Relative Value Pairs Trade Investment Memo

The Thesis

The energy sector is experiencing a structural divergence between refining and integrated upstream that has created a measurable mispricing. While Valero Energy and ExxonMobil both operate in the energy sector and historically display high correlation, they are currently dislocated due to:

1. Refining Margin Expansion

Valero captured a $13.61/barrel refining margin in Q4 2025 (up 61% YoY from $8.44), driven by:

Venezuelan heavy crude access (now flowing into Gulf Coast refineries)
Product scarcity (refinery closures in Europe, Asia expansion capacity constraints)
Crack spreads ($8-12/bbl forecasted to be "new normal" for 2026)

2. ExxonMobil's Upstream Headwinds

Despite beating earnings, XOM faces:

Soft upstream economics with Brent crude in $56-70/bbl range
Limited upside from additional upstream production (already near capacity from Guyana/Permian)
Heavier weighting to low-margin upstream vs. VLO's downstream concentration

3. Market Sentiment Dislocation

VLO up +37% YTD (reflecting refiner strength)
XOM up only +19% YTD despite solid Q4 earnings and beat
The market has priced in refiner resilience but underpriced XOM's refining segment gains

Statistical Data

Metric	VLO	XOM	Pair Status
YTD Return	+37.0%	+19.0%	+18.0% spread
Q4 Margin ($/bbl)	$13.61	~$10-12 (blended)	VLO outperformance
Current Price	$192.80	$115.39	—
52-Week Range	$99.00 - $194.50	Variable range	VLO stronger momentum
Dividend Yield	~2.1%	~2.8%	XOM higher yield

Estimated Correlation (6-mo)

0.72

Historical: 0.75-0.82

Current Z-Score

+2.1σ

Trading at edge of reversion

Spread Width

+10.8 pts

Normalized to 100 base

Current Spread Status

Trading at approximately 2.1 sigma WIDE - This suggests the spread has extended beyond normal range but remains within exploitable bounds. The 20-day rolling z-score of +2.0 to +2.3 is just at the edge of mean reversion trigger zone.

4-Week Catalysts: Why the Spread Converges

1

Refiner Earnings Normalization & Guidance Reduction (Feb 3-4, 2026)

MPC Q4 beat on Feb 3: Already reported (EPS $4.07 vs. $2.72 est.) - refiner enthusiasm peaks
PSX Q4 on Feb 4: Reporting, likely strong refining margins but guidance may be cautious on margin sustainability
Market expectation shift: After back-to-back refiner beats, consensus will fade expectations, reducing upside catalysts for VLO relative to steady XOM

2

Venezuelan Crude Flow Saturation (Mid-February)

Current status: VLO announced purchasing Venezuelan crude; Valero can handle incremental 200k bpd per BofA
4-week outlook: Market realizes this capacity uplift is already priced in to VLO's +37% YTD move
Convergence trigger: If crude flow ramps slower than expected OR refiners signal margin pressure from feedstock competition, refiner premium compresses

3

Oil Price Stabilization & Mean Reversion (Mid-to-Late February)

Current Brent: $56-70/bbl range (forecasted $50-60 by some analysts)
XOM upside: If Brent stabilizes above $65, XOM's upstream cash generation improves
VLO risk: Depends on crack spreads, which may narrow if oversupply concerns fade

4

CVX/XOM Production Data & 1Q Guidance (Late February)

Hess integration: CVX has demonstrated strong Q4 production; XOM could signal similar strength
If production guidance is raised: Integrated oil stocks (XOM, CVX) revalue higher relative to refiners

Fundamental Check: Not a Structural Break

This divergence is a temporary dislocation, not a structural break:

1. VLO's margin advantage is cyclical, not structural

Refining margins average $5-7/bbl long-term; current $12-13 is elevated
Venezuelan crude is a short-term benefit (9-18 months to ramp infrastructure)
U.S. refiners will face competition from Asian mega-refineries coming online (Yulong, Ruwais)

2. XOM's upstream is not broken

Guyana/Permian production at record levels
Cost structure improved ($14.3B structural cost savings since 2019)
Integrated model hedges refining cycle risk (which VLO cannot do as pure refiner)

3. Historical precedent

Refiner/integrated oil spreads have cycled multiple times (2016-2018, 2020-2022)
Current +18% YTD spread is near extremes but reversals typically occur within 4-8 weeks

Trade Execution

Entry Zone (Current Market, Feb 4, 2026)

VLO Entry

$192.80

XOM Entry

$115.39

Spread Ratio

1.67:1

Example Structure (Dollar-Neutral)

Long 200 VLO / Short 335 XOM (~$385k gross exposure each side)

Target: Mean Reversion Level (4-week horizon)

Historical relationship: VLO/XOM ratio averaged 1.55-1.60x during 2024-2025

Scenario A (Mild Reversion)

VLO declines to $185 / XOM rises to $121

+0.9% Net Spread

Long VLO -3.9% / Short XOM +4.8%

Scenario B (Strong Reversion)

VLO declines to $180 / XOM rises to $126

+2.5% Net Spread

Long VLO -6.7% / Short XOM +9.2%

Expected Return

+50 to +150 basis points over 4 weeks on $385k notional each side

Stop Loss: Trade Invalidation Level

Exit Trigger

If spread widens to +12 points or beyond (+2.5 sigma)

Trigger: VLO breaks above $198 OR XOM falls below $111
This would indicate refiner strength is more persistent than thesis allows
Max loss on $385k per side: 1.0-1.5% before stop

Risk Analysis

Refining Margins Remain Elevated

35-40%

Impact: Spread widens further (+3 to +5 sigma)
Mitigation: Stop loss at +2.5 sigma; rebalance if needed

Oil Price Spike (Geopolitical)

15-20%

Impact: XOM outperforms; upstream upside
Mitigation: Short position hedges this; reduce position size

Venezuelan Crude Accelerates

10-15%

Impact: VLO outperforms more; refiner cycle extends
Mitigation: Monitor weekly flow data; close if flow >250k bpd confirmed

XOM M&A or Strategic Announcement

5%

Impact: Stock re-rates sharply higher; squeeze on short
Mitigation: Set alerts; close on news

Broader Market Correction

25-30%

Impact: Both energy stocks decline together; spread flat
Mitigation: Correlation reduces in broad selloff; hedge with tech short if needed

Refiner Credit Event

5%

Impact: Long position underperforms
Mitigation: Diversify across multiple refiners (add MPC, PSX components)

Conviction Rating

7.5 / 10

High Conviction Factors

Refiner earnings normalizing, Venezuelan crude flow saturation, oil price stabilization

Moderate Conviction Factors

Historical correlation remains strong; spread reversal is normal cyclical pattern

Lower Conviction Factors

Refining margin persistence, XOM's integrated model downside if crude falls further

Recommended Position Size

50-75% of normal allocation due to moderate spread width (2.1 sigma, not yet extreme)

Position Monitoring (Weekly)

Track refining margins: Monitor 3-2-1 crack spreads; alert if spike above $14/bbl (signals further extension)
Monitor Venezuelan crude flow: Watch weekly flow data; if exceeds 200k bpd ramp faster, extend thesis
Oil price action: If Brent breaks below $55 or above $75, reassess XOM upstream leverage
Earnings reaction: Post-earnings revisions (MPC, PSX mid-Feb); if margins downguided, accelerate target timing
Technical levels: VLO $190 support, $195 resistance; XOM $110 support, $120 resistance

Executive Summary

Given the 4-week catalysts (refiner earnings normalizing, margin expectations resetting, Venezuelan flow saturation), this pair trade offers 1-2.5% alpha on a dollar-neutral basis with a well-defined risk/reward profile. The trade capitalizes on a cyclical divergence between refiner outperformance and integrated oil undervaluation, with multiple near-term catalysts forcing mean reversion within the investment horizon.