TALES OF THE TAPE:Refiners May See Enduring Wider Margins
By DAVID BOGOSLAW
Of DOW JONES NEWSWIRES
NEW YORK -- The spike in U.S. gasoline prices toward the end of the summer driving season may have crested, but oil refiners might be on the verge of seeing wider profit margins for some time to come.
Independent refiners are typically viewed as a short-term investment play, with buy and sell decisions made based on strength or weakness in refining margins. The introduction of tougher environmental standards for gasoline in January is expected to significantly reduce U.S. gasoline supply, paving the way for higher prices that could endure over the longer term.
The environmental regulations are twofold. First there are the Tier II standards for reducing sulfur content in gasoline to 120 parts per million from the current 300 parts per million in 2004 and to incrementally lower levels through 2010.
The National Petrochemical and Refiners Association estimates the industry will lay out roughly $8 billion to comply with the gasoline sulfur regulations, and another $8 billion a couple years down the road to meet new sulfur specifications for onroad diesel fuel.
Refiners, such as Valero Energy Corp. (VLO) in San Antonio, willing to spend the money to upgrade their plants to comply with the stricter regulations may be gambling that some of their peers will choose to shut down plants instead of making such a costly capital investment.
Last year Premcor Inc. (PCO) shut down two refineries - one in Illinois, one in Connecticut - that produced a combined 145,000 barrels of gasoline per day, deciding it couldn't afford the environmental upgrade. Crown Central Petroleum Corp. of Baltimore has been trying to sell two Texas refineries with combined production capacity of 152,000 barrels a day for the same reason.
Besides the probable loss of domestic refining capacity, there are also questions about how much foreign gasoline imports may taper off due to reluctance of foreign refiners to invest to meet the higher standards.
"Venezuela is doing very little investing in new capacity and new complexity in their refineries," said Al Silver, an analyst and portfolio manager at Brean Murray. "The political situation has contracted gasoline exports that normally come to U.S."
He estimated that Venezuela gasoline accounted for 15% to 20% of the 1 million barrels of gasoline in daily imports required during the summer driving season, most of which satisfies demand on the East Coast.
Ban On MTBE Will Also Restrict Gasoline Supply
In addition to the tougher pollution regulations, the mandated elimination of the clean-blending component methyl tertiary butyl ether, or MTBE, in California, New York and Connecticut and substitution of ethanol will further constrict gasoline supplies. That's because where MTBE contributed about 11% to total gasoline volume, the ethanol contribution in California is capped at 6%. After the removal of high-evaporating components, 10%, or about 100,000 barrels a day, in total refining production capacity will be lost in California due to the MTBE ban, according to the Energy Information Administration.
California will make up for lost production with gasoline imports from other areas, such as the Pacific Northwest, the Gulf Coast and Asia. Refiners would have to spend more on transportation costs but wouldn't necessarily be able to pass those on entirely to consumers in higher gasoline prices, said Joanne Shore, senior analyst at the EIA.
Less strict pollution standards in the Northeast mean that only up to 5% of refining production capacity would be lost there with the substitution of ethanol for MTBE, Shore said. Rather than lost refinery capacity, what may push refining margins higher on the East Coast is the uncertainty during the transition to the ethanol blend.
"There are a lot of opportunistic import refiners that supply the Northeast that may not be ready to step up to the plate until they see how the supply situation shakes out," and how attractive gasoline prices become, she said.
The strength of refining margins is only part of the picture for refiners. Many also rely on the differential between light and heavy crude - sometimes called sweet and sour - oil prices to increase their profits. That differential widens with increased supply of sour crude, which is cheaper than sweet crude but requires more expensive equipment to process.
Despite favorable margins, the shut-in of Iraqi oil production during the war and the slow return to pre-war levels has narrowed the light-heavy crude differential by taking light crude off the market, according to Valero Energy, the largest independent refiner in the U.S. The disruption of Venezuelan crude supply earlier this year and ongoing production delays similarly reduced sweet crude supplies.
Greg Haas, analyst at Sanders Morris Harris, predicts the sweet/sour crude spread will improve going forward, as Iraqi sour barrels return to the market and with the added supply coming from exploration projects in the deepwater Gulf of Mexico.
The volume that Premcor loses by not upgrading plants to meet the new sulfur regulations it may make up for with an expanded investment in sour crude processing at other refineries, such as the one in Port Arthur, Texas.
The company will spend slightly more than $200 million to expand capacity at that plant by 75,000 bpd to 325,000 bpd, 100% of which will be a heavy, high-sulfur crude slate.
The expansion is due to be completed by the fourth quarter of 2005 and is expected to increase quarterly earnings even more so than a Memphis refinery acquired in March, which will add more than 43 cents a share to earnings, the company has said.
A spokeswoman at Valero said that every 50-cent improvement in the sweet/sour differential equates to 80 cents earnings per share for the company.
Tesoro Petroleum Corp. (TSO) is also increasing its exposure to sour crude processing to 60% of total production volume in California.
One company that isn't shifting to a sour crude slate is Philadelphia-based Sunoco Inc. (SUN), preferring to stick with the lower-cost refining process required for sweet crude.
The returns the company is missing out on by not taking advantage of the sweet-sour spread could discourage investors, but they'll probably like the fact that Sunoco has returned $740 million to shareholders since 2000, $540 million through its share repurchase program, which it plans to continue.
Still, the volatility of refining margins makes independent refiners less alluring to some investors than integrated oil companies, which can offset occasional refining weakness with returns from high oil and natural gas prices.
Rich Howard, a portfolio manager at White Mountains Advisors, who prefers to buy and hold rather than buy and sell, says he stays away from pure refiners.
"I don't like the business on 10-year, 20-year basis. It's very commodity-driven, very cyclical, and returns are hard to get. They might be good for three or four years."
-By David Bogoslaw, Dow Jones Newswires; 201-938-5289;
david.bogoslaw@dowjones.com
Updated September 10, 2003 7:30 a.m.
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Above is just one of many articles that have referred to the new standards being likely to limit imports. |
