Historical Refinery Prices and Likely Future Developments

by: James Shell

A brief internet search of refinery transactions over the last decade or so gives the following list: Our common measurement of cost will be "dollars per BPD of capacity."

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1. Pricing and capacities are posted at the announced price from the press release at the time. Actual transaction costs and capacity might be different.

2. I've included the announced greenfield refinery projects by Saudi Aramco in the calculations.

3. The transactions may have also come with other assets, so some more detailed analysis of the deals may be in order.

4. In the transaction of August 2006, Lyondell bought out the 42% of an existing joint venture that was co-owned by Citgo.

5. The transaction/refinery sale of the BP (NYSE:BP) Texas City facility was recently written up in the Houston Chronicle, and is particualry noteworthy because BP has put upwards of $1B in the place for upgrades and other projects after the tragic fire of a few years ago.

6. The Giant Industries refinery in Virginia was sold by BP in 2002 for $170M and then the same refinery was sold to Western Refining in 2007 for $2.1B.

Here is an additional table of current market capitalization and capacities for some of the independent oil refiners we have been looking at:

Note: Each of these companies has a variety of other assets, such as retail, pipelines, and other activities, and also has varying levels of debt that might complictate the calculation if you were really interested in buying some refinery capacity.

So, what are we to conclude from all of this:

A. This is a tough business. When refinery margins are terrible, such as in the early 2000s and right now, the value of a unit of refining capacity is low. When margins pick up, people will be scrambling around and be willing to pay greatly higher amounts for capacity if they feel it is needed.

B. It is still much cheaper to buy one of these refineries from someone who wants to sell one than to build one from the ground up. I suppose we can assume that the cost of a greenfield plant in North America would be greatly higher than in Arabia.

C. The cost of refining capacity is not much different whether you buy the refinery from someone who wants to sell one, or to go into the stock market and buy the stock of one of these independent refiners and run it.

D. Keep in mind that if, by some sort of thought disorder, you really do want to get into the refinery business, it is likely that you will have to pump many millions of dollars into the place to keep the thing running. I believe that Valero (NYSE:VLO) is the poster child of someone who bought a lot of refining capacity in the 2000-2003 time frame, put some money into them to keep them running, and still had a lot of downtime and other issues during the 2006-2007 time frame when these things are running full-out.

E. At the current level, due to low margins, the economics of the industry are still below "replacement economics" which is, no one is making enough money to justify a new unit to replace an old one, given that the cost of startup capacity is something like 4 or 5 times higher than some debottlenecking project might be.

F. Given all of this, are the refining stocks, as some measure of their value, "cheap?" Well, it depends entirely on what you think will happen with refining margins, but you might need to be patient, maybe 5 years worth of patience, for the refiners to get to the point at which they are making money. Clearly we are on the low end.

G. If you were someone that did not care about short-term rate of return, and really needed refinery capacity, such as CNOOC (NYSE:CEO), would you buy refinery capacity now, at pennies on the dollar, knowing that at some point it is cheaper than building it from the ground up? Maybe. We know that the walkaway price, that is, the price at which a refiner like Valero will walk away from a plant like they nearly did in Delaware City not too long ago, is at or near $1000 per BOD, so it is possible that some local government would be delighted to have CNOOC buy their refinery and ship the fuel to China rather than have all of those workers unemployed. The purchaser of the Delaware City plant was from Switzerland.

H. If you keep track of these transactions, can the price per BOD of refinery capacity be a predictor of the market picking up? We will have to see, of course, but there are a lot of issues, such as feedstock capability and output product mix that you would have to worry about that might add some noise to the calculation.

I. If you were a refiner, and you know that you have an old production unit, or old refinery, that is currently valued at $1000 per BOD, would you sell it right now? At some point as we were saying, it becomes a matter of whether you want to put money into it, or just shut the door and walk away. That's how the market works. They do that, demand picks up, there is need for the products and the margins pick up and the whole cycle starts again. This makes it really difficult for a capitalist to get excited about investing in this business unless one is patient.

There is plenty here to think about.

Disclosure: No positions