Refiners Gear Up for Earnings Bonanza

The reason is simple. Big oil producers, such as Saudi Arabia, are currently producing more heavy crude than light and sweet oil, because that's what is left as oil fields deplete. This allows refiners with heavy crude processing abilities to enjoy the discounts.

Also lending support to refiners' earnings is an extraordinarily strong demand for distillates, which has pushed retail prices of gasoline and diesel to record highs.

With hefty distillates and gasoline demand, record high retail prices and plenty of cheap crude, Valero looks posed for a bright future. And once the merger with Premcor is completed, it will become the largest refiner in the U.S.

"Valero has yet to reach its replacement value, which means it is still valued less than what it's really worth," says John Selser, portfolio manager for the Maple Leaf Partners hedge fund, which is long the stock. "The company is reaping the rewards of years of investment in highly complex refineries that can process heavy crude."

As for Premcor, the same market conditions have worked well for the company, as illustrated by Wall Street's expectation for a 65% jump in second-quarter earnings to $2.66 a share. Full-year estimates are pegged at $6.64 a share, up from last year's $5.75 a share, according to Thomson Financial. At $76.08, the stock fetches 11 times this year's estimate and 10 times next year's.

Premcor CEO Jefferson Allen said that "conditions in the second quarter to date have been robust, with refining margins even stronger than during the first quarter, and crude oil price differentials only slightly weaker."

Jay Saunders, analyst at Deutsche Bank, however, thinks that shares of Premcor are trading near a takeover price, and doesn't see much upside for the company.