Americans' seemingly insatiable demand for gasoline may be bad for the environment and national security, but it's not a bad thing for the refinery industry. With $3/gallon prices around the country, no real move toward conservation, and substitute fuels a ways off, these are heady days for independent refiner Valero (NYSE:VLO).
How heady? Revenue jumped 49% this quarter on a 33% jump in volume, and the growth could have been even greater if not for some unexpected production outages. Running close to capacity and selling at robust prices certainly isn't hurting margins, either. Operating income more than doubled, and the operating margin rose three and a half points on a reported basis.
The big secret at Valero is really no secret at all. With little in the way of new refinery capacity coming on line, refining margins are exceptionally strong -- rising another 51% to over $15/bbl this quarter. That's roughly double what you might consider a "normalized" margin, so these are definitely the golden days for a company like Valero.
These good times will have to end someday, but that day could be further off than some think. For starters, while many Americans seem to regard cheap gasoline as a Constitutional right, nobody wants a new refinery in their community. Ethanol could replace some gasoline demand, but expected ethanol capacity in '08 will only cover about 5% of gasoline demand, and there's a limit to how fast companies like ADM (NYSE:ADM) can put up plants. Likewise with coal-to-liquids. Sasol (NYSE:SSL) has proven its economic viability, but it would take years for any real capacity to come online in the U.S.
Even if and when ethanol and coal-to-liquids become more meaningful sources of alternative supply, Valero will have a definite role to play. Not only will there still be a strong ongoing demand for gasoline, but ethanol blending makes it more difficult to produce higher-octane gasolines. That means more demand for alkylates, and that should benefit refiners like Valero, ExxonMobil (NYSE:XOM), and Marathon (NYSE:MRO) with alkylate capacity.
One way or another, as long as people are willing to skimp and sacrifice in other areas of their financial life to fill their gas tanks without otherwise changing their driving habits, Valero will have plenty of customers.
Fuel up with more Foolishness:
Check out our suite of newsletters with a 30-day trial.
Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
