Valero Energy Corporation Earnings: Can Refiners Keep Soaring?

On Tuesday, Valero Energy (VLO 0.08%) will release its quarterly report, and the stock has recently moved to levels not seen since before the financial crisis. Even though favorable conditions have lifted prospects for peers HollyFrontier (HFC) and Phillips 66 (PSX -0.35%), Valero has fared even better, and investors want to know if refining in general and Valero in particular can keep providing strong returns in the future.

Oil and gas exploration and production companies have business models that are easy to understand. When prices rise, the value of their production goes up, helping them become more profitable. But for Valero, HollyFrontier, Phillips 66, and other refiners, the interplay between crude oil prices and prices of refined goods like gasoline and diesel fuel is much more important. What's behind Valero's most recent upsurge? Let's take an early look at what's been happening with Valero Energy over the past quarter and what we're likely to see in its report.

Stats on Valero Energy

Source: Yahoo! Finance.

Which way are Valero earnings headed this quarter?
In recent months, analysts have gotten a lot more optimistic about Valero earnings, boosting first-quarter estimates by more than 20% and raising their projections for the full 2014 and 2015 years as well. The stock has responded favorably, climbing 12% since late January.

Valero's fourth-quarter results showed solid growth that encouraged shareholders. Net income jumped 28% even as overall revenue fell about 1% from year-ago levels. Despite some sluggishness in its refining segment, the ethanol business performed extremely well, and exports of refined products also climbed substantially as overseas prices for those products were extremely favorable.

Source: Valero.

Valero's earnings are volatile because of the changing dynamics of spreads between domestic West Texas Intermediate crude prices and prevailing prices for Brent crude on the international oil market. Rising U.S. production and bottlenecks in transporting crude generally lead to supply gluts and widening discounts for domestic oil, making it relatively cheaper for Valero and its peers to produce their refined products. Meanwhile, geopolitical conflict has made Brent crude more expensive, also helping to widen the price spread.

But Valero has key refining assets in strategic locations that let it take maximum advantage of whatever spreads prevail in the oil market. Valero has a bigger presence on the Gulf Coast than HollyFrontier or Phillips 66, putting it closer to the Eagle Ford as well as other plays in Texas, Louisiana, and neighboring states. Valero also has refineries located mid-continent, which put them closer to other highly productive areas of energy exploration. In addition, Valero has made substantial capital expenditures aimed at helping it increase its processing capacity for light crude, and that should allow Valero to take advantage of higher world-market costs for gasoline and other refined products.

The big question Valero faces is whether the U.S. will keep its ban on exporting crude oil. Currently, Valero benefits greatly from the fact that oil producers can't export crude directly, while the company benefits from exporting refined goods. Some policymakers are looking to lift that ban, and the resulting equalization in U.S. and world oil prices would take away one of Valero's key profit drivers.

In the Valero earnings report, watch to see how the company's ethanol division fares against its refining segment. With its having bought its 11th corn ethanol plant last month, Valero clearly thinks that ethanol has promise for the future, and if the numbers bear that theory out, it could give Valero a key advantage over HollyFrontier and Phillips 66 and allow its stock to keep climbing even if favorable conditions in the broader refining industry start to deteriorate.

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