Over the past 60 days, the refining sector has experienced significant gains. However, due to concerns about valuation and risks associated with peaking margins, analyst groups like Bank of America have downgraded the industry as a whole. This raises the question of whether these companies are still a good investment at current prices.

While Bank of America’s viewpoints seem reasonable, it’s important to note that not all refiners are the same. In fact, when comparing the three largest refiners in the US (Marathon, Valero, and Phillips 66), you’ll find distinct differences in their business structures.

In this article, we will focus on two refiners, Phillips 66 (NYSE:PSX) and Valero (NYSE:VLO). Only one of these companies has the potential for long-term growth and warrants your investment, while the other is at greater risk of facing the challenges feared by Bank of America.

The Refiner’s Advantage

Since the pandemic, the refining industry has undergone significant changes. Refinery capacity has decreased to 2014 levels due to closures and underinvestment, leading to a shift in supply and demand and higher rates for refiners. As a result, refiners have posted outstanding financial results over the past 12-18 months.

Additionally, with the growing focus on renewable diesel and its environmental and economic benefits, major players in the industry are investing in renewable diesel projects to capture high margins offered by renewable credits. Some notable renewable diesel projects include Valero’s DGD 3 at Port Arthur, PSX’s Rodeo Renewed project, PBF’s St. Bernards facility, and Marathon’s Martinez Renewable Fuels facility.

Although the market may take some time to fully respond to these changes, the Energy Information Administration projects that crack spreads will remain elevated in 2023 before settling back to slightly higher levels by 2024.

So, does all of this indicate the demise or regression of the refinery sector? Let’s dive into Valero and Phillips 66 to find out.

Valero Energy: A Risky Investment

Valero, with a market cap of $46 billion, operates 15 refineries and has a renewable fuels segment consisting of two renewable diesel facilities and 12 ethanol plants. While Valero’s renewable initiatives show promise, their economic value is still uncertain.

Valero’s Q2 10-K report reveals that the renewable diesel and ethanol groups account for 12% of its operating income, indicating a contribution to the company’s bottom line. However, the profitability of the renewable fuels segment heavily relies on government incentives such as RIN credits, LCFS credits, and BTC credits. These incentives are subject to supply and demand fluctuations, and their value could decrease as more renewable projects come online.