Valero has a cost advantage, thereby higher margins as compared to its competitors because unlike any of its rivals, approximately 70 percent of the crude oil processed by Valero is sour crude, which is cheaper than the sweet crude used by its competitors.
The good news is that crack spreads in the second quarter have increased from the first quarter of this year. Also, since Valero’s refineries can process the cheaper "heavy sour" crude oil, the company has a sustainable competitive advantage over other refiners, giving its refineries staying power through rough times like these. For very-long-term holders, this is when you buy stocks such as this one; since the weaker rivals often disappear (the rivals either eventually get shut down, get sold off - or both), and the strong players emerge as the victors.
The U.S. government expects crack spreads to improve moving forward, but those spreads remain well below where they were in last year’s second quarter. That’s good because it means there’s room for improvement - in both the margins and the share prices.
Another plus is that as oil prices have been dropping precipitously recently from the high of almost $150 per barrel, crack spreads have been increasing. And the drop in prices of natural gas, which is an input to Valero’s refining process, has also declined, further adding to margins.
In the refinery sector, that strong player - and eventual victor - is Valero. But we are not there yet, and the lack of expansion in refining capacity in the U.S. market over the past decade has established a definite floor under crack spreads, meaning there’s only so low they can go.
