The Wall Street Journal: Refiners Cash In on High Gasoline Prices

In Shift, Processors See
More of Profit Windfall
Than Producers of Oil
By ANA CAMPOY
May 18, 2007; Page A10

Record gasoline prices are changing the equation of the refining business, generating unprecedented profits for the companies that transform crude oil into fuel.

For every barrel of oil they use to make gasoline, refiners are pocketing more than $30 in profit before taxes and other expenses. That is the most they have reaped per barrel since Hurricane Katrina in 2005. The major producers of gasoline in the U.S. earned about $10 billion from their refining operations domestically and abroad in the first quarter, up 50% from a year earlier.

Analysts are projecting earnings will be even higher in the second quarter, due to lower-than-normal gasoline inventories. Rising demand, a string of refinery outages and a drop in gasoline imports earlier this year curbed supplies and raised prices. Some refiners, such as Tesoro Corp., are using the cash gusher to finance upgrades. Others, such as Valero Energy Corp., the largest refiner in North America in terms of capacity for crude oil and other feedstocks that go into the refining process, are shipping the cash back to shareholders by buying back shares.

The average retail price of a gallon of regular gasoline reached about $3.10 this week, up five cents from the week before and its highest level ever, according to the Energy Information Administration. A rise in oil prices is contributing — yesterday benchmark oil futures jumped $2.31 per barrel, or 3.7%, to $64.86 on the New York Mercantile Exchange. In London, benchmark Brent crude oil futures rose $2.30, or 3.4%, to $70.27.

A Change in Who Profits

But crude oil is still 16% below its nominal high of $77.03 a barrel reached last year, underscoring a shift in the oil industry after more than three years of flush profits. Rising demand and prices fattened the bottom lines of companies across the industry. But gasoline’s current run-up is mainly boosting profits for refinery operators, while the business of pumping oil out of the ground has seen its profits plateau or fall a bit.

Refiners have been on a roller coaster since hurricanes slammed into the nation’s refining belt along the Gulf of Mexico in 2005. Gasoline prices spiked above $3 a gallon. That led to a rise in what the industry calls the refining margin, or the difference between the price refiners pay for oil and the prices their fuels fetch. But gas prices eased, and refining margins collapsed in 2006.

Supply-and-demand economics aren’t the only forces behind the current rise in fuel prices. Hedge funds and other investors have plunged into the gasoline futures market in recent years, creating more volatility and magnifying price swings.

“The fundamental factors don’t come close to justifying either the current peak in margins, or even the elevation of margins of the last two to three years,” says Mark Gilman, analyst at financial broker Benchmark Co.

In addition, the U.S. gets about 13% of its gasoline from abroad. Many refineries overseas have hit their own operating snags or are shifting to produce more diesel, which is growing in popularity in other countries.

Fuel prices aren’t likely to stay this high for too long. Gasoline prices and margins are expected to fall in the next few years as major refining projects under way in Asia and the Middle East, as well as refinery expansions in the U.S., help fill the growing gap between domestic supply and demand.

Prices Likely to Moderate

Prices could start moderating later this year as more imports flow into the market and idled refineries come back on line. “The market does expect supply will rebound,” says Anatol Feygin, head of global commodity strategy at Bank of America. Although Bank of America projects that average refining margins for the full year will rise to $12.71 from $12.15 in 2006, it expects them to fall to $9.50 in 2008 and to $8 in 2009.

For decades, there was too much refining capacity in the U.S., margins were crummy and many companies were closing or selling off refineries. In 1986, refiners made little more than $2 for every barrel they processed. “We used to commission studies to get rid of the refineries,” says Fadel Gheit, who formerly worked at Mobil, now part of Exxon Mobil Corp., and is now senior energy analyst of Oppenheimer & Co. “We wanted to give them away.”

Consolidators such as Valero acquired refineries on the cheap in the 1990s. The extra capacity disappeared, and when energy prices soared in recent years, so did refining margins.

Now, refining operations are the stars of integrated oil behemoths such as Exxon and Chevron Corp. In the first quarter, lofty refining earnings at both companies helped offset declining profits from producing crude oil and natural gas. Exxon made $1.91 billion from its refining and marketing unit, up 50% from the previous year; Chevron posted earnings of $1.62 billion from refining, more than double the $580 million it made a year ago.

Marathon Oil Corp., a smaller integrated oil company, is constructing a $3.2 billion addition to its largest refinery, in Garyville, La. About half the output will be diesel fuel, which has had loftier prices in recent years than gasoline.

For pure refiners, the bonanza has been even greater. Tesoro’s earnings rose more than one and a half times in the first quarter; Sunoco Inc., another big refiner, said profit more than doubled in the same period. Sunoco’s stock price has risen more than 50% in the past few years, while Tesoro’s share price has more than tripled.

Tesoro is plowing money back into operations. It is updating several refineries to reduce outages and modifying them to process heavy crude, which is a cheaper feedstock than low-sulfur oils and generates higher margins. The company also recently bought a refinery from Royal Dutch Shell PLC.
Valero is cashing in. The company just agreed to sell its refinery in Lima, Ohio, for $1.9 billion. “Just as we bought assets at low prices when valuations were low, we are exploring options for unlocking the value of assets now that valuations are high,” said Valero spokesman Bill Day. The company also just launched an ambitious share-buyback program.

‘Not in My Backyard’

Hardly anyone is using the extra cash to build new refineries from scratch, says Nicole Decker, an energy analyst at Bear Stearns. “The permitting process is daunting, and there is a ‘not in my backyard’ mentality, which together, have stalled out proposals to build,” she said.

President Bush’s energy-conservation push may give refiners even less incentive to boost output in the short term. The president has proposed to increase alternative- and renewable-fuels use to 35 billion gallons a year by 2017, lessening the need for gasoline. This week, the Bush administration said it planned to substantially lift the fuel-economy standards for automobiles, another step designed to cut gasoline use.

Refiners are also reluctant to spend billions of dollars in building refineries because it would take years to recover their investment and they say they are unsure about future demand. The last new refinery in the U.S. opened in 1976. “It’s a very, very cloudy investment picture,” says Lynn Westfall, chief economist and senior vice president at Tesoro.

AT THE PUMP
 
•  Rising Margins: Refiners’ profit per barrel of oil used to make gasoline has grown as gasoline prices have risen.
 
•  Tight Supply: Refinery outages, lower imports and continued customer demand have contributed to the rise in gasoline prices.
 
•  Industry Shift: Big profits for refiners come as the profitability of producing oil has leveled off.

Write to Ana Campoy at [email protected]

This website and sisters royaldutchshellgroup.com, shellnazihistory.com, royaldutchshell.website, johndonovan.website, and shellnews.net, are owned by John Donovan. There is also a Wikipedia segment.