netrashetty
Netra Shetty
Valero Energy Corporation (NYSE: VLO) is a Fortune 500 international manufacturer and marketer of transportation fuels, other petrochemical products, and power based in San Antonio, Texas, United States.[1] The company owns and operates 15 refineries throughout the United States, Canada and the Caribbean with a combined throughput capacity of approximately 2.8 million barrels per day, 10 ethanol plants with a combined production capacity of 1.1 billion gallons per year, and a 50-megawatt wind farm. Valero is also one of the US's largest retail operators with approximately 5,800 retail and branded wholesale outlets in the United States, Canada and the Caribbean under the Valero, Diamond Shamrock, Shamrock, Ultramar and Beacon brands.[2]
Valero Energy Corporation (NYSE: VLO) is the largest U.S. refiner in terms of throughput capacity. Valero Energy Corporation owns and operates 15 refineries located in the United States, Canada and Aruba that produce conventional gasolines, distillates, jet fuel, asphalt, petrochemicals, lubricants and other refined products. At the end of 2009, Valero's total throughput capacity was 2.8 million barrels per day, making the company the largest independent refiner in the United States. The company also owns and operates a network of 5,800 gasoline and retail stations located throughout the United States.[1]
Like many U.S. refiners, Valero’s profits are determined by the refining margin, which is the price difference between purchased crude oil and refined products. As a result, Valero’s revenue and profitability are susceptible to changes in crude prices, refined prices, and consumer demand for refined products. While revenue increased rapidly over 2002 and 2007, high inventory levels, lower demand, and tighter refining margins have negatively impacted Valero's revenue and profitability in 2008 and 2009.[2] In addition, year-over-year declines in refining margins for 2009 have hurt the company's ability to generate profit and, more importantly, cash from its operations. Despite the fact that 65% of Valero's output uses cheaper forms of crude oil, the decline in discounts on sour crude oil, in addition to lower margins on diesel and jet fuel contributed have reduced the financial advantage of Valero's technologically advanced refineries.[3]
Contents
1 Company Overview
1.1 Business Segments
2 Trends and Forces
2.1 Valero has the potential of increasing its exports while reducing costs in second-half 2010 and all of 2011
2.2 Increases in U.S. shipping activity and European distillate prices boost diesel demand and prices for Valero
2.3 When profits margins are low for U.S. refiners, Valero’s advanced refineries give it a production and price advantage
2.4 Valero’s advanced refineries can switch from producing conventional gasoline to refining and selling petroleum products that are in higher demand or have higher refining margins
2.5 Amid economic downturn, Valero plans for a Biofuels Future
2.6 Approximately half of Valero's Refining Capacity is located in the Gulf Region and is vulnerable to seasonal storms
3 Competitive Landscape
4 Notes
As a result, Valero took several steps in 2009 to reduce costs, including temporary plant shutdowns and worker layoffs.[4] Additionally, in response to greater incorporation of biofuels-gasoline fuel blends, Valero acquired several biofuel production companies in 2009.[5]
Company Overview
For 2009, Valero announced a loss of $1.41 billion compared to a prior-year loss of $3.28 billion.[6] Rising oil prices and high inventory levels in 2009 contributed to the loss and the 58% decline in refining margins.[7] Rising crude prices have also reduced the company's cash reserves, which fell by approximately $775 million during the fourth quarter of 2009.[8] For 2009, the company focused on reducing costs and managing its cash flow. To reduce costs, Valero reduce throughput at several of its refineries and temporarily closed its Aruba plant in July 2009 and its Delaware City plant in December 2009.[9]
In 2009, Valero entered the ethanol production business through its acquisition of seven ethanol plants located in the United States. With a yearly production capacity of 1.1 billion gallons, Valero has the potential of benefiting substantially from the increased incorporation of biofuels in gasoline and other fuels. Through acquisitions, Valero is rapidly expanding its ethanol production capacity. In December 2009 and January 2010, Valero acquired five plants from various companies. For the fourth quarter of 2009, operating income from biofuel increased 91% to $94 million due to high ethanol margins.[10]
Quarterly Analysis
4Q 2010: Stronger margins, as well as increased sales of its distillate products contributed to a 24% year-over-year rise in revenues.[11] Despite these promising trends, Valero reported a $438 million loss in the fourth quarter of 2010 as a result of the sale of some of its refineries. Charges from selling its Paulsboro and Delaware City refineries during the fourth quarter 2010 led to a loss of 77 cents per share compared with a loss of $2.51 a share for the final quarter of 2009.[12] The year-over-year improvement in product sales can be partially attributed to the rise in distillate exports to Western Europe.[13] Processing lower-quality crude has also helped lower operating costs from $3.90/barrel to $3.64/barrel, although sour crude oil has dropped in price relative to 2009 levels due to increased production of sour crude from the Gulf of Mexico.[14]
3Q 2010: Valero reported earnings of $292 million for the third quarter 2010 compared with a loss of $629 million for the third quarter 2009.[15] Production volumes rose from 2.22 million barrels in the third quarter 2009 to 2.36 million barrels in the third quarter of 2010. Per barrel operating costs dropped $0.07 from $5.31.[16] These two improvements contributed signifcantly to the rise in operating income to $571 million in 2010, compared to an operating loss of $238 million in the third quarter 2009.[17]
2Q 2010: While Valero reported the first quarterly profit in five quarters, a grim outlook on oil prices and refining margins suggests that earnings improvements have the potential of being short-lived.[18] The refiner reported net income for the second quarter of $583 million compared with a loss of $254 for the comparable quarter in 2009.[19] Valero's refining business reported earnings of $921 million in the second quarter of 2010, versus a loss of $143 million for the second quarter in 2009.[20] Wider margins for diesel and secondary products, such as petrochemicals and asphalt, were partially responsible for the increase in year-over-year earnings in the second quarter.[21] For the quarter, Valero's average per-barrel margin rose from $4.74 in the second quarter 2009 to $9.39 in the comparable quarter in 2010.[22] However, many analysts believe that economic conditions and current oil price trends have the potential of reducing the industry's refining margin significantly.[23] One analyst said that the margin experienced by Valero between Gulf Coast ultra-low-sulfur diesel and West Texas Intermediate oil declined 22% in the second quarter.[24]
1Q 2010: First quarter 2010 earnings reflected the impact of the year-over-year decline in refining margins as well as Valero's response to tighter profit margins. Overall, Valero reported a loss from continuing operations of $101 million for the first quarter of 2010 compared to first quarter 2009 income from continuing operations of $364 million.[25] While refining margins declined from a year-over-year perspective, refining margins for several of Valero's petroleum products increased relative to the fourth quarter of 2009. However, Valero was not able to take complete advantage of this margin expansion due to heavy maintenance on refineries in Port Arthur, Corpus Christi, St. Charles, Quebec, and Memphis.[26] Valero expects these refineries to be fully operational during the second quarter of 2010. Yet, lost income from this downtime is estimated at slightly over $200 million.[27] Throughput volumes compared to the first quarter of 2009 declined by 254,000 barrels per day due to the maintenance and the extended shutdown of the Aruba refinery. For the first quarter of 2010, retail and ethanol segments reported operating income of $71 million and $57 million, respectively.[28] Through reductions in capital expenditures as well as increases in margins and production, Valero's second quarter earnings have the potential of showing profit rather than losses.[29]
4Q 2009: While Valero's 2009 annual earnings exemplified the difficulties US refiners faced in 2009, its fourth quarter earnings have the potential of being a good indicator of the refining market in 2010. For the final quarter of 2009, Valero experienced an operating loss, excluding special items, of $179 million.[30] This is a substantial decline from the same quarter in 2008, in which operating income was $1.3 billion.[31] The decline in discounts on sour crude oil in addition to lower margins on diesel and jet fuel contributed to the fourth quarter loss in 2009. Throughput margin per barrel in the fourth quarter of 2009 was $4.63, a 5% decline from the previous quarter and a 140% drop from the same quarter in 2008.[32] In the fourth quarter conference call, Valero's Chief Executive Officer, Bill Klesse, said that margins are not likely to rebound quickly in 2010 due to high inventory levels and low refining capacity. As a result, Valero has the potential of continuing its focus on trimming its costs and preserving its cash on hand. Valero ended the fourth quarter with $825 in cash and temporary cash investments.[33] Its main cost cutting techniques have been to temporarily stall unprofitable refineries and, in the fourth quarter, Valero announced the reduction of its dividend by 75%.[34]
Business Segments
Refining Segment (2009 Operating Income: $105 million): Valero’s refining segment sells petroleum products that have been processed and extracted from crude oil and other feedstock.[35] The company purchases crude oil, either through long term contracts or in the spot market, processes it, and sells its refined products to third parties or consumers at its retail stations. While its 15 refineries are located in the United States, Canada, and Aruba, over half of its refineries are located in the Gulf region.[36]
2009 financial performance reflected Valero's efforts to combat costs amid lower demand and profit margins.[37] Throughput margin per barrel in 2009 was $5.85, compared to $11.10 in 2008. In response to lower margins, Valero also cut throughput volumes by 8.2% in 2009 compared to 2008 levels.[38] In an effort to cut production and raise money from sources other than refining, Valero sold two refineries, temporarily shut down two Texas refineries, and reduced gasoline production at its other refineries.[39] The decline in production and refining margins was partially offset by a 15% reduction in costs.[40] Overall, operating income decline from $995 million in 2008 to $105 million in 2009.[41]
In addition to being the U.S.’s largest refiner in terms of throughput capacity, Valero also has the greatest number of refineries that can process crude oil with high sulfur content, known as "sour" crude oil.[42] Because 65% of Valero’s production can use cheaper, lower quality forms of crude oil to produce high quality “light” petroleum products, its profits benefit from the price differences between sweet, light crude and heavy sour crude.[43] As a result, the “sour crude oil differential” is significant to Valero’s profits because the company purchases sour crude at prices lower than sweet light crude, processes the cheaper crude into light refined products, and sells its products at the same prices as refiners that refine light crude.[44] The price disparity between refined products and crude oil, known as the “refining margin,” is the primary determinant of U.S. refiner’s profitability. Because 65% of Valero’s refineries use sour crude as an alternative to light sweet crude, Valero can significantly lower its feedstock costs and increase its refining margin during times when the sour crude differential is large.
In May 2009, Valero agreed to buy (Dow) Chemical Company's stake in a Netherlands-based refinery for $725 million plus working capital and inventories.[45] Operated by Total Raffinaderij Nederland N.V (TRN), the refinery has a total throughput capacity of 190,000 barrels per day.[46] Although of the acquisition has not been finalized, purchasing Dow's 45% stake in the refinery would be Valero's entry into the European refining market.[47] The purchase has the potential to close as early as the third quarter of 2009.[48]
In 2010, Valero's refining operations will differ compared to 2009 due to plant restarts and sales. In February 2010 and March 2010, Valero announced the resumption of a few of its refineries that had previously be stalled for repairs or due to unprofitably.[49] Also, PBF investments, an energy focused fund, has bid for Valero's New Jersey refinery.[50] The fund has also bid for Valero's Delaware refinery, which was shut down to poor performance.[51]
In October 2010, Valero's Marketing and Supply Co. received a $180.7 million contract from the Defense Logistics Agency for aviation turbine fuel.[52] The contract is for one year.[53]
In December 2010, Valero announced that its Aruba refinery is ready to restart after being idled in July 2009 due to poor economic conditions.[54]
Retail Segment (2009 Operating Income: $293 million): Although Valero’s retail stations sell goods other than gasoline and diesel, operating income and profitability are significantly determined by the price of conventional fuels sold to consumers. In 2009, Valero's U.S. and Canada operations realized fuel margins of $.154 and $.260, respectively, compared to $.229 and $.268, respectively in 2008.[55] The 20.5% year-over-year decline in operating income reflected these drops in margins.
Retail Financial Performance for 2009 & 2008
2009 2008
Operating Income (in $ millions) 194 369
U.S. fuel margin per barrel (in $) 0.154 0.229
U.S. fuel volumes (gallons per day per site) 4,983 5,000
Source: VLO 2009 10-K [56]
Ethanol (2009 Operating Income: $165 million): Valero's ethanol operations engage in the sale of internally produced ethanol. Major operations did not begin until 2009, and annual information is not available for 2008. Daily production in 2009 was approximately 1.5 million gallons.[57] Gross margin per barrel was $0.65.[58]
Ethanol Financial Performance for 2009 & 2008
2009 2008
Operating Income (in $ millions) 165 N/A
Production (thousand gallons per day) 1,479 N/A
Gross Margin per gallon (in $) .65 N/A
Source: VLO 2009 10-K [59]
Trends and Forces
Valero has the potential of increasing its exports while reducing costs in second-half 2010 and all of 2011
In September 2010, Valero CEO said the Valero has the potential to grow with global demand despite sluggish growth in the U.S. Slow growth demand for refined petro-products in North America has depressed margins realized by U.S. refiners.[60] On the other hand, fuel demand has began rising more favorably globally as emerging markets continue to use fuel to growth their economies.[61] As a result, many refiners have adapted the strategy of reducing costs and boosting exports.[62] Valero also expects sour-crude differentials to improve globally as Columbia and Venezuela increase production of sour crude amid stabilizing supplies.[63] An increase in sour-crude differential has the potential of benefiting Valero because the company’s advanced refineries can handle the cheaper form of crude.[64]
Increases in U.S. shipping activity and European distillate prices boost diesel demand and prices for Valero
About 9.6% more freight was moved by trucks in April 2010 than in same period in 2009, which has led to an increase in the need for diesel fuel.[65] Demand for the fuel increased 12% for four weeks ended June 11, 2010 compared to the same period in 2009.[66] Prices have also improved: June 2010 prices are nearly double of their levels in June 2009. Due to a recovering economy, consumption of U.S. distillates are predicted to expand 1.4% this year, which is the largest annual increase since 2005.[67] As the largest refining in the U.S., Valero is taking steps to capitalize from the rise in diesel prices. According to Valero CEO Bill Klessen April 2010, distillate demand in the world is growing at a rate two to three times greater than the rate of gasoline demand.[68] Declining domestic inventories in Europe have made it more profitable for traders to ship U.S. fuel to Europe than to purchase it domestically.[69] In response to the increase in export demand, Valero announced in April 2010 that its diesel-making hydrocrackers in Texas and Louisiana have the potential of being completed soon. Not only can these plants produce diesel for consumption in the U.S., but they also have export capability.[70]
When profits margins are low for U.S. refiners, Valero’s advanced refineries give it a production and price advantage
Valero’s ability to refine large quantities of heavy sour crude has the potential to increase refining margins and profits, especially when the price of light crude, like West Texas Intermediate sweet crude, rises.[71] When the price of light crude began to rise to $140 per barrel in July 2008, the prices of refined products, such as gasoline, were not able to increase as quickly. For many independent refiners, the rapid increase in crude prices initially cut refining margins and reduced quarterly profits substantially; Sunoco (SUN) and Tesoro Petroleum (TSO) reported that profits fell by more than 80% and 90% during this period.[72] While Valero’s net refining margin fell by 36% during the same period, the decrease in earnings was not as drastic as it was with many other competitors.[73] The rise in crude prices effected Valero’s profits less than its competitors during 2007 and 2008 because 65% of Valero’s refining capacity uses crude that was $6/barrel to $16/barrel cheaper on average than light sweet crude.[74] As a result, volatile changes in the prices of light sweet crude oils did not affect Valero's refining margins as much it did the Valero's competitors.[75]
However, falling crude prices have reduced the low-production-cost advantages of Valero's refineries.[76] Industry-wide cuts in crude supplies have reduced the price difference between the sour Maya crude oil and the sweet West Texas Intermediate in March 2009 to $4 from $14 in the fourth quarter of 2008.[77] Declining consumption of refined products, which fell 6%in 2008, has not only reduced Valero's profits, but also reduced the production advantages Valero has over other U.S. refiners like Sunoco (SUN).[78] Despite declining refining prices, Soleil Securities energy analyst Jacques Rousseau maintains that the price difference between sour and sweet crude has the potential to widen when the U.S. economy begins to recover and oil prices rise.[79]
Valero’s advanced refineries can switch from producing conventional gasoline to refining and selling petroleum products that are in higher demand or have higher refining margins
Through its investments in equipment upgrades and acquisitions, Valero has 15 refineries that are worth over $25 billion at the end of 2008.[80]The high value of Valero's refineries indicate that the company has made substantial investments in new refining equipment and equipment upgrades. For example, in 2007, Valero sold a refinery with throughput capacity of 165,000 bpd for $1.9 billion. By contrast, Sunoco (SUN) plans to sell a refinery with throughput capacity of 100,000 bpd for $1 billion.[81]
Due to its equipment investments, not only can Valero produce gasoline and distillate fuels with lower production costs than its competitors, but the company is not as susceptible to the low demand for gasoline beginning in 2008.[82] Beginning in 2008, Valero reduced its production of gasoline blends, which accounted for almost 46% of its 2007 annual production, in order to produce products that carried better profit margins and had higher demand.[83] In 2008, Valero produced and exported more diesel fuel as those profit margins increased 30%. Diesel demand has skyrocketed internationally, especially in Europe, thanks to the fuel's higher better efficiency; globally, diesel prices have risen 56% in the last year[84] Overall, U.S. refiners exported 160% more diesel in 2008 in order to meet rising worldwide demand for energy while overall domestic consumption of gasoline fell by 6%.[85]
Amid economic downturn, Valero plans for a Biofuels Future
Refining margins were smaller as crude oil prices increased in partly due to higher concentrations of biofuels mixed with retail gasoline. Beginning in July 2008, the price corn and ethanol dropped, as ethanol producers could not cut costs in step with falling fuel prices. In particular, ethanol maker Verasun Energy (VSE) filed for chapter 11 bankruptcy in February 2009 after losing a significant amount of money on hedges to protect the company against rising corn prices corn.[86] Verasun Energy (VSE) has accepted Valero's bid for seven of its ethanol plants to Valero for $477 million.[87]
In December 2009, Valero purchased three more ethanol plants for $272 million.[88] U.S. ethanol producers were hit hardly by the economic downturn in 2008 that forced many producers into bankruptcy. However, Valero has been able to purchase seven plants in 2009 at depressed prices. The December-purchase adds a combined capacity of 330 million gallons per year, bringing the refiner's total capacity to 1.1 billion gallons per year. [89] During the first month of 2010, Valero acquired two ethanol plants for $200 million from ASA Ethanol Holdings.[90] The two plants, located in Indiana and Ohio, add an annual production capacity of 110 million gallons to Valero's growing ethanol business.[91]
Valero’s bid for these biofuel plants suggests that the company believes ethanol will once again be a profitable fuel when energy prices rise and that consumers will demand more environmentally friendly forms of energy in the future.[92] As a producer of ethanol as well as a petroleum refiner, Valero will be able to profit from higher concentrations of ethanol in gasoline.[93] Valero and Marathon Oil are the only two U.S. refiners that will not have to purchase ethanol from third parties in order to make gasoline.[94]
Although the U.S. government raised the ceiling for the amount of ethanol that mixed into conventional gasoline, Valero and other refiners may be reluctant to sell gasoline blended with higher concentrations of ethanol.[95] The EPA is expected to raise the ceiling from 10% to 15% ethanol, but refiners are not obligated to increase the amount of ethanol blended into their conventional gasoline[96]. In fact, Valero is likely not to increase ethanol concentrations due to fears that it will be liable for any engine damage resulting from the higher levels of ethanol. Because the new ceiling does not include any liability protection, many refiners do not plan on increasing ethanol concentrations.[97] While increased concentrations of ethanol would benefit Valero's ethanol business, which is the third largest in the U.S., the increase also reduces the amount of gasoline sold per gallon of fuel.[98] As a result, the reluctancy of U.S. refiners to increase ethanol concentrations illustrates the limitations surrounding ethanol use as a fuel. Higher ethanol concentrations not only have the potential of hurting the refining businesses of U.S. refiners, but also may lead to engine damage.[99]
Approximately half of Valero's Refining Capacity is located in the Gulf Region and is vulnerable to seasonal storms
With refineries located in Texas and Louisiana, about half of Valero's refining capacity is exposed to hurricanes and tropical storms occurring in the Gulf of Mexico. In the fall of 2008, BP (BP), Royal Dutch Shell (RDS'A), and Transocean (RIG) had to such down refineries, oil rigs, and other operations on the Gulf coast in order to protect their workers and equipment from Hurricane Gustav.[100] While Valero did not have to close any of its Gulf refineries during the storm, half of Valero's production capacity remains open to destruction from future hurricanes and other Gulf storms.
Competitive Landscape
Oil Majors( Chevron Corporation (CVX) , Exxon Mobil (XOM), CONOCOPHILLIPS (COP), BP (BP)): The oil & gas majors are vertically integrated oil and gas companies that have exploration, production, refining, and marketing operations. In the refining segment, many of the oil & gas majors operate more cost-effectively than independent refiners like Valero because they do not have to purchase their crude oil supply from third parties. Not only do many of the majors have comparable refining capacity to Valero's, but many of them operate in the Texas and Lousiana, where Valero has more than half of its refineries.[101]
Holly Corp. (HOC): Holy Corp. is a United States-based petroleum refiner. The Company operates two oil refiners and distributes its refined products in the Southwest and West United States. Holly Corp. also owns 900 miles of crude oil pipelines located in Texas and New Mexico. the Company transports asphalt and liquid petroleum gas(LPG) to wholesalers and LPG retailers.[102]
Sunoco (SUN): Sunoco is U.S. petroleum company with refining, retail, chemical, coke, and logistics segments. As the second largest U.S. refiner in terms of capacity,the company has a refining capacity of approximately 1.3 million barrels per day, with operations spread across the Northeast and Mid-West. Unlike Valero Energy (VLO), a majority of Sunoco's refining feedstock comes from sweet crude oil.[103]
Tesoro (TSO): Like Valero, Tesoro operates in two segments: refining and retail. As of December 31, 2008, Tesoro owns and operates 7 refineries with a total throughput capacity of 658,000 bpd. 93% of their operating income comes from their refining segment. In 2007, Tesoro made $21.9 billion in revenue from its refining and retail segments and $967 million in operating income.[104]
Comparison to Competitors - 2008
CONOCOPHILLIPS ROYAL DUTCH SHELL EXXONMOBIL CHEVRON BP LUKOIL(1) Eni S.p.A(1) Total S.A.
Reserves
Oil and Gas Liquids
(Millions of barrels) 5,817[105][106] 3775[107] 7,576(2)[108] 7,350[109] 10,353[110] 15,715[111] 3,219[112] 5,695[113]
Natural Gas
(Billions of cubic feet) 24,948[114] 40,895[115] 31,402(2)[108] 23,075[109] 45,208[110] 27,921[116] 18,090[112] 26,218[113]
Production
Oil and Gas Liquids
(Thousand b/d) 1,108[117] 1,695[107] 2,405[118] 1,649[119] 2,401[120] 1,954[121] 1,020[112] 1,456[122]
Natural Gas
(Million cf/d) 4,970[117] 8,595[115] 9,095[118] 5,125[119] 8,334[120] 1,586[123] 4,114[112] 4,837[122]
(1) Latest data is for 2007 (2) Does not include reserves of equity affiliates
Refining Industry 2008 Metrics
SUNOCO CHEVRON VALERO EXXON MOBIL Royal Dutch Shell SINOPEC WESTERN REFINING ConocoPhillips BP LUKOIL(1) Eni S.p.A(1)[124] Total S.A.
Refinery Capacity
(Million BPD) 0.91[125] 2.139[126] 2.99[127] 6.2[128] 3.678[129] 3.376[130] 0.238[131] 1.986[132] 2.678[133] 1.135[134][135] 0.544 2.604[136]
Number of Refineries (including partial interests) 5[137] 18[126] 16[138] 37[128] 40[139] 17[140] 4[141] 12[132] 17[133] 9[142] N/A 25[136]
Number of Retail Gas Stations 7,785[143] 25,000[144][145] 5,800[138] 10,516[146] 45,000[147] 29,279[148] 153[149] 8,340[150] 22,600[151] 6,287[152] 6,441 (in Europe) 16,425[136]
Valero Energy Corporation (NYSE: VLO) is the largest U.S. refiner in terms of throughput capacity. Valero Energy Corporation owns and operates 15 refineries located in the United States, Canada and Aruba that produce conventional gasolines, distillates, jet fuel, asphalt, petrochemicals, lubricants and other refined products. At the end of 2009, Valero's total throughput capacity was 2.8 million barrels per day, making the company the largest independent refiner in the United States. The company also owns and operates a network of 5,800 gasoline and retail stations located throughout the United States.[1]
Like many U.S. refiners, Valero’s profits are determined by the refining margin, which is the price difference between purchased crude oil and refined products. As a result, Valero’s revenue and profitability are susceptible to changes in crude prices, refined prices, and consumer demand for refined products. While revenue increased rapidly over 2002 and 2007, high inventory levels, lower demand, and tighter refining margins have negatively impacted Valero's revenue and profitability in 2008 and 2009.[2] In addition, year-over-year declines in refining margins for 2009 have hurt the company's ability to generate profit and, more importantly, cash from its operations. Despite the fact that 65% of Valero's output uses cheaper forms of crude oil, the decline in discounts on sour crude oil, in addition to lower margins on diesel and jet fuel contributed have reduced the financial advantage of Valero's technologically advanced refineries.[3]
Contents
1 Company Overview
1.1 Business Segments
2 Trends and Forces
2.1 Valero has the potential of increasing its exports while reducing costs in second-half 2010 and all of 2011
2.2 Increases in U.S. shipping activity and European distillate prices boost diesel demand and prices for Valero
2.3 When profits margins are low for U.S. refiners, Valero’s advanced refineries give it a production and price advantage
2.4 Valero’s advanced refineries can switch from producing conventional gasoline to refining and selling petroleum products that are in higher demand or have higher refining margins
2.5 Amid economic downturn, Valero plans for a Biofuels Future
2.6 Approximately half of Valero's Refining Capacity is located in the Gulf Region and is vulnerable to seasonal storms
3 Competitive Landscape
4 Notes
As a result, Valero took several steps in 2009 to reduce costs, including temporary plant shutdowns and worker layoffs.[4] Additionally, in response to greater incorporation of biofuels-gasoline fuel blends, Valero acquired several biofuel production companies in 2009.[5]
Company Overview
For 2009, Valero announced a loss of $1.41 billion compared to a prior-year loss of $3.28 billion.[6] Rising oil prices and high inventory levels in 2009 contributed to the loss and the 58% decline in refining margins.[7] Rising crude prices have also reduced the company's cash reserves, which fell by approximately $775 million during the fourth quarter of 2009.[8] For 2009, the company focused on reducing costs and managing its cash flow. To reduce costs, Valero reduce throughput at several of its refineries and temporarily closed its Aruba plant in July 2009 and its Delaware City plant in December 2009.[9]
In 2009, Valero entered the ethanol production business through its acquisition of seven ethanol plants located in the United States. With a yearly production capacity of 1.1 billion gallons, Valero has the potential of benefiting substantially from the increased incorporation of biofuels in gasoline and other fuels. Through acquisitions, Valero is rapidly expanding its ethanol production capacity. In December 2009 and January 2010, Valero acquired five plants from various companies. For the fourth quarter of 2009, operating income from biofuel increased 91% to $94 million due to high ethanol margins.[10]
Quarterly Analysis
4Q 2010: Stronger margins, as well as increased sales of its distillate products contributed to a 24% year-over-year rise in revenues.[11] Despite these promising trends, Valero reported a $438 million loss in the fourth quarter of 2010 as a result of the sale of some of its refineries. Charges from selling its Paulsboro and Delaware City refineries during the fourth quarter 2010 led to a loss of 77 cents per share compared with a loss of $2.51 a share for the final quarter of 2009.[12] The year-over-year improvement in product sales can be partially attributed to the rise in distillate exports to Western Europe.[13] Processing lower-quality crude has also helped lower operating costs from $3.90/barrel to $3.64/barrel, although sour crude oil has dropped in price relative to 2009 levels due to increased production of sour crude from the Gulf of Mexico.[14]
3Q 2010: Valero reported earnings of $292 million for the third quarter 2010 compared with a loss of $629 million for the third quarter 2009.[15] Production volumes rose from 2.22 million barrels in the third quarter 2009 to 2.36 million barrels in the third quarter of 2010. Per barrel operating costs dropped $0.07 from $5.31.[16] These two improvements contributed signifcantly to the rise in operating income to $571 million in 2010, compared to an operating loss of $238 million in the third quarter 2009.[17]
2Q 2010: While Valero reported the first quarterly profit in five quarters, a grim outlook on oil prices and refining margins suggests that earnings improvements have the potential of being short-lived.[18] The refiner reported net income for the second quarter of $583 million compared with a loss of $254 for the comparable quarter in 2009.[19] Valero's refining business reported earnings of $921 million in the second quarter of 2010, versus a loss of $143 million for the second quarter in 2009.[20] Wider margins for diesel and secondary products, such as petrochemicals and asphalt, were partially responsible for the increase in year-over-year earnings in the second quarter.[21] For the quarter, Valero's average per-barrel margin rose from $4.74 in the second quarter 2009 to $9.39 in the comparable quarter in 2010.[22] However, many analysts believe that economic conditions and current oil price trends have the potential of reducing the industry's refining margin significantly.[23] One analyst said that the margin experienced by Valero between Gulf Coast ultra-low-sulfur diesel and West Texas Intermediate oil declined 22% in the second quarter.[24]
1Q 2010: First quarter 2010 earnings reflected the impact of the year-over-year decline in refining margins as well as Valero's response to tighter profit margins. Overall, Valero reported a loss from continuing operations of $101 million for the first quarter of 2010 compared to first quarter 2009 income from continuing operations of $364 million.[25] While refining margins declined from a year-over-year perspective, refining margins for several of Valero's petroleum products increased relative to the fourth quarter of 2009. However, Valero was not able to take complete advantage of this margin expansion due to heavy maintenance on refineries in Port Arthur, Corpus Christi, St. Charles, Quebec, and Memphis.[26] Valero expects these refineries to be fully operational during the second quarter of 2010. Yet, lost income from this downtime is estimated at slightly over $200 million.[27] Throughput volumes compared to the first quarter of 2009 declined by 254,000 barrels per day due to the maintenance and the extended shutdown of the Aruba refinery. For the first quarter of 2010, retail and ethanol segments reported operating income of $71 million and $57 million, respectively.[28] Through reductions in capital expenditures as well as increases in margins and production, Valero's second quarter earnings have the potential of showing profit rather than losses.[29]
4Q 2009: While Valero's 2009 annual earnings exemplified the difficulties US refiners faced in 2009, its fourth quarter earnings have the potential of being a good indicator of the refining market in 2010. For the final quarter of 2009, Valero experienced an operating loss, excluding special items, of $179 million.[30] This is a substantial decline from the same quarter in 2008, in which operating income was $1.3 billion.[31] The decline in discounts on sour crude oil in addition to lower margins on diesel and jet fuel contributed to the fourth quarter loss in 2009. Throughput margin per barrel in the fourth quarter of 2009 was $4.63, a 5% decline from the previous quarter and a 140% drop from the same quarter in 2008.[32] In the fourth quarter conference call, Valero's Chief Executive Officer, Bill Klesse, said that margins are not likely to rebound quickly in 2010 due to high inventory levels and low refining capacity. As a result, Valero has the potential of continuing its focus on trimming its costs and preserving its cash on hand. Valero ended the fourth quarter with $825 in cash and temporary cash investments.[33] Its main cost cutting techniques have been to temporarily stall unprofitable refineries and, in the fourth quarter, Valero announced the reduction of its dividend by 75%.[34]
Business Segments
Refining Segment (2009 Operating Income: $105 million): Valero’s refining segment sells petroleum products that have been processed and extracted from crude oil and other feedstock.[35] The company purchases crude oil, either through long term contracts or in the spot market, processes it, and sells its refined products to third parties or consumers at its retail stations. While its 15 refineries are located in the United States, Canada, and Aruba, over half of its refineries are located in the Gulf region.[36]
2009 financial performance reflected Valero's efforts to combat costs amid lower demand and profit margins.[37] Throughput margin per barrel in 2009 was $5.85, compared to $11.10 in 2008. In response to lower margins, Valero also cut throughput volumes by 8.2% in 2009 compared to 2008 levels.[38] In an effort to cut production and raise money from sources other than refining, Valero sold two refineries, temporarily shut down two Texas refineries, and reduced gasoline production at its other refineries.[39] The decline in production and refining margins was partially offset by a 15% reduction in costs.[40] Overall, operating income decline from $995 million in 2008 to $105 million in 2009.[41]
In addition to being the U.S.’s largest refiner in terms of throughput capacity, Valero also has the greatest number of refineries that can process crude oil with high sulfur content, known as "sour" crude oil.[42] Because 65% of Valero’s production can use cheaper, lower quality forms of crude oil to produce high quality “light” petroleum products, its profits benefit from the price differences between sweet, light crude and heavy sour crude.[43] As a result, the “sour crude oil differential” is significant to Valero’s profits because the company purchases sour crude at prices lower than sweet light crude, processes the cheaper crude into light refined products, and sells its products at the same prices as refiners that refine light crude.[44] The price disparity between refined products and crude oil, known as the “refining margin,” is the primary determinant of U.S. refiner’s profitability. Because 65% of Valero’s refineries use sour crude as an alternative to light sweet crude, Valero can significantly lower its feedstock costs and increase its refining margin during times when the sour crude differential is large.
In May 2009, Valero agreed to buy (Dow) Chemical Company's stake in a Netherlands-based refinery for $725 million plus working capital and inventories.[45] Operated by Total Raffinaderij Nederland N.V (TRN), the refinery has a total throughput capacity of 190,000 barrels per day.[46] Although of the acquisition has not been finalized, purchasing Dow's 45% stake in the refinery would be Valero's entry into the European refining market.[47] The purchase has the potential to close as early as the third quarter of 2009.[48]
In 2010, Valero's refining operations will differ compared to 2009 due to plant restarts and sales. In February 2010 and March 2010, Valero announced the resumption of a few of its refineries that had previously be stalled for repairs or due to unprofitably.[49] Also, PBF investments, an energy focused fund, has bid for Valero's New Jersey refinery.[50] The fund has also bid for Valero's Delaware refinery, which was shut down to poor performance.[51]
In October 2010, Valero's Marketing and Supply Co. received a $180.7 million contract from the Defense Logistics Agency for aviation turbine fuel.[52] The contract is for one year.[53]
In December 2010, Valero announced that its Aruba refinery is ready to restart after being idled in July 2009 due to poor economic conditions.[54]
Retail Segment (2009 Operating Income: $293 million): Although Valero’s retail stations sell goods other than gasoline and diesel, operating income and profitability are significantly determined by the price of conventional fuels sold to consumers. In 2009, Valero's U.S. and Canada operations realized fuel margins of $.154 and $.260, respectively, compared to $.229 and $.268, respectively in 2008.[55] The 20.5% year-over-year decline in operating income reflected these drops in margins.
Retail Financial Performance for 2009 & 2008
2009 2008
Operating Income (in $ millions) 194 369
U.S. fuel margin per barrel (in $) 0.154 0.229
U.S. fuel volumes (gallons per day per site) 4,983 5,000
Source: VLO 2009 10-K [56]
Ethanol (2009 Operating Income: $165 million): Valero's ethanol operations engage in the sale of internally produced ethanol. Major operations did not begin until 2009, and annual information is not available for 2008. Daily production in 2009 was approximately 1.5 million gallons.[57] Gross margin per barrel was $0.65.[58]
Ethanol Financial Performance for 2009 & 2008
2009 2008
Operating Income (in $ millions) 165 N/A
Production (thousand gallons per day) 1,479 N/A
Gross Margin per gallon (in $) .65 N/A
Source: VLO 2009 10-K [59]
Trends and Forces
Valero has the potential of increasing its exports while reducing costs in second-half 2010 and all of 2011
In September 2010, Valero CEO said the Valero has the potential to grow with global demand despite sluggish growth in the U.S. Slow growth demand for refined petro-products in North America has depressed margins realized by U.S. refiners.[60] On the other hand, fuel demand has began rising more favorably globally as emerging markets continue to use fuel to growth their economies.[61] As a result, many refiners have adapted the strategy of reducing costs and boosting exports.[62] Valero also expects sour-crude differentials to improve globally as Columbia and Venezuela increase production of sour crude amid stabilizing supplies.[63] An increase in sour-crude differential has the potential of benefiting Valero because the company’s advanced refineries can handle the cheaper form of crude.[64]
Increases in U.S. shipping activity and European distillate prices boost diesel demand and prices for Valero
About 9.6% more freight was moved by trucks in April 2010 than in same period in 2009, which has led to an increase in the need for diesel fuel.[65] Demand for the fuel increased 12% for four weeks ended June 11, 2010 compared to the same period in 2009.[66] Prices have also improved: June 2010 prices are nearly double of their levels in June 2009. Due to a recovering economy, consumption of U.S. distillates are predicted to expand 1.4% this year, which is the largest annual increase since 2005.[67] As the largest refining in the U.S., Valero is taking steps to capitalize from the rise in diesel prices. According to Valero CEO Bill Klessen April 2010, distillate demand in the world is growing at a rate two to three times greater than the rate of gasoline demand.[68] Declining domestic inventories in Europe have made it more profitable for traders to ship U.S. fuel to Europe than to purchase it domestically.[69] In response to the increase in export demand, Valero announced in April 2010 that its diesel-making hydrocrackers in Texas and Louisiana have the potential of being completed soon. Not only can these plants produce diesel for consumption in the U.S., but they also have export capability.[70]
When profits margins are low for U.S. refiners, Valero’s advanced refineries give it a production and price advantage
Valero’s ability to refine large quantities of heavy sour crude has the potential to increase refining margins and profits, especially when the price of light crude, like West Texas Intermediate sweet crude, rises.[71] When the price of light crude began to rise to $140 per barrel in July 2008, the prices of refined products, such as gasoline, were not able to increase as quickly. For many independent refiners, the rapid increase in crude prices initially cut refining margins and reduced quarterly profits substantially; Sunoco (SUN) and Tesoro Petroleum (TSO) reported that profits fell by more than 80% and 90% during this period.[72] While Valero’s net refining margin fell by 36% during the same period, the decrease in earnings was not as drastic as it was with many other competitors.[73] The rise in crude prices effected Valero’s profits less than its competitors during 2007 and 2008 because 65% of Valero’s refining capacity uses crude that was $6/barrel to $16/barrel cheaper on average than light sweet crude.[74] As a result, volatile changes in the prices of light sweet crude oils did not affect Valero's refining margins as much it did the Valero's competitors.[75]
However, falling crude prices have reduced the low-production-cost advantages of Valero's refineries.[76] Industry-wide cuts in crude supplies have reduced the price difference between the sour Maya crude oil and the sweet West Texas Intermediate in March 2009 to $4 from $14 in the fourth quarter of 2008.[77] Declining consumption of refined products, which fell 6%in 2008, has not only reduced Valero's profits, but also reduced the production advantages Valero has over other U.S. refiners like Sunoco (SUN).[78] Despite declining refining prices, Soleil Securities energy analyst Jacques Rousseau maintains that the price difference between sour and sweet crude has the potential to widen when the U.S. economy begins to recover and oil prices rise.[79]
Valero’s advanced refineries can switch from producing conventional gasoline to refining and selling petroleum products that are in higher demand or have higher refining margins
Through its investments in equipment upgrades and acquisitions, Valero has 15 refineries that are worth over $25 billion at the end of 2008.[80]The high value of Valero's refineries indicate that the company has made substantial investments in new refining equipment and equipment upgrades. For example, in 2007, Valero sold a refinery with throughput capacity of 165,000 bpd for $1.9 billion. By contrast, Sunoco (SUN) plans to sell a refinery with throughput capacity of 100,000 bpd for $1 billion.[81]
Due to its equipment investments, not only can Valero produce gasoline and distillate fuels with lower production costs than its competitors, but the company is not as susceptible to the low demand for gasoline beginning in 2008.[82] Beginning in 2008, Valero reduced its production of gasoline blends, which accounted for almost 46% of its 2007 annual production, in order to produce products that carried better profit margins and had higher demand.[83] In 2008, Valero produced and exported more diesel fuel as those profit margins increased 30%. Diesel demand has skyrocketed internationally, especially in Europe, thanks to the fuel's higher better efficiency; globally, diesel prices have risen 56% in the last year[84] Overall, U.S. refiners exported 160% more diesel in 2008 in order to meet rising worldwide demand for energy while overall domestic consumption of gasoline fell by 6%.[85]
Amid economic downturn, Valero plans for a Biofuels Future
Refining margins were smaller as crude oil prices increased in partly due to higher concentrations of biofuels mixed with retail gasoline. Beginning in July 2008, the price corn and ethanol dropped, as ethanol producers could not cut costs in step with falling fuel prices. In particular, ethanol maker Verasun Energy (VSE) filed for chapter 11 bankruptcy in February 2009 after losing a significant amount of money on hedges to protect the company against rising corn prices corn.[86] Verasun Energy (VSE) has accepted Valero's bid for seven of its ethanol plants to Valero for $477 million.[87]
In December 2009, Valero purchased three more ethanol plants for $272 million.[88] U.S. ethanol producers were hit hardly by the economic downturn in 2008 that forced many producers into bankruptcy. However, Valero has been able to purchase seven plants in 2009 at depressed prices. The December-purchase adds a combined capacity of 330 million gallons per year, bringing the refiner's total capacity to 1.1 billion gallons per year. [89] During the first month of 2010, Valero acquired two ethanol plants for $200 million from ASA Ethanol Holdings.[90] The two plants, located in Indiana and Ohio, add an annual production capacity of 110 million gallons to Valero's growing ethanol business.[91]
Valero’s bid for these biofuel plants suggests that the company believes ethanol will once again be a profitable fuel when energy prices rise and that consumers will demand more environmentally friendly forms of energy in the future.[92] As a producer of ethanol as well as a petroleum refiner, Valero will be able to profit from higher concentrations of ethanol in gasoline.[93] Valero and Marathon Oil are the only two U.S. refiners that will not have to purchase ethanol from third parties in order to make gasoline.[94]
Although the U.S. government raised the ceiling for the amount of ethanol that mixed into conventional gasoline, Valero and other refiners may be reluctant to sell gasoline blended with higher concentrations of ethanol.[95] The EPA is expected to raise the ceiling from 10% to 15% ethanol, but refiners are not obligated to increase the amount of ethanol blended into their conventional gasoline[96]. In fact, Valero is likely not to increase ethanol concentrations due to fears that it will be liable for any engine damage resulting from the higher levels of ethanol. Because the new ceiling does not include any liability protection, many refiners do not plan on increasing ethanol concentrations.[97] While increased concentrations of ethanol would benefit Valero's ethanol business, which is the third largest in the U.S., the increase also reduces the amount of gasoline sold per gallon of fuel.[98] As a result, the reluctancy of U.S. refiners to increase ethanol concentrations illustrates the limitations surrounding ethanol use as a fuel. Higher ethanol concentrations not only have the potential of hurting the refining businesses of U.S. refiners, but also may lead to engine damage.[99]
Approximately half of Valero's Refining Capacity is located in the Gulf Region and is vulnerable to seasonal storms
With refineries located in Texas and Louisiana, about half of Valero's refining capacity is exposed to hurricanes and tropical storms occurring in the Gulf of Mexico. In the fall of 2008, BP (BP), Royal Dutch Shell (RDS'A), and Transocean (RIG) had to such down refineries, oil rigs, and other operations on the Gulf coast in order to protect their workers and equipment from Hurricane Gustav.[100] While Valero did not have to close any of its Gulf refineries during the storm, half of Valero's production capacity remains open to destruction from future hurricanes and other Gulf storms.
Competitive Landscape
Oil Majors( Chevron Corporation (CVX) , Exxon Mobil (XOM), CONOCOPHILLIPS (COP), BP (BP)): The oil & gas majors are vertically integrated oil and gas companies that have exploration, production, refining, and marketing operations. In the refining segment, many of the oil & gas majors operate more cost-effectively than independent refiners like Valero because they do not have to purchase their crude oil supply from third parties. Not only do many of the majors have comparable refining capacity to Valero's, but many of them operate in the Texas and Lousiana, where Valero has more than half of its refineries.[101]
Holly Corp. (HOC): Holy Corp. is a United States-based petroleum refiner. The Company operates two oil refiners and distributes its refined products in the Southwest and West United States. Holly Corp. also owns 900 miles of crude oil pipelines located in Texas and New Mexico. the Company transports asphalt and liquid petroleum gas(LPG) to wholesalers and LPG retailers.[102]
Sunoco (SUN): Sunoco is U.S. petroleum company with refining, retail, chemical, coke, and logistics segments. As the second largest U.S. refiner in terms of capacity,the company has a refining capacity of approximately 1.3 million barrels per day, with operations spread across the Northeast and Mid-West. Unlike Valero Energy (VLO), a majority of Sunoco's refining feedstock comes from sweet crude oil.[103]
Tesoro (TSO): Like Valero, Tesoro operates in two segments: refining and retail. As of December 31, 2008, Tesoro owns and operates 7 refineries with a total throughput capacity of 658,000 bpd. 93% of their operating income comes from their refining segment. In 2007, Tesoro made $21.9 billion in revenue from its refining and retail segments and $967 million in operating income.[104]
Comparison to Competitors - 2008
CONOCOPHILLIPS ROYAL DUTCH SHELL EXXONMOBIL CHEVRON BP LUKOIL(1) Eni S.p.A(1) Total S.A.
Reserves
Oil and Gas Liquids
(Millions of barrels) 5,817[105][106] 3775[107] 7,576(2)[108] 7,350[109] 10,353[110] 15,715[111] 3,219[112] 5,695[113]
Natural Gas
(Billions of cubic feet) 24,948[114] 40,895[115] 31,402(2)[108] 23,075[109] 45,208[110] 27,921[116] 18,090[112] 26,218[113]
Production
Oil and Gas Liquids
(Thousand b/d) 1,108[117] 1,695[107] 2,405[118] 1,649[119] 2,401[120] 1,954[121] 1,020[112] 1,456[122]
Natural Gas
(Million cf/d) 4,970[117] 8,595[115] 9,095[118] 5,125[119] 8,334[120] 1,586[123] 4,114[112] 4,837[122]
(1) Latest data is for 2007 (2) Does not include reserves of equity affiliates
Refining Industry 2008 Metrics
SUNOCO CHEVRON VALERO EXXON MOBIL Royal Dutch Shell SINOPEC WESTERN REFINING ConocoPhillips BP LUKOIL(1) Eni S.p.A(1)[124] Total S.A.
Refinery Capacity
(Million BPD) 0.91[125] 2.139[126] 2.99[127] 6.2[128] 3.678[129] 3.376[130] 0.238[131] 1.986[132] 2.678[133] 1.135[134][135] 0.544 2.604[136]
Number of Refineries (including partial interests) 5[137] 18[126] 16[138] 37[128] 40[139] 17[140] 4[141] 12[132] 17[133] 9[142] N/A 25[136]
Number of Retail Gas Stations 7,785[143] 25,000[144][145] 5,800[138] 10,516[146] 45,000[147] 29,279[148] 153[149] 8,340[150] 22,600[151] 6,287[152] 6,441 (in Europe) 16,425[136]