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saunafool (< 20)

Time to Buy Refineries



December 07, 2010 – Comments (11) | RELATED TICKERS: ANDV , VLO , ALJ

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.

11 Comments – Post Your Own

#1) On December 07, 2010 at 8:08 AM, lemoneater (56.77) wrote:

Do you think that natural gas will be part of the picture for automotive fuel in the future?

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#2) On December 07, 2010 at 8:42 AM, Gemini846 (34.60) wrote:

I might argue Nat gas for big rigs, and local fleets (garbage trucks and school busses) but the fueling distribution is a lot harder to get set up than electric.

On the other hand, if more people buy electric cars then airlines will go up since people can't drive the long distances as easily. they'll have to fly and rent a car.

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#3) On December 07, 2010 at 10:10 AM, lemoneater (56.77) wrote:

Thanks for your answer, Gemini846. 

Unless airlines change some of their recent policies, I think that they will start becoming the travel choice of last resort. My husband and have decided that we don't want to take flights for vacations any more and will only fly when we have to. Flying used to be an adventure, not a nightmare.

I wonder if huge companies will start buying private jets again or do more web conferencing than ever. For domestic travel business and pleasure recently friends have opted to drive rather than fly. If only the range of the electric car could be tripled from its current distance, but I guess we are waiting for a breakthough in battery technology.

It will be interesting to see what will be the dominant energy of the future. I think Oil has been the beauty queen for a long while. Who will take her crown? Are there any close runnerups yet?


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#4) On December 07, 2010 at 11:06 AM, saunafool (< 20) wrote:

Natural gas will be a part of the puzzle, but primarily in the form of GTL (gas to liquids) refining. Most of these plants are going to be (or already exist) in Qatar, UAE, and Saudi. The volumes will be so small compared to traditionally refined oil that I wouldn't factor it into the U.S. consumption.

The U.S. is too busy creating a market for ethanol.

Otherwise, I agree with Gemini that straight natural gas will play a role in things like local bus fleets. It will only be a small fraction of total fuel supply.

The dominant energy of the future (for transportation purposes) will be oil. Will be for the rest of our lives. However, the overall energy mix will be much more diverse both for domestic energy and transportation. We are already seeing it--more wind, solar, natural gas, maybe some new nuclear plants. Coal will still be the largest player, but with a lot of other sources mixed in.

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#5) On December 07, 2010 at 1:40 PM, lemoneater (56.77) wrote:

Thanks, saunafool, very informative blog.

From what I've read it seems to take a lot of land to grow the corn needed for ethanol. (My brother lives in South Dakota, so ethanol is big business out there.) I wonder if there are better less land intensive sources for ethanol than corn.



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#6) On December 07, 2010 at 2:59 PM, saunafool (< 20) wrote:

Sure, sugar makes ethanol a lot more efficiently than corn. Too bad American Ag policy has put tariffs on imported sugar for years. So, no sugar from Brazil for ethanol. Also tariffs prevent Brazilian sugar-based ethanol from being exported to the U.S.

The whole ethanol thing is the biggest taxpayer givaway to agribusiness in American history.

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#7) On December 07, 2010 at 3:52 PM, lemoneater (56.77) wrote:

Another taxpayer giveaway. Just what we don't need :(.

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#8) On December 07, 2010 at 11:31 PM, Option1307 (30.53) wrote:

The time to buy was this past spring/summer as I mentioned back then, before the recent run-up. However, I agree with you that they are still excellent long term buys.

The quick pop for the refining sector may soon be over, but that doesn't mean I plan on selling out of my positions anytime soon. There will certainly be large pullbacks but I continue to like them going forward.

WNR is getting a little frothy right now, but VLO and SUN are still great positions IMO.

Nice thoughts, +1.

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#10) On December 09, 2010 at 5:40 PM, anchak (99.91) wrote:

I must say i have a distinct sense of deja-vu from June 2008.


Please do not take it the wrong way - things are possibly different - yet I just think back to the blog you did on refiners then. 


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