Oil refining has entered a "golden age" of strong profit
For decades, refineries were the grunts of the oil industry -- crucial steps between the wellhead and the gas tank,
but inconsistent money-makers. That dim view has changed, with many industry analysts and executives convinced that
oil refining has entered a "golden age" of strong profit and stellar stock-market returns.
"As long as it's not economic for someone to put a lot of new refining capacity in this country, refining is going to be a good business to be in," said Phil Adams, a debt analyst with Gimme Credit in Chicago.
The stock prices and profit of large independent refiners -- companies that make gasoline and other petroleum
products but do not pump oil from the ground -- have skyrocketed in the last couple of years, as demand for petroleum
products has grown faster than the industry's capacity to produce them.
So as the cost of crude oil has reached a new plateau, refining companies such as Philadelphia-based Sunoco have profited from continued heavy demand and high gasoline prices. Since the end of 2002, shares of the three largest independent refiners -- Valero Energy, Sunoco, and Premcor -- have posted average annual returns of 88 %, 69 % and 52 %, respectively. All handily beat the 38 % return of the Standard & Poor's 500 energy index, which includes integrated oil companies, natural-gas producers, and energy-services providers.
The force behind those returns is an improvement in average refining profit margins, from $ 4.27 per barrel in 2002
to $ 9.50 per barrel last year, according to Prudential Equity Group in New York. Prudential expects margins to
remain in the $ 9 range this year and next year.
Margins have grown because increases in demand for petroleum products have outpaced increases in refiners' capacity in the 2000s. Some analysts expect that to continue for the rest of the decade, with refinery growth held back by environmental regulations regarding the amount of sulphur allowed in gasoline and diesel fuel. Those rules are forcing refiners to spend billionson clean-fuel equipment instead of expansion.
Building a new refinery in the United States from the ground up would cost at least $ 2 bn, according to industry
estimates, and it would take years to get permits before construction could even begin. The tight market has resulted
in the highest global profit margins for refined products in 20 years, according to a report released by Morgan
Stanley analyst Douglas Terreson.
Analysts said that all refiners' shares likely had more room to rise, but most argue that Valero and Premcor have better prospects than Sunoco because they are geared toward refining "heavy-sour" crudes that cost less than the "light-sweet" crude that Sunoco refines. The highest-quality and most expensive crudes are "light" and "sweet," which are easier to process and contain less air-polluting sulphur.
Some "heavy" crudes are as thick as molasses and require more energy and more complex equipment to upgrade them into
gasoline. "Sour" crudes contain more sulphur that needs to be removed to meet environmental standards.
The financial advantage of being able to refine heavy, sour crudes -- as both Valero and Premcor can -- has never been greater. This year, the light-sweet benchmark, West Texas Intermediate, costs $ 17 per barrel more than the heavy-sour benchmark, Mexican Maya.
San Antonio, Texas-based Valero, which is among the leaders in capacity to process heavy crudes, owns a refinery in
Paulsboro that can process 195,000 bpd. Premcor, of Old Greenwich, Connecticut, owns a 190,000-bpd refinery in
Delaware City that processes exclusively heavy, sour crude.
Sunoco's refineries, on the other hand, do not have the $ 500 mm to $ 1 bn "coker" system that makes it possible to process cheaper, heavier crudes. Among its refineries are those in Philadelphia, Marcus Hook and West Deptford, which have the capacity to process 655,000 bpd.
"You've got to have very, very good returns to get a good return on the capital that goes into a coker," said Thomas W. Hofmann, Sunoco's CFO.
While competitors Valero and Premcor have scrambled to buy refineries with heavy-crude capacity, Sunoco has
diversified by building a larger chemicals business than is usual for a refiner and expanding its division that makes
fuel for steel blast furnaces.
Andrew F. Rosenfeld, an analyst with Prudential Equity Group, said in a report that Sunoco might actually do better than its rivals because of that diversification, along with its efforts to use less expensive crude oil that has a high acid content and its penchant for repurchasing shares.