Updated from 8:55 a.m. EDTPetroleum refiner Valero's ( VLO) second-quarter earnings shot up 34% from a year ago, reflecting widening margins among crude varieties and surging prices for distillates like heating oil and diesel. San Antonio-based Valero earned $847 million, or $3.06 a share, in the quarter, compared with $633 million, or $2.28 a share, a year ago. Analysts surveyed by Thomson First Call had been forecasting earnings of $2.94 a share in the quarter. The company took the unconventional step of describing its stock, which is up 86% this year, as "a great value for investors." Valero predicted that "as good as 2005 is proving to be, next year should be even better for Valero with the addition of Premcor ( PCO) and the dramatic changes in fuel specifications the industry is facing in 2006." Before Tuesday's release, Wall Street expected Valero to earn $8.29 a share this year and $7.97 a share next year. At Monday's close of $84.25, Valero shares cost 10.2 times this year's estimate and 10.6 times next year's. The stock is currently down 1.5% at $83. Valero has been at the sweet spot of the energy rally, with refineries equipped to capitalize on the especially fat profit potential from improving heavier, so-called "sour" grades of crude. The company is also making money serving red-hot markets with distillates and gasoline. In sour crude, Valero noted, margins actually contracted midway through the quarter due to tightening residual fuel markets in Europe and Asia. Nevertheless, the company had its best April ever and its second-best May because of the strength in distillates. In a conference call, the company also said it expects sour crude margins to widen again through 2006 to $16 or $17, up from the current $13 or so. Valero said Gulf Coast distillate margins were $9.61 a barrel in the second quarter compared with $1.61 a barrel a year earlier. Chairman and CEO Bill Greehey said Valero would consider hedging some of its 2006 and 2007 production, a statement that took analysts by surprise after the company recorded a $180 million loss after hedging 30% this year's production based on a $5.15 margin. Had it not hedged that production, earnings could have been 20 to 25 cents higher, analysts say. For gasoline, Gulf Cost margins were $9.64 a barrel in the latest quarter, down from last year's record $12.95. "The fact that both distillate and gasoline margins are strong in the middle of the summer driving season demonstrates how tight the global refining system has become," the company said. As for its capital expenditures, Valero said it will spend $3 billion in 2006 from its cash flow, which includes the $1.6 billion cash component of its $8 billion acquisition of Premcor, as well as $700 million for "strategic growth spending." Over the quarter, it has spent $115 on facility turnarounds and maintenance. Management indicated in the conference call that it intends to increase its dividends and continue its stock buy back program. It declined, however, to provide any financial guidance for the foreseeable future, except for stating that "2006 should be another record breaking year for Valero."