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This article is part of our "Best Stocks for 2011" series where our Foolish writers pick their top stocks ideas for the year ahead. Click here to see a review of last year's picks and our 12 recommendations for the year ahead.
In the form it's in when first pumped out of the ground, oil is pretty useless. As it's refined into products like gasoline, heating oil, asphalt, and other petrochemicals, however, it becomes some of the most useful stuff on Earth.
Refiners -- the companies that make oil useful -- play a critical role in that value chain. None are better poised for success in 2011 than North America's biggest independent refiner, Valero (NYSE: VLO ) . After a rough year of recovering from expensive refinery shutdowns amid industry overcapacity, Valero looks poised to have a more successful 2011.
Better than integrated majors?
2010 was a great year for the integrated oil giants. Other than BP (NYSE: BP ) , which suffered huge oil-spill-related losses, the integrated majors rode oil's relentless climb to stupendous profits. Over the past four reported quarters, ExxonMobil (NYSE: XOM ) earned more than $27 billion, Chevron (NYSE: CVX ) earned more than $16 billion, and Royal Dutch Shell (NYSE: RDS-A ) earned more than $15 billion.
And while there's every reason to believe that those integrated oil giants will continue to be tremendously profitable, these days their growth is largely tied to the price of oil. With oil in the $90s per barrel and fuel stocks near long-term highs, you have to ask yourself where future oil price growth will come from. Aside from speculation on the falling dollar, there's little fundamentally holding up the price of oil.
The thing about refiners like Valero, though, is that their profits are tethered to what's known as the crack spread, rather than the raw price of oil itself. And that spread seems to have essentially returned to normal, after the beating it took in the fourth quarters of 2008 and 2009. In essence, now that the bulk of that expensive downsizing is behind them, refiners are well-positioned to handsomely profit, no matter what the price of oil itself does.
Better than any other stock?
Like it or not, the world still runs on refined oil products. That's not going to change any time soon. And in a world where even major oil producers like Saudi Arabia need to import refined oil products like gasoline, wouldn't you want to own one of the biggest and best refiners out there?
What sets Valero apart in the refining business is something called "refinery complexity," where it tends to be near or at the head of its class. Its more complex refineries are able to handle lower-grade crude oil, which allows them to further improve their profitability when the spread between high- and low-grade oil increases.
On top of that advantage in oil refining, Valero is responding to new mandates for increased ethanol usage by aggressively buying ethanol production capacity. No matter what you may think of the true utility of increased ethanol, it is the law of the land. Along with Archer Daniels Midland (NYSE: ADM ) , Valero is now one of two major ethanol producers in the country. That gives it a tremendous advantage as the new ethanol rules come into force.
Whether it's the energy demands of today's economy or the actual regulations driving the rules of the road for tomorrow, Valero is well-positioned to shine from an operational perspective.
From a financial perspective, it wasn't that long ago that Valero's stock traded hands for more than $77 a stub, which may have been a bit "irrationally exuberant." At today's prices closer to $23 a share and around 11 times next year's expected earnings, it's a fundamentally strong business available at an attractive price. And even if the expected turnaround fizzles, at a price-to-book ratio of around 0.84, there's a decent margin of safety priced into its shares.
When looking for the best stock to own, is there really any more that you could ask for?
Which is the best stock for 2011? See all 12 candidates here.