The Crack Spread Scramble: HollyFrontier Corp (HFC), Valero Energy Corporation (VLO)

Over the past several years, advanced extraction techniques have turned the energy sector on its head. The ability to retrieve natural gas from shale deposits, using horizontal drilling and hydrofracking, is so effective that the U.S. will soon become a net exporter, instead of a net importer of the fuel.

Natural gas exports from the U.S. are logistically challenging, and to most markets, banned. Without the ability to export surpluses to foreign markets, a natural gas glut grew out of control. In the spring of 2012, the Henry Hub natural gas spot price plummeted to below $2 per MMBtu.

Valero Energy Corporation (NYSE:VLO)With natural gas prices so low, producers turned their attentions to oil and liquids rich plays. The end result is a situation that was unthinkable just a few years ago. West Texas Intermediate crude (oil sourced primarily from the U.S.) has become significantly less expensive than Brent crude (a benchmark for European, African and Middle Eastern oil exported to the west).

WTI Crude Spot Price data by YCharts

Until recently, refining oil in the U.S. into more valuable end products like gasoline and diesel was a risky business with slim profit margins. A spike in crude oil prices nearly always resulted in refineries losing money for a while and praying for stabilization. Since WTI oil always rose and fell in tandem with Brent, refiners were forced to produce at a loss, or limit production until gasoline prices rose or oil stabilized.

As you can see in the chart above, the difference in price between WTI and Brent, often called the Crack Spread, has come unglued. The reason this is so exciting for U.S. based refineries has everything to do with conventional end product pricing. Despite the spread, Brent has been, and still is, the global benchmark used to set gasoline prices, even in the U.S.

The winners:

Although the Crack Spread has kept integrated energy giants with refineries in the U.S. in the black, it is the independent refineries that have the most to gain. So far this year, investors have been scrambling to acquire shares of Valero Energy Corporation (NYSE:VLO), HollyFrontier Corp (NYSE:HFC), and Marathon Petroleum Corp (NYSE:MPC).

VLO data by YCharts

Valero Energy Corporation (NYSE:VLO) is the world’s largest independent refiner. This behemoth has had a terrific run up of over 150% over the past 3 years, but still appears somewhat undervalued. As of March 1, it was trading at just 1.43 times book value, with an earnings yield of just over 8%.