Taking Advantage of the Crude by Rail Trend

We all like straight recommendations to buy stock, but sometimes just staying away from a sector is a very good call.  This year, it’s been tough in the energy patch, and I’ve worked hard to make sure my calls were very focused and not sector wide, missing much of the latent disasters that have befallen various parts of the energy patch, particularly in mid-cap E+P players and in refining.

It is in refining where I want to look now to find a focused play that is riding one of these negative trends.  The intensifying focus on “crude by rail” continues to hurt refiners but will greatly benefit some well-positioned MLP’s. 

In the last several weeks, I’ve gone against the recommendations of the big energy traders at Goldman Sachs and Morgan Stanley and predicted that the spread between West Texas Intermediate (WTI) and Brent crude would continue to contract, moving finally under $10.  That spread, if you’ve been reading my columns, has been largely responsible for the tremendous outperformance of the refiners in 2012 and early 2013, particularly the mid-con refiners, who have taken advantage of the low priced domestic crudes and the relatively high prices they could charge for refined products.

That’s been changing as the spread has slowly collapsed and we can see the relative weakness of the mid cons and other refiners in the last days – refining is not the place you’ve recently wanted to be. Exposed refiners like Marathon (MPC) and Valero (VLO) have been literally crushed in recent sessions and will continue to underperform should the WTI-Brent spread continue to show weakness.

I definitely think it will.  But instead of trying to short refiners or sell other weakening majors, is there something we can instead buy to take advantage of this trend? 

Perhaps there is.  WTI has begun to ‘catch up’ to international crude prices largely because of some pipeline rescheduling (like Seaway), but also significantly because of the use of rails to transport crude from new production nexus points.  And there are specific rail companies that are poised to benefit from that trend.  Canadian Pacific (CP) and Canadian National (CNI) are two rail stocks that are moving Western Canadian grades of cheap crudes out towards the West and East coasts.  The rails have been and will continue to be a great recovery sector to invest in and crude by rail (CBR) is just another reason why these stocks haven’t reached the end of their run here.

But MLP’s are also beginning to establish rail car fleets of their own to transport faraway crudes.  I’ve been a big believer that everyone needs these companies as part of a correctly diversified energy portfolio and CBR is a growing trend that points you in the direction of some better ones. 

Both Plains All-American (PAA) and Global Partners (GLP) have significant rail car fleets that have been driving both stocks higher in 2013.  Plains is far more diversified and might be overbought with its 4% yield.  But Global partners, even after it’s run is delivering over 6% -- more appropriate for this tinier and less well capitalized MLP, but equally safe, in my view.

An investor looking to start a necessary MLP portfolio could do worse than to start with these two, both taking advantage of a growing trend of crude by rail.