Kodiak Oil & Gas Corp (USA) (KOG), Continental Resources, Inc. (CLR): Buy E&Ps and Sell Refiners

Every story has two sides, and this one is no different. While exploration and production firms will see their margins rise over the next two years, many refiners face the opposite trend. The U.S. does not allow for raw crude exports, so refiners have been making a pretty penny by buying cheap American oil and selling refined products internationally.  

HollyFrontier Corp (NYSE:HFC) has played the market very well with refineries in Wyoming, Kansas, Oklahoma, Utah and New Mexico. In the coming years the placement of its refineries close to shale producers will continue to be an advantage for the company, but expect its margins to fall. The above chart shows how its operating margin follows the Brent WTI spread very closely, and there is no reason for the relation to break down.

HollyFrontier Corp (NYSE:HFC)’s balance sheet is healthy with a total debt to equity ratio of 0.16. It is highly unlikely that falling margins would bankrupt the company, but it is likely that its special dividends and any future share repurchase programs will be scaled back.

While the majority of refiners are looking at painful years ahead, Tesoro Corporation (NYSE:TSO) is a different story. It has refineries in Alaska, North Dakota, Utah, Washington, California and Hawaii. The company has a relativity difficult time acquiring substantial supplies of cheap Midwest oil.

In 2012, 55% of Tesoro Corporation (NYSE:TSO)’s Washington refinery’s input was expensive Alaskan North Slope, or ANS, crude. Thanks to improved rail links and better transportation from Canada and the Bakken, the refiner hopes to replace a significant portion of ANS with cheaper Midwest crude. While many refinery dividends have questionable futures, Tesoro Corporation (NYSE:TSO)’s 2.1% yield is a different story thanks to future changes in its crude oil consumption.

Conclusion
Right now infrastructure is being built that will boost Bakken drillers like Continental Resources, Inc. (NYSE:CLR) and Kodiak Oil & Gas Corp (USA) (NYSE:KOG) and bring down the margins of Midwest refiners like HollyFrontier Corp (NYSE:HFC). It would be tempting to simply downgrade Tesoro with the rest of the refining industry, but it is just starting to take advantage of cheaper crude. Fundamental changes are reshaping the industry, and this is a great time to reshuffle your portfolio or watchlist.

The article Buy E&Ps and Sell Refiners originally appeared on Fool.com and is written by Joshua Bondy.

Joshua Bondy has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

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