An All-Weather Energy Stock

06/17/2009 12:00 pm EST


Jack Adamo

Editor, Jack Adamo's Insiders Plus

Jack Adamo, editor of Jack Adamo’s Insiders Plus, says energy demand is too weak to support current prices, but he likes a well-managed refiner for the long run.

Total petroleum and natural gas demand for the past four weeks is down 7.7% from last year’s figure, with drops in all product categories: gasoline, natural gas, jet fuel and other distillates.

Not surprisingly, inventories of all those products, except gasoline, are far above their five-year averages. What is surprising is that crude oil has risen [above $70 a] barrel. Goldman Sachs is predicting an average price of $80 this year. Either they have a far better long-view of the market than I do, or there’s something really rotten, and it isn’t in Denmark.

My Oklahoma oil buddy still says he sees no fundamental reason for the price rise. We both think China probably drove up the price initially by buying oil in the futures market, so as to get some hard assets in place of their rapidly rotting dollar reserves. They did the same with copper and iron. But now, I think the oil market is being driven by speculators who’ve interpreted the price rise as bullish in itself.

That kind of action can continue for longer than one might think, but it almost always ends badly. Speculators could get bailed out by a stronger economy, but so far there’s no sign of that in demand or inventory numbers. Moreover, if China withdraws from the futures market to let prices subside, we could see a hard down draft.

Our position in Valero Energy Corp. (NYSE: VLO) gave up all its gains when the company announced [last] week that it would report a loss for the second quarter, and was selling more common stock, which would increase the number of shares outstanding by 7.7%. The impending loss was blamed on extended downtime in two of its refineries, and by weak sour crude oil discounts and lower diesel margins. The latter two factors are related to weak overall demand.

Valero made a sizeable investment in ethanol plants recently. They got them at fire-sale prices when a company went bankrupt. Part of the proceeds of the share offering will go to paying for the acquisitions.

Valero has been an extremely well-managed company with a great long-term track record. Even with the big recession slide and the recent drop, the stock has still grown at a compound annual rate of more than 21% for the last 20 years. I don’t see any reason it shouldn’t continue its strong performance as we emerge from the current malaise.

Therefore, I think the shares are a good long-term holding. Should they pull back noticeably from here in an extended recession, I’ll gladly add to the position. In the meantime, the stock’s 3.3% dividend yield provides adequate comfort while waiting for things to turn around. Valero Energy is a buy up to $20. (It closed above $17 Tuesday—Editor.)

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