Description

Potato did a great write up of the refiner Valero (VLO) in October 01 so I will not repeat the background. Rather, if you find his secular thesis attractive (recommended reading), I believe there is now a catalyst for the thesis.

Specificially, I believe the next 12 to 18 months should be particularly favorable for VLO's economics (as well as the other refiners) and worth looking at here. Refinery margins (i.e. crack spreads) are at very high levels -- and I believe likely to stay high for at least a year if not much longer. In fact, if you just plug the current forward curve into an income statement model for VLO, you will come up with earnings as high as $10/sh+. If your style cares about consensus, it is around half of that level. The major change since Potato's write up is the civil unrest in Venezuela. Venz is the most important oil partner to the US, in my opinion, due to their close proximity, rich reserves, and refining capacity. I believe the (understandable) focus on Iraq has diverted almost all focus from the Venezuelan situation, one of the most important dynamics in the petroleum world. They have gone from being a meaningful exporter to the US (around 250K barrels per day (bbl/d) of refined products to a meaningful importer (250K bbl/d) [only 5 day trip versus 45 days from persian gulf -- so much cheaper from Venz). This may not seem like a large amount in the context of the US daily requirements but on the margin it makes a big difference given the industry's very tight supply situation pointed out by Potato. The Chavez government has fired the large majority of the country's oil engineers (somewhere between 15K and 20K) and, even if they hired them back today (very unlikely), it could take a year to get their highly complex refiners back up and running properly. In fact, if the Chavez people try and start these complex refiners themselves, they are at high risk of blowing up and never coming back on-line (possible).

Moreover, in addition to the Venezuelan situation, Kuwait's refineries are reported to be operation 20% below normal level, although this is likely a temporary phenomenon. Another dynamic that is unconfirmed and likely temporary are reports that Iraq blew up an Iranian refinery on Monday. Neither of these are key legs to the catalyst but could be s-t positives.

The overall thesis here is that investors haven't realized the depth of the Venezuela problem and the impact it will have on US refinery margins. I believe investors will realize this over time as earnings are generated and it will be a catalyst for VLO and other refiners.

The key risk to VLO is that it is a business with high financial leverage, relatively high operating leverage, and an acquisitive management -- operating in a cyclical environment.

Catalyst