The rapid meltdown in oil prices appears to have caught almost everyone off guard. When I looked at the crude oil market in early October, oil prices (for West Texas Intermediate Crude) had just moved below $90 a barrel. Quite suddenly, we’re approaching the $80 mark, and the shakeout may not an end until we hit the $70 mark. That’s a likely price-point when it will become unprofitable for many oil producers to continue drilling new wells.

The price slump is leaving no industry unscathed. Shares of companies in oil services, exploration & production and the refiners are all seeing their shares move lower.

Yet it’s that last group that should make you do a double-take. Investors are dumping refinery stocks, even though the broader operating backdrop for these firms is actually improving. Investors now have a chance to profit — before the crowd catches on.

The U.S. Output Boom

To understand profit margin trends for oil refiners, you need to understand the impact of price differences in the United States — West Texas Intermediate is the benchmark — against the rest of the world, which uses the Brent Crude benchmark.

European refineries, which ship gasoline and diesel to our shores, must use the pricier Brent Crude. U.S. refiners, meanwhile, can undercut the importers whenever the gap between West Texas and Brent prices widen. That figure has recently widened back to $5. And according to Citigroup, the gap may grow further. They recently boosted their price targets for refiners “on our view that crude differentials will widen on the back of growing North American production and a lack of any major change in oil export policy in the near future.”

#-ad_banner-#U.S. oil producers, operating in the various shale regions, have relatively low production costs and are unlikely to feel the need to sharply cut production, even as crude prices — both West Texas and Brent — drift lower. Citigroup’s analysts, though, expect rising U.S. output to push West Texas prices down even faster than Brent prices. What is now a $5 gap should grow to $8 next year, and $10 in 2016, according to these analysts. The key takeaway: U.S. oil refiners will be able to produce gasoline, diesel, jet fuel and other distillates at much lower prices than their peers, setting the stage for rising domestic market share and a rise in exports.

For investors, there a range of choices. For yield seekers, Alon USA Partners, LP (NYSE: ALDW) will be able to generate a $2.64 dividend payment in 2015, according to Citigroup forecasts. That’s a 15% yield, based on current prices. Citigroup’s $22 target price adds 25% potential share price appreciation to that income stream.

I’m partial to HollyFrontier Corp. (NYSE: HFC), which has established a solid track record with shareholders, delivering buybacks, regular dividends and special dividends. A current $500 million buyback plan is in place now, and investors should look for more special dividends in 2015, based on the scenario outlined above.

Analysts at Barclays also looked at the refinery landscape and came up with a similar conclusion: “We believe the U.S. refiners remain significantly undervalued. In our base case scenario, we estimate the group’s average potential upside at 53% over the next couple years.”  In the context of potential gains related to Barclays recent upwardly revised targets, they suggest focusing on Delek U.S. Holdings, Inc. (NYSE: DK), which has 68% upside to their $50 price target; Phillips 66 (NYSE: PSX), with 60% upside to the $109 price target; and Valero Energy Corp. (NYSE: VLO) with nearly 100% upside to Barclays’ $86 price target. My preferred pick, HollyFrontier, has 56% upside, according to Barclays.

Risks to Consider: If U.S. oil producers decide to sharply cut output in the face of falling crude oil price, then the West Texas-Brent spread may narrow, which would negatively impact refinery margins.

Action to Take –> Despite the storms roiling the oil market, refineries represent a rare bit of stability. Most of them have greatly modernized their operations in recent years and are now in a position to reap tremendous cash flows from the expanding crude oil spreads. Alon USA and CVR Refining, LP (Nasdaq: CVRR) offer the prospect of double-digit annual dividend yields, albeit with a high degree of seasonality, while the larger refiners such as Valero and HollyFrontier appear set to offer solid dividends and ongoing share buybacks.

If oil, natural resources or commodities are what interests you, look no further than StreetAuthority’s Scarcity & Real Wealth. Our resident natural resources expert Dave Forest has more than a decade’s experience as a trained geologist and analyst. His industry insight allows him to read the markets and provide the most timely, potentially lucrative advice for everything from oil and gold to molybdenum. To gain access to Dave’s latest research, click here.