The Margin Between Two Liquids

A refinery is a machine for buying one liquid and selling several more expensive ones, and a refining stock is a leveraged bet on the gap between those prices. The gap — the crack spread, in the trade's language — is having a very good year, which is most of what anyone needs to know about why Valero's earnings grew more than fourfold year over year.

Fundamentals

Valero is one of the biggest independent refiners in the US, with Gulf Coast scale, an export business into Latin America, and a renewable diesel arm bolted on. When product demand runs ahead of refining capacity — and capacity is the one thing this industry reliably under-builds, since nobody has greenlit a major new US refinery in decades — the spread widens and the operating leverage does the rest. Revenue up 52%, earnings up a multiple of that. The machine works in both directions, which is worth remembering.

At 14 times trailing earnings and 12 times forward it is, with Travelers, one of the two cheap things in this week's batch. Cheap for a reason: everyone knows crack spreads mean-revert, and the argument is only ever about when.

Technicals

$136 at the 52-week low, $343 at the high, and Friday's close of $341.67 sits essentially on the top of that range. The move from Wednesday's $330 to Friday's close already put the position a few percent ahead in its first week — the only one of the six entries meaningfully in the green so far. Buying a cyclical at its high is the uncomfortable version of trend-following; it works until the spread turns, and the spread gives little notice.