Novice Investing - Refining Valero

Date: Thursday 28th 2008f August 2008 01:00:19 AM

Refining Valero - 06/27/2008

By: Hari Wibowo

Valero Energy Corporation.
One Valero Way
San Antonio, TX 78249
United States

With gasoline price topping $ 4 per gallon nationwide, many folks will blame oil companies and refiners for being the ruthless businessman that profit from our misery. Having said that, let's look at the oil refining business and analyze them briefly. The data from the Energy Information Administration (EIA) shows that the US refining capacity has not been increasing at all since 1981 In 2007, installed capacity is at 18.558 Mbpd (Million barrels per day). Meanwhile, appetite for petroleum products has increased from 14.74 Mbpd in 1981 to 18.480 Mbpd in 2007. Granted, there are many refineries in other part of the world that can supply our gasoline demand but there is always cost associated in transporting it. This makes it more profitable for existing refineries in the US. The table below shows the biggest US refiners.

Company	Capacity (Mbpd)
Valero	3.100
Conoco	2.208
Exxon	1.963
BP	1.460
Marathon	1.016
Chevron	0.840
Tesoro	0.658
Murphy	0.150

Being the largest, Valero Energy Corp. (VLO) with 16.7% total refinery capacity is definitely worth a look. With $ 95.3 Billion of sales and $ 5.23 Billion in net profit during 2007, refinery is definitely getting close to 100% of Valero's business. How so? Knowing refinery capacity of Valero, and knowing that average gasoline price is $ 2.81/gallon in 2007 (where 1 barrel

= 42 gallons), Valero's revenue should be north of $ 100 Billion. I am assuming that Valero is supplying gasoline to states with lower than average price. Since there is no exact information on the amount of gasoline that Valero supplies to which states in the US, we cannot verify it.

Anyway, Valero is the largest and purest US refinery there is around. Thus, if you'd like to investigate the impact of high gasoline price to a refiner's bottom line, you can start with Valero. The gasoline that you pay at the pump consists many components. The latest Californian unbranded gasoline price is $ 4.59 per gallon and it includes: Crude Oil Cost ($3.22), State and Local Sales Tax ($ 0.34), State Excise Tax ($ 0.18), Federal Excise Tax ($ 0.18), Distribution, marketing costs & profit ($ 0.19) and finally Refinery cost and profits ($ 0.46). The last item is what we commonly call Refiner Margin. This is the spread between the wholesale price of gasoline and the cost of crude oil and its taxes.

Now, with gasoline price 70 cents higher than 2007 level, are the big evil refiners making any money from poor US consumers? Let's look at their refiner margin in 2008 versus 2007.

	Refiner Margin ($/ Gallon)
	Jan	Feb	Mar	Apr	May	Jun	Jul	Aug	Sep	Oct	Nov	Dec
2008	$ 0.22	$ 0.38	$ 0.36	$ 0.39	$ 0.31	$ 0.62
2007	$ 0.58	$ 0.76	$ 1.06	$ 1.09	$ 1.06	$ 0.76	$ 0.61	$ 0.37	$ 0.34	$ 0.42	$ 0.39	$ 0.34
2006	$ 0.38	$ 0.48	$ 0.57	$ 0.74	$ 1.00	$ 0.81	$ 0.81	$ 0.60	$ 0.41	$ 0.50	$ 0.60	$ 0.54

Ok. At a glance 2008 looks awful for the refiners. How about 2007 compared with 2006? Average refiner margin for 2006 and 2007 is $ 0.648 and $ 0.62 per gallons respectively. While you may feel that your good local refineries were ripping you off during 2007, please note that crude oil price was higher in 2007 than in 2006. The cost of processing crude oil depends on the price of natural gas, which is subsequently related to crude oil price itself. Therefore, while nominal refiner margin is higher in 2007, it is not surprising that Valero reported lower net profit in 2007 (2007 net profit: $ 5.23 Billion, 2006 net profit: $ 5.46 Billion).

2008 will be a very awful year for US refiners. If you look at January-June refiner margin, 2008 sets to be significantly depressed with refiner margin of $ 0.38 per gallon in 2008, $ 0.89 in 2007, $ 0.66 in 2006. Margin is cut in half while cost of production, which follows crude oil price, doubles. No wonder refiner stocks such as Valero has been cut in half. They will probably reports more than 50% drop in net income if this trend continues until year end. The Exxon Mobil and Conoco in the world are affected as well. However, refinery represents smaller portion of their business and therefore, their shares are not punished that hard. Thus, despite the high price at the pump, do not chastise the big evil refiners for your gas pain. Big refiners are feeling your pain as well.

END

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding Valero Energy Corp. (VLO) or any other securities.

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