Oil Slick

I know it's too late now
But I wish I could go back in time
And start all over somehow
And get it right from the start
--Jefferson Starship

Crude's two day, 10 handle decline has some thinking that the monster uptrend in oil is over for now. Technically, the chart certainly sports a parabolic look often associated with bubbly tops. On the other hand, it's hard to ignore the macro supply/demand imbalances in black gold.

Personally, I've largely been observing the energy bull market from the sidelines. My big picture view makes me bearish on world GDP, and it's been difficult for me to confidently bet on higher oil prices given the probability I assign to a scenario of slowing world demand.

One oil-related name that has caught my eye is Valero (VLO). North America's largest (and I think best) refiner has seen its stock price crushed as crude rocketed higher. Higher crude prices mean higher feedstock costs for VLO, resulting in lower crackspreads and profits.

Because VLO has largely been trading inverse to crude, it seems an attractive way to play a pullback in oil. Moreover, general market action over the past couple of days suggests an oversold rally may be at hand--one that could put the wind at the back of the average stock for a while.

While my primary thesis is shorter term and trading oriented, I think there's a decent fundamentally-driven investment story as well. This is a well managed company in an industry that lacks spare domestic capacity. Unlike others, VLO has retrofitted facilities to efficiently refine heavy sour crude. The heavy stuff is cheaper than light sweet crude, and as light supplies dwindle, VLO is positioned to refine at wider crackspreads than others. This is an interesting strategic position.

Financially, the company's been throwing off $2-3 billion in free cash flow annually for the last few years, and sports a manageable debt:equity of 0.3. At today's close of $33.56, VLO's free cash flow to enterprise value is nearly 7, which is about as cheap as I've seen among companies I follow.

Boo's side of the story? Resumption of crude's march higher for one thing. More offshore refined gasoline shipped to the US for another, which would impair ability of domestic refiners to raise prices.

The risk/reward looks favorable enough to me for at least a trade.

position in VLO