Refiners are unlike almost any other group in the energy patch because they don’t benefit from rising oil and natural gas prices. In fact, all else constant, rising oil prices are actually bad news for the group, suggests Elliott Gue, editor of Energy & Income Advisor.

Valero Energy (VLO) is the largest independent refiner in the US, owning a total of 15 refineries with total throughput capacity of 3.15 million barrels of oil per day. Most of its facilities are in the US although the company does own a refinery in Quebec City (Canada) and one in the UK.

The US Gulf Coast is the most important refining center in the US and that’s where the bulk of VLO’s operations are located including a massive 395,000 bbl/day facility in Port Arthur, Texas and a 340,000 bbl/day plant in St. Charles, Louisiana.

In particular, the Texas Gulf Coast is home to just over half of Valero’s total refining capacity — this is the region of the US with the greatest feedstock and market flexibility, a major advantage for Valero.

And Valero’s facilities are mainly complex refineries capable of processing a wide variety of crude oil types from light sweet shale oil to heavier and sourer grades. In addition, its  owns two facilities in California as well as two inland facilities in Oklahoma and Tennessee.

The company also has among the cleaner balance sheets in the industry with a low cost of capital. Valero continues to pay its 5.9% dividend, free cash flow should rebound into 2021 and 2022 as demand returns, particularly for gasoline and diesel.

In 2019, a middling year for refining margins, VLO traded as high as 13.5 times free cash flow. Using 2022 mid-cycle estimates for FCF, that would imply a valuation for the stock in the $85 to $90 region.

While it will take time to get there and we’ll likely need to see a more favorable environment for refining margins late this year and early in 2021 to improve sentiment, that’s not an unreasonable long-term target for Valero.

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