With pump prices for gasoline approaching $4/gal everywhere and $5/gal in some US cities, it would seem logical that crude oil refiners are a good bet to do well. It’s not that simple, though, and today’s earnings report from Valero Energy Corp. (NYSE: VLO) gives clues as to why.

The next refiner report will be Hess Corp. (NYSE: HES) on April 27th. Hess is expected to post EPS of $1.95 on revenue of $9.45 billion. On May 3rd, Marathon Oil Corp. (NYSE: MRO) reports earnings, and analysts are looking for EPS of $1.41 on revenue of $21.84 billion. On May 4th, Tesoro Corp. (NYSE: TSO) is expected to report EPS of $0.65 on revenue of $5.83 billion. Three more refiners report on May 5th. Frontier Oil Corp. (NYSE: FTO) is expected to post EPS of $0.98 on revenue of $1.75 billion; Western Refining Inc. (NYSE: WNR) is expected to post EPS of$0.29 on revenue of $1.66 billion; and Holly Corp. (NYSE: HOC) is expected to post EPS of $1.38 on revenue of $2.11 billion. Hess, Marathon, and Holly also have crude production operations.

As for Valero, the company reported EPS of $0.30 on revenue of $26.3 billion. In the same period a year ago, Valero reported an EPS loss of -$0.14 on revenue of $18.5 billion. Analysts were expecting EPS of $0.30 on revenue of $22.3 billion.

In early March, Valero lowered its guidance for the first quarter from $0.47 to $0.15-$0.30. The company also said it would take a $0.61/share charge on hedging losses, which it did. Refining throughput margins increased by $3.93 in the first quarter of 2011 compared with the same period a year ago.

It’s not just margins, however, it’s also down to the spread. The difference in cost between WTI crude and Brent crude gives refiners with inland refineries a huge cost break compared with refiners along the US Gulf coast. The lead indicator on crude pricing is now Brent, not WTI.

Gulf coast refineries mostly pay Brent, or what are called waterborne, prices for crude while inland refineries pay WTI prices because there is no pipeline to carry the less expensive WTI from storage in Cushing to the Gulf Coast. Moving WTI crude to the coast by rail or truck is possible at the current spreads, but prices paid by the refiner are closer to Brent than WTI because of the increased transportation cost.

Here’s how Valero states it in their earnings report: “Combined with our heavy and sour crude oil processing capabilities, more than 80 percent of Valero’s refining capacity can process feedstocks that price below waterborne light-sweet crude oils.” And that’s what puts profits on the board for Valero and the others.

The refiners face two issues. First is volatility, where the Brent price could drop to significantly closer to the WTI price. Second, US drivers could stop buying gasoline.

The former is not likely to happen soon, but could be on the horizon for June. Investors have been playing the WTI/Brent spread by going long on Brent and short on WTI then following US economic data to move in and out of the spread bet.

Less driving happens slowly when it happens at all. While there is some evidence that drivers are staying off the road as prices climb to $4/barrel and more, it’s not happening in very great numbers yet.

Valero said that it expects a strong second quarter based mostly on the wide spread between WTI and Brent. The company also expects to boost its capacity utilization.

At market open this morning, Valero shares are down about -1%, to $28.83, within the 52-week range of $15.49-$31.12.

Paul Ausick

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