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Refiners Gear Up for Earnings Bonanza

As refiners approach earnings season, Wall Street is abuzz with anticipation.

The sector is thriving, with the price of petroleum products consistently outpacing even the soaring price of crude; margins are fat. Companies that process heavier and cheaper oil, whose prices have held relatively low during the rally in light crude, are winning big-time.

Companies such as Valero (VLO - Get Report) and acquisition target Premcor (PCO - Get Report) are expected to post record earnings this quarter, as they continue to benefit from high retail prices and wide refining margins.

"It's been an unbelievable performance," says Fadel Gheit, oil analyst at Oppenheimer & Co. "Margins and prices are going to remain very high." (Oppenheimer has no investment-banking relationship with the companies in this story.)

With no significant additions to refining capacity on the horizon either in the U.S. or globally, the uptrend is likely to continue.

Valero recently said in an update to investors that it expects record-breaking second-quarter earnings of $3 a share, compared with the $2.28 a share it earned in the second quarter of 2004. It chalked up the performance to "exceptionally strong distillate margins and wide sour crude discounts." Shares are up 83% this year to $82.82, about 10 times the 2005 earnings consensus.

"The real demand is for crude products, not for crude, and refiners today are in the driver's seat," Gheit says. He says the refining industry has made more money in the first quarter of this year than it has over the last three years put together. "Refiners went from dust to gold in three years."

Thanks to its refining capabilities, Valero benefits from buying heavy oil at cheap prices and turns it into lighter, "sweeter" products such as diesel. Called differentials, the spread between the two types of crude has increased to four times its historic norm. From a $3 average spread between heavy and sweet crude, the gap has widened to $11 recently and was as high as $18 in 2004.
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