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Oil refiners have been in the news lately with the higher gasoline prices so an industry snapshot is timely. First of all refinery inputs were down in 2011from 2005 due to the recession, higher fuel economy of vehicles and increased ethanol blending (Source US EIA). The Chart below shows the utilization of refineries on the East Coast is very low (68%) as compared to 93% in 2005.

FIGURE 1


(Click to enlarge)

Source: US Energy Information Administration

According to the US EIA, the East Coast refinery shutdowns are due to poor economics. One part of this is the imported crude in this region is typically priced against Brent Crude (North Sea) which averaged $16/B higher than West Texas Intermediate in Cushing, OK. This divergence is unusual and based on transportation logistical issues in getting oil from Cushing to Gulf Coast refineries. (Source: US EIA). Another element is gasoline prices on the East Coast are relatively low therefore their margins are squeezed. Figure 2 below shows California is over $4.25/gal while New Jersey and New York are in the $3.60- $4.00 range. California is high due to no pipeline connecting north and south areas and port congestion. The East Coast is lower due to ease of marine shipments from the Gulf Coast, Caribbean and Europe and pipeline connections to the Gulf. Retail price, of course, include local, State and National sales taxes.

FIGURE 2


(Click to enlarge)

Source: US EIA

The conventional measure of refining profitability is the crack spread which is the difference between the value of the refined products and the crude oil price. A 3-2-1 spread refers to the difference in the cost of a barrel of oil and the value of two barrels of gasoline and one barrel of #2 heating oil, divided by three. In Figure 3 I show the historical data for Brent crude and a crack spread based on New York Harbor spot prices for regular gasoline and #2 heating oil. You can see these track reasonable closely for most of the period with the exception of the crude run up in starting 2007and peaking in June 2008 at $140/B. The fact that crack spreads did not change much at all, despite a tripling of crude prices, indicates refiners do not collude to set prices. Also, this is what you would expect for mature commodity products with essentially zero switching costs.


(Click to enlarge)

Source: US EIA, NEAA

Additional examination of the crack spread trend as a percentage of Brent cost is shown in Figure 4. The 52 week moving average has been declining for at least ten years. The ratio is now below ten % and this is confirmed by financial data to follow. When you factor in capital, environmental, safety and maintenance capital, this is a low return business. In fact, news reports say that eighteen refineries with 2 million barrel per day capacity have been closed in the US, Caribbean and Europe in the last three years. For example, Hovensa shut down their St. Croix Virgin Islands refinery in February and said they lost $1.3 billion in the last three years. (Source)


(Click to enlarge)

So with that back drop let's look at the independent refiners (they have no oil production in contrast to the integrated refiners). I identified ten such refiners that have 37% of U.S. capacity.

A brief profile of each company is as follows:

Alon USA Energy (NYSE:ALJ):

Have refineries in LA, TX, OR and CA.

Calumet Specialty Products Partners, LP (NASDAQ:CLMT): Primarily a refiner of base oils used as industrial and food grade applications.

CVR Energy, Inc (NYSEMKT:CVR):

Have a refinery and nitrogen fertilizer plant in KS. Investor Carl Icahn made a tender offer in January at a premium to the market and has received proxies for 55% of the shares outstanding. He intends to install a new Board and sell the Company.

Delek US Holdings (NYSE:DK):

Operate a refinery in East TX and own 412 retail convenience stores throughout the south east.

HollyFrontier Corporation (NYSE:HFC):

Holly and Frontier Oil merged in July, 2011 Mid- continent and Western base. Also have midstream MLP operation.

Marathon Petroleum Corporation (NYSE:MPC):

Spin off of refinery business from Marathon Oil in June 2011.

Sunoco (NYSE:SUN):

Philadelphia based refiner and chemical company. Have shut down one refinery, sold two and have a third for sale in Philadelphia. Also have chemical business.

Tesoro Corporation (NYSE:TSO):

Have western and west coast refineries. Announced intent to sell Hawaiian Refinery Jan. 2012. Have 1,175 retail stations.

Valero Energy Corporation (NYSE:VLO):

Largest independent refiner in US. Also have ten ethanol plants with combined capacity of 1.1 billion gallons per year capacity. Acquired assets from Marathon Oil and Chevron in 2011.

Western Refining, Inc (NYSE:WNR):

Two refineries in TX and NM. Sold Yorktown, VA refinery in 2011 to Plains All American who will convert to storage terminal.

Source: Company, Yahoo Finance

Table 1 Independent Refiners Capacity

Company

Symbol

Refining Capacity, BPD

# Refineries

Capacity/

Refinery

ALON USA ENERGY, INC.

ALJ-N

250,000

4

62,500

CALUMET SPECIALTY PRODUCTS PARTNERS, L.P.

CLMT-O

94,000

8

11,750

CVR ENERGY, INC.

CVI-N

115,000

2

57,500

DELEK US HOLDINGS, INC.

DK-N

60,000

1

60,000

HollyFrontier Corporation

HFC-N

440,000

3

146,667

MARATHON PETROLEUM CORPORATION

MPC-N

1,200,000

6

200,000

SUNOCO, INC.

SUN-N

505,000

4

126,250

TESORO CORPORATION

TSO-N

665,000

7

95,000

VALERO ENERGY CORPORATION

VLO-N

3,000,000

16

187,500

WESTERN REFINING, INC.

WNR-N

151,000

2

75,500

Independent Total

6,480,000

53

122,264

US Total (US EIA 1/1/2011)

17,736,000

148

119,838

Independents,% Total

37%

36%

-

I think gross margin is an important indicator. It reflects how management has positioned their refineries around the country to capture the lowest crude costs and highest product value. For example, SUN has the lowest margin at 3.1% and is mostly on the East Coast while HollyFrontier had a 17.9% margin last year and is mostly in the west and mid-continent area. The industry average is 10.4% which is close to the crack spread/Brent ratio calculated in Figure 4.

However, the analysts following these stocks give the highest EPS growth prospects to two other companies: Calumet Specialty Products and Valero Energy Corporation . CLMT also has a 7.45% dividend yield and is a niche manufacturer primarily of base oils used as industrial lubricants. They made several acquisitions in recent years. Most of their business is non-transportation so the deteriorating crack spread margin does not affect them to the extent it does the other refiners who are mostly transportation fuels oriented. For these reasons this is my top pick in the industry.

Table 2 Independent Refiners Financials

Company

Symbol

2011 Revenue, $B

Gross Margin,%

Operating Margin,%

Est. '12 EPS

Est. '13 EPS

EPS Growth,%/yr

Yield,%

ALON USA ENERGY, INC.

ALJ-N

7.19

10.1%

2.5%

$1.01

$1.13

11.9%

1.83%

CALUMET SPECIALTY PRODUCTS PARTNERS, L.P.

CLMT-O

3.13

8.7%

3.5%

$2.14

$2.50

16.8%

7.45%

CVR ENERGY, INC.

CVI-N

5.03

14.9%

11.2%

$4.11

$3.92

-4.6%

0.00%

DELEK US HOLDINGS, INC.

DK-N

7.20

10.7%

4.2%

$2.37

$1.70

-28.3%

2.20%

HollyFrontier Corporation

HFC-N

15.44

17.9%

11.1%

$5.33

$4.06

-23.8%

1.05%

MARATHON PETROLEUM CORPORATION

MPC-N

78.64

7.5%

4.8%

$5.87

$6.12

4.3%

1.06%

SUNOCO, INC.

SUN-N

46.82

3.1%

-5.1%

$1.31

$1.56

N/A

1.54%

TESORO CORPORATION

TSO-N

30.30

10.9%

3.6%

$3.78

$4.00

5.8%

0.00%

VALERO ENERGY CORPORATION

VLO-N

125.99

8.2%

2.9%

$3.71

$4.46

20.2%

1.19%

WESTERN REFINING, INC.

WNR-N

9.07

11.9%

3.9%

$3.23

$2.78

-13.9%

0.00%

Average

32.88

10.4%

4.3%

$3.29

$3.22

-1.3%

1.6%

Source: Thomson-Reuters, Yahoo Finance

Source: Refiners Under Pressure Despite High Oil Prices: Independent Oil Refiners Overview