By Robert Swift 

Energy investing has its own social hierarchy. At the top sit the fashionable: solar developers with ambitious targets, battery makers with ambitious valuations and explorers with ambitious geologists. Somewhere near the bottom, rarely asked to give the conference keynote, sits the refiner. Refining is plumbing. It takes a black and often unpleasant liquid and turns it into the diesel, petrol and jet fuel the world still runs on, whatever the brochures say. 

Plumbing becomes interesting when the pipes are under pressure, and this year they have been under a great deal of it. Flows through the Strait of Hormuz have been disrupted since the conflict with Iran began in late February, Russia continues to restrict diesel exports, and US refiners have been running flat out with almost nothing in reserve. In early September the average US diesel price hit a record US$5.85 a gallon, above the 2022 peak. 

Valero stock has noticed. Valero Energy (NYSE: VLO), one of the world’s largest independent refiners, has roughly tripled from its 52 week low of about US$155 to trade around US$457. We have owned it from the early 100’s. The more useful question now is not how it got here, but whether the reasons it got here are temporary or structural. My answer is that more of them are structural than the market assumes, although not all of them. 

Refiners earn the spread, not the oil price 

Most investors look at a refiner and think about the price of crude. That is the first mistake. A refiner earns the gap between what it pays for crude and what it receives for the products it makes. Expensive crude is perfectly tolerable if diesel is more expensive still, which has been precisely the situation this year. 

The second mistake is to treat all refiners as interchangeable. They are not. A simple refinery can process only light, sweet crude, the expensive kind, and turns a meaningful share of each barrel into low value residual fuel. A complex refinery, equipped with cokers, hydrocrackers and catalytic crackers, can take heavy, sour, sulphurous crude, which trades at a discount because relatively few plants can handle it, and turn it into high value diesel and jet fuel. 

Valero sits firmly in the second camp. Its Port Arthur refinery in Texas, the largest in its system at 435,000 barrels a day, is described in the company’s own filings as processing heavy sour crude, and its Wilmington plant in California runs a blend of heavy and high sulphur grades. Across the system, Valero processed around 514,000 barrels a day of heavy sour crude in the second quarter. Discounted feedstock, run through equipment that most competitors lack, is a durable source of margin rather than a lucky quarter. 

Venezuela comes back on the menu 

That capability has become considerably more valuable this year. Following the removal of Nicolas Maduro in January, Washington eased sanctions and issued general licences covering Venezuelan oil exports. Valero moved quickly. Reuters reported in February that the company planned to take up to 6.5 million barrels of Venezuelan crude in March alone, its largest intake since sanctions began in 2019, with the potential to overtake Chevron as the largest US refiner of Venezuelan barrels. 

Venezuelan crude from the Orinoco belt is extra heavy, closer in consistency to tar than to the light crudes produced in the Permian. It is cheap precisely because it is awkward. Valero ran heavy Latin American crude for decades before sanctions shut the tap, and Port Arthur was expanded in 2023. When the supply returned, Valero did not need to build anything. It needed only to buy. 

Management made a related point on its second quarter call, citing the outlook for heavy sour crude discounts as one reason the floor under refining margins may now sit higher than historical averages suggest. 

Owning the plumbing to the plumbing 

The second advantage is geography. Valero operates 15 refineries in the US, Canada and the UK with combined throughput capacity of about 3.2 million barrels a day, and its Gulf Coast plants account for more than half of that throughput. That places them beside domestic crude supply, imported heavy crude and the export docks. On the second quarter call, management noted that an arbitrage had opened to ship jet fuel to Europe, a continent that has lost Russian supply and closed a number of its own refineries. 

Just as important, Valero owns much of the infrastructure that serves those plants. Its annual report lists crude oil pipelines, product pipelines, terminals, storage tanks and marine docks, and states that these assets support its refining operations and export capabilities. In a world where supply chains are increasingly used as instruments of policy, a refiner that controls its own access to feedstock and to export markets is considerably harder to squeeze than one that relies on others to deliver its crude and collect its products. 

The broader system is not getting any looser. US refining capacity has been drifting lower as older plants close, utilisation ran close to 98% in late August, and distillate inventories sat well below their five year average. Spare refining capacity is rather like a reliable electricity grid: its value becomes obvious only when it is not there. 

A hedge against a return to Wokeworld 

Valero also runs two businesses that would surprise anyone who thinks of it purely as an oil company. 

Diamond Green Diesel, its joint venture with Darling Ingredients, is one of the world’s largest renewable diesel producers, with around 1.2 billion gallons a year of capacity on the Gulf Coast. Valero also operates 12 ethanol plants in the US Mid-Continent with combined capacity of about 1.7 billion gallons a year. 

These are policy businesses, dependent on fuel standards, renewable credits and tax incentives, and they have been volatile. In the second quarter they earned their keep: renewable diesel delivered US$717 million of operating income against a loss a year earlier, and ethanol contributed US$318 million. More importantly, they hedge the portfolio against a return to Wokeworld. Should the political pendulum swing back towards mandates and subsidies, Valero is one of the few refiners positioned to be paid on both sides of the argument. 

The numbers 

The second quarter of 2026 showed what the business earns when conditions align. Net income was US$3.72 billion, or US$12.62 a share, against US$2.28 a year earlier. The refining margin averaged US$23.62 a barrel, almost double the prior year’s US$12.35, on throughput of about 2.95 million barrels a day. 

Capital allocation has been sensible rather than heroic. Valero returned US$2.6 billion to shareholders in the quarter, 59% of adjusted operating cash flow, and pays a quarterly dividend of US$1.20. Net debt to capitalisation was 11%, and cash of US$7.9 billion sits well above management’s long term target of US$4 billion to 5 billion. As Ray Dalio and others have been pointing out, governments and AI builders are now competing hard for the world’s savings. A business that funds itself and still hands cash back is worth a premium in that environment, not a discount. 

Valero stock valuation: cheap, or cheap for a reason? 

At around US$457, Valero has a market capitalisation of roughly US$131 billion. Consensus earnings for 2026 are about US$51 a share, which puts the stock on roughly 9 times this year’s earnings. Estimates for 2027 are materially lower, at around US$42 to 43 a share, implying something closer to 11 times. 

That gap tells you what the market believes. A single digit multiple for a business generating this much cash looks undemanding, but it is low precisely because investors assume they are looking at a peak. The sell side is divided in instructive ways. Wells Fargo and Citigroup both lifted their price targets to US$485 in the past few days, while the average analyst target, at around US$380, sits well below the current share price. Several brokers, including Jefferies, Bank of America and Mizuho, rate the stock a hold or neutral. 

The bull case is that structurally tight refining capacity, persistent geopolitical disruption, rising compliance costs and a steady supply of discounted heavy crude justify a higher mid cycle margin than history implies. The bear case is that every refining boom in living memory has been followed by a bust. Both camps have history on their side, which is rather what makes it a market. 

Risks 

Refining margins are cyclical and have historically mean reverted, sometimes brutally. Goldman Sachs expects Brent to fall to around US$85 a barrel by December and US$80 in 2027 as supply normalises. A settlement in the Gulf and a reopened Strait of Hormuz would ease the strain on product markets and, with it, Valero’s margins. 

The share price has already moved a very long way, and the average analyst price target sits below it. Buying a cyclical business near the top of its cycle is the classic way to lose money in cyclical businesses. Consensus already expects earnings to fall next year. 

Record fuel prices invite demand destruction, and they also invite politicians. Windfall taxes, export restrictions and public pressure on refiners are perennial temptations when diesel is at record highs. 

The Venezuelan opportunity rests on US Treasury licences that can be withdrawn as quickly as they were granted, and on Venezuelan production actually rising. Valero’s own annual report flags uncertainty around events involving Venezuela as a risk to supply and margins. 

Operational risk never disappears. Valero is repairing a diesel hydrotreater at Port Arthur at an estimated cost of US$250 million, much of which it expects insurance to cover. Refineries are complicated and dangerous places. 

Finally, the hedge works in both directions. The renewable diesel and ethanol businesses depend on standards, credits and incentives that change with administrations, and management has flagged tariffs as a possible headwind. 

Third quarter results are due on 22 October and will provide an early test of whether margins are holding. 

TAMIM Takeaway 

Valero is neither a transition story nor a technology story. It is a plumbing story, and the plumbing is under strain. Its refineries are built to process discounted heavy crude that simpler competitors cannot, its Gulf Coast footprint and owned pipelines, terminals and docks give it dependable access to feedstock and export markets, and its renewable diesel and ethanol businesses hedge against a return to Wokeworld. 

The market recognises that Valero is earning exceptional margins and is pricing them as temporary. For long term investors, the question is how much of today’s advantage is structural. The best opportunities in energy often sit not with whoever owns the most barrels, but with whoever can turn the awkward ones into something the world actually needs. After a run of this size, valuation discipline and a clear view of the cycle matter more than ever. 

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Disclaimer: Valero Energy (NYSE: VLO) is held in TAMIM portfolios as at the date of article publication. Holdings can change substantially at any time.