Time to Buy Refineries
December 07, 2010
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One of my great regrets in life is not buying Tesoro stock in the bear market of early 2002. Sure, with their mountain of debt, they looked like they might go under. However, I was there--working at the Tesoro, Golden Eagle refinery. Valero had just poured hundreds of millions into plant improvements, refining margins were getting better, the economy was recovering, and the stock was $1.70 a share. It eventually went to $140/share (split adjusted) or something to that effect.
But, there is no need for regret. The refining industry is a wonderful beast. It goes up and down, back and forth, between elation and desperation every decade. It is either pure greed or pure fear and nothing in between.
Now, there is nothing but fear. The economy will never recover. Electric cars will replace gasoline. Fuel consumption will forever shrink in America. Huge Indian and Chinese oil refineries will begin exporting to the U.S. Ethanol production will quadruple. Cap and trade legislation will kill the oil business. And so on.
Some of this is true, much is overblown, and that is why we can buy companies like Valero, Tesoro, Alon, Frontier, Sunoco, and Holly for 80% off their all time high prices.
I am not alone. PBF Energy--run by Thomas O'Malley of Tosco and Premcor fame--has recently begun a buying spree, picking up his 3rd U.S. refinery in the past year. He is buying cheap when everyone else wants to sell. He's done this twice before and made billions both times.
Take a look at the recent purchses and price per barrel per day (bpd) of capacity:
Valero, Delaware City: 210,000 bpd refinery. Purchased for $220 million with $150 million in plant improvements required. Total price $1,760/bpd.
Valero, Paulsboro: 185,000 bpd refinery. Purchased for $635 million. Price $3432/bpd
Sunoco, Toledo: 170,000 bpd refinery. $400 million. Price $2355/bpd
Compare that to the price of the all time worst refinery purchase:
Tesoro buys Shell, Wilmington 100,000 bpd refinery for $1.63 billion. Price $16,300/bpd
Or, compare it to refinery expansion projects:
Marathon, Garyville: 180,000 bpd expansion for $3.2 billion. Price $17,800/bpd
Motiva, Port Arthur: 325,000 bpd expansion for $7 billion+. Price $21,000/bpd
Or a new refinery:
Arizona Clean Fuels, Yuma: 140,000 bpd for $4 billion. Price $27,000/bpd
Sure, the new refineries will be more complex--meaning they can vary their product output and crude purchases to optimize profit margins. But the two East Coast refineries PBF has recently purchased are also complex refineries. Is it worth 5X the price to build new capacity? Is it worth 8X the price to build from grass roots?
No, it is better to buy old refineries that no one else wants right now. Alon and Holly have also been picking up capacity on the cheap. Eventually, refining spreads will return and these companies will make huge gains.
Why will refining margins return?
Two things: refineries are shutting down. Sunoco, Eagle Point; Western, Yorktown; and Valero, Aruba are just a few that are either permanently mothballed or currently idle. In Europe (a major gasoline exporter to the U.S.), 2 refineries in France, 3 in Italy, at least 1 in the U.K., and perhaps 1 in Span will be closed in the next couple of years. European refiners are also investing heavily to shift their production to more diesel, further restricting gasoline imports to the U.S.
The other thing is that the U.S. still has positive population growth. More people means more cars, and for the forseeable future those cars will run on gasoline. Even the most optimistic predictions for electric cars only have them being 2-3% of the vehicle fleet by 2020.
So, sometime in the next decade, the greed will return to the refining sector, margins will improve, PBF will sell their refineries for 4X more than they paid, and I will unload my shares of refining companies. It might take 5-7 years and things might get worse before they get better, but I can think of a lot worse people to follow into the fear than Thomas O'Malley.
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