Shigeki Makino is the chief investment officer at Putnam Investments. Valero Energy is one of the largest oil refining companies in the country. Mr. Makino spoke to David Dalley of The New York Sun and explained why current supply constraints in the refining industry make Valero a strong investment.

Why do you like Valero?

There’s a supply-side constraint in the industry at the moment, and Valero is well-positioned to take advantage of it. Essentially, refining capacity hasn’t increased for quite some time for a number of reasons. Historically it has been a really bad business, and refiners weren’t able to earn their cost of capital. It’s also pretty expensive to add capacity, and the lead time is very long. For environmental and regulatory reasons it can take up to five years to build a new refinery. Plus, the industry is volatile, so you have to be very sure of future performance before you go ahead and build. But the business has been great for the last couple years, so people now want to add to capacity. Problem is they’ve got the long lead time to deal with. Meanwhile demand is robust and those already in the business are reaping the benefits.

Part of the supply issue also has to do with the crude oil market. A lot of the decline rates that we’ve seen in terms of production for crude oil have been in light sweet crude. A lot of the new oil we’re finding is of the heavy sour variety, and capacity is not ample in that area. That shift in the mix of inputs is creating more constraints, and heavy crude is selling at a discount. So if you’re able to refine heavy sour crude, then you have an immediate cost advantage on your inputs. Valero has the most heavy-refining capacity in the industry.

What are the fundamentals like?

The stock is up a lot, but earnings are up even more. The P/E ratio is just below 8 on this year’s earnings, and earnings estimates have continued to rise. We think they’ll rise even further because of constraints on supply. In addition to what I’ve just discussed, there are three other issues worth keeping in mind.

First, from May this year, refiners will have to deal with the MTBE [Methyl Tertiary Butyl Ether] issue. Companies that haven’t upgraded their capacity so that they don’t have MTBE in their output will have to upgrade.

Second, clean fuel requirements are rising (i.e., the percentage of octane required in fuel output). That pushes yields down and cuts capacity out of the system.

And third, you have the effect of turnarounds. Last year, with the hurricanes a lot of refineries had to work overtime to compensate for lost facilities. Many of those refineries that worked overtime will be offline for the first half of this year for maintenance.

None of those individual events is huge, but cumulatively they will have a material supply effect, further exacerbating an already tight situation.

Some of these positive factors would already have been priced into the stock. Does it remain a good buy?

I think it does. In the energy sector generally, investors assume a reversion to the mean – they assume that refining margins will head back down. The P/E multiple of 7.8 suggests that people expect earnings to go down. But that isn’t taking into account the time it takes to add more capacity. This sup ply shortage can be pretty acute for several years.

It’s also behavioral. People tend to anchor. If an industry has been really bad for a long time, and this one has, even when things pick up, people don’t pay attention. They just assume it’s a bad business. But this company looks very attractive on all valuation metrics.