between August of 2008 and January of 2009, crude prices went down 77%, but retail gasoline prices declined on average by only 54%, or less than 1 cent for each $1 decline in the crude price.

If we should reach $140 per barrel next year, starting from the current crude oil price of about $71, the result should be a net addition of 97 cents per gallon of gasoline. But that is a national average. It will be higher in places like California and Chicago (where special blends are required) or western Pennsylvania (with a significant running distance from refineries), and says nothing about national and state taxes staying the same.

Q: I work at a Credit Union in Trinidad. Trinidad trades with the U.S., and BP operates in Trinidad doing offshore drilling. How will the present situation in BP affect the operations at the Credit Union? ~ Kathleen T.

A: While there are a number of factors that would impact credit operations in the Caribbean basin, the current results of the Macondo blowout are not among them.

First, the U.S. moratorium on deepwater drilling will not affect BP (NYSE:BP) operations offshore – in the more southern regions of the basin. Second, the main refinery locations on the two islands receive their crude flow from sources other than those in the affected spill area. Third, much of the BP operations in Trinidad results from onshore terminals producing and exporting liquefied natural gas (LNG), with the source of the gas being much of that extraction taking place immediately offshore. The LNG market is the fastest-growing component of the worldwide energy picture.

Q: A small Australian outfit called Elk Petroleum is working over old fields in the U.S. What do you think are their chances of hitting something worthwhile? ~ Brian S.

A: Elk Petroleum (OTC:EKPTF) specializes in well workovers in Wyoming and elsewhere in the U.S. midlands. It also has 100% ownership of two fields in the Wind River Basin and 50% of a field in the Power River Basin (both in Wyoming). The company has had a nice 12-month run (up over 150%) and a three-month return of 40%. However, this is a micro, and its revenue flow remains dependent upon strong well recovery rates on a few parcels. It stands at $0.19 a share and should have another go at its high of $0.30 over the next six months. But approach this one carefully. This is a very thinly traded stock, and a slight downturn in its extraction rates will result in a serious negative pressure. Watch the company’s access to affordable working capital.

Q: Any thoughts on CGX Energy? Thanks. ~ Gary K.

A: CGX Energy (TSX Venture:OYL:CA; OTC:CGX.F) is a Canadian E&P company that drills offshore Guyana (northern coast of South America), having a 100% position in the Eagle well (Corentyne license) and 25% of the Jaguar (Georgetown license). The company has filed for a $65 million placement to fund both projects. That is certain to dilute the current share value, which has lost 65% in the last three months and currently stands at $0.59.

A March independent assessment of the Corentyne deposits by Gustavson Associates (Boulder, CO) puts the P50 (Prospective Resource) total at 2.8 billion barrels. However, this figure needs to be taken with a considerable amount of caution. No seismic has been done, and there have been no discoveries in this area previously. This is an estimate of potential undiscovered oil and gas “prospective resources.” I would wait until there is more hard data.

Q: I read your E-mails with interest. Wild Stream Exploration is a small oil firm that I found on the Toronto Venture Exchange. Just how big could this one get? ~Michael B.

A: Wild Stream Exploration (TSX:WSX:CA) is another Canadian minnow. At $5.60, WSX is midway between its 52-week highs and lows. The company has primary activities in Alberta (Red Coulee and Coults) and Saskatchewan (Antelope Lakes) and has acquired additional acreage. It changed its name from Eagle Rock Exploration in November of last year, along with a 30:1 share consolidation – resulting in relatively few common shares trading (about 25 million) for a company having no debt. WSX also focuses upon low- to middle-risk wells. That means it is a “safe” E&P company emphasizing steady volume over spectacular results.

Michael wants to know how big it will get. Now I never answer that kind of open-ended question, because there are simply too many variables involved. So allow me to respond this way. For WSX to grow bigger, it will need to farm in some players with access to working capital. Retaining 100% of its fields will mean about 10 to 15 low-yielding wells a year. That will have little major impact on share pricing. Therefore, discount information on new acquisitions and watch for the likely alliances with other producers needed to move this company to the next level. In the process, WSX will need to give up some control and will probably resort to credit markets (meaning debt) and/or share placements (which, absent a significant rise in extractions, will put pressure on current share levels).

I’ll try to answer E-mails more regularly from now on, but remember, the only answers I can provide will be posted here, for everyone’s benefit. And again, if you have a question for me, just send it to


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