In late July of this year the spread between Brent crude Oil and WTI (West Texas Intermediate) Crude Oil was at its highest, the difference between the two prices reached an astounding $23. In mid-October the spread came close to duplicating those highs but has since pulled back. As a result of the widening spread, many small refiners, and a few of the larger ones as well, were able to rake in some tidy profits as their cost of raw materials declined. Since that time however, the spread has tightened significantly, with the two crude oils trading currently at a $12 spread. Even with the eurozone growing stronger and maintaining greater confidence of investors, Iranian officials continue to be their stubborn selves. Earlier this week, officials threatened to block a significant waterway used along shipping routes causing the price of Brent crude to rise faster than its counter partner, WTI.
Also affecting the spread for the near term would be the rebalancing of a couple of major crude oil indexes, the S&P GSCI Index and the DJ-UBS Index. It is presumed that within the week the two funds will be dumping approximately $6 Billion worth of WTI futures contracts and buying up about $5 Billion in brent futures. These transactions should help widen the spread between the two commodities.
As with the previous expansion of the spread, the best place to invest would be the smaller refiners. Previous refiners who experienced big gains were CVR Energy (CVI), HollyFrontier (HFC) and Western Refineries (WNR). Of course if you prefer to be invested in the larger refiners, Valero (VLO) and Exxon Mobil (XOM) both may rally along with the smaller refiners, albeit to a significantly lesser degree, if the WTI / Brent spread widens.
Of the group, Valero seems to be the best investment based on valuation. With current analyst estimates projecting the company to earn $3.87 in 2012, even if the company experiences no growth over the next 5 years, a discounted cash flow analysis (using a 15% discount rate) shows the present value of the company's earnings to be $12.97/share. Adding back the company's current $5.05/share in cash, the intrinsic value of the company is $18.02/share. With the current price trading around $21/share, this represents, in my opinion, a great bargain.