By Phil Lassiter
Valero Energy Corporation (NYSE:VLO) reported fourth quarter earnings, which were quite a bit higher than in 2011. Revenues were $34.7 billion, or equivalent to revenues in the fourth quarter of 2011. Net income was $1 billion, up from $45 million in the fourth quarter of 2011. Earnings per share came in at $1.81, compared to $0.08 in 2011. It was important to rehash Valero’s earnings because it is likely that the company will continue to see earnings increases through the 2013 calendar year.
Where is Valero Now?
What was most surprising about the report was that Valero’s $955 million earnings increase was achieved despite no increase in revenues. The catalyst for the earnings increase was that Valero was able to reduce domestic refining cost by buying West Texas Intermediate (WTI) crude oil, as opposed to Brent Crude oil. Currently the spread between the cost of WTI crude ($93 per barrel) and Brent crude oil ($109 per barrel) is $20 per barrel. Obviously changing their refineries’ feedstock from Brent crude to WTI crude had a major impact on margins. In the fourth quarter, Valero’s operating margin was 3.66%, and its profit margin was 1.51%. These are very respectable margins for the traditionally low margin refining business. In the fourth quarter, Valero posted a $14.90 operating income per barrel for their mid-continent refineries, where most of the WTI crude is processed.
Valero is in the sweet spot of the refining business. Most of its 14 refineries are located in the central part of the U.S. This is important because its refineries have easy access to the cheaper WTI oil and the transportation costs are lower.
Another development that is working in Valero’s favor is that, as a result of the new technical advances that are now used in gathering oil, there is a glut of WTI oil coming to market. The domestic supply glut is the primary reason that refiners like Valero have had the upper hand when negotiating prices. It is also why Valero and other U.S. refining companies have been able to post such strong refining margins. This arrangement is likely to continue as oil-rich drilling areas, like the Bakken fields, the Wattenberg fields in northeast Colorado, or the Eagleford shale field in Texas, are likely to continue producing oil at current or even higher levels for years. Some oil and gas exploration companies, like Apache Corporation (NYSE:APA), Devon Energy Corporation (NYSE:DVN) EOG Resources Inc. (NYSE:EOG), Chesapeake Energy Corporation (NYSE:CHK), and Anadarko Petroleum Corporation (NYSE:APC), have stated their intentions to increase their domestic oil production in the coming quarters. EOG Resources (EOG) predicts that its 2013 U.S. crude oil production will grow by 28%, and Apache (APA) predicts that its 2013 U.S. crude oil production will increase by 30%. Building on this trend, Reuters states: “In November, the International Energy Agency forecast that U.S. oil output, aided by surging volumes from shale and other onshore rock formations, could top production from Saudi Arabia and Russia by 2017.”
CNBC stock analyst, Jim Cramer, said, “Valero has become the most aggressive company to take advantage of our newfound, technologically derived oil riches”. Valero’s CEO, Bill Klesse, seemed to validate Cramer’s statement when, in the fourth quarter earnings call, he said, “We replaced all imported light foreign crude oils with cheaper domestic crude oils at our Gulf Coast and Memphis refineries. Since we expect U.S. and Canadian crude oils to become increasingly available, we are purchasing options to process additional volumes of these cost–advantaged crudes throughout our refining system.” Later in the earnings announcement, the company further confirmed its commitment to using only feedstock from the U.S. and Canada when it announced that, by the end of the year, Valero will have 9,000 rail cars to ship crude to refineries on the West Coast, the Gulf Coast, in Quebec, and in Memphis.
A second development that has come out of Valero’s access to WTI crude is that it is now exporting refined products to foreign countries. Bill Klesse claims that the company has plans to export 400,000 barrels per day of refined products to what he describes as premium markets. That would represent almost 15% of Valero’s total yield for finished products. The over-all estimates are for Valero’s gasoline exports to rise to 250,000 barrels from 225,000, and for distillate exports (jet fuel and diesel) to climb to 425,000 barrels in 2013 from 280,000. This could be a tremendous development for Valero. The company will now be able to refine oil that is purchased at the cheaper WTI prices and then sell its finished products on the open market that is based on Brent crude oil prices.
In additional good news, another Reuters report states that: “Valero also said that its 14 refineries are expected to have a combined throughput of 2.575 million barrels per day, or 95% of total capacity, in the first quarter.”
Valero Energy’s stock is on a roll. Since its June low, the stock price has increased by 128%. Other refiners with access to WTI crude have also seen their stock prices rally. For instance, over the last 52 weeks, HollyFrontier Corporation (NYSE:HFC) stock is up 56%, Tesoro Corporation (NYSE:TSO) stock is up 97%, and Marathon Petroleum Corporation (NYSE:MPC) stock is up 103%. It is obvious that investors, who once thought of refiners as being low-margin highly cyclical businesses, now see the value in these companies.
We know that no stock can continue to move straight up, and I expect that some investors will take their profits and that Valero’s stock price will pullback. However, I believe that the trend that has been put in place by rising U.S. oil and gas production will continue, and that Valero is a great long-term investment.
Disclosure: Long VLO