Tuesday, October 26, 2010

Pacific Ethanol: Potential Buyout Target

PEIX is an operator of a handful of ethanol plants in the western states. They are trying to emerge from bankruptcy, and have recently arranged a line of credit to become a credible ethanol producer. Their current stock price is about $1 per share and they have about $80M in debt:

Stock Price $ 1
Shares Outstanding 83,000,000
Debt (Bal Sheet) $ 25,000,000
New Debt $ 53,000,000
Total Cost to Buy Co $ 161,000,000



Capacity Gal/Yr 240,000,000
Capacity Gal/Day 657,534 gallons per day
Capacity Barrels/Day 15,656 barrels per day



Acquisition Cost $ 10,284 $ per BOD

A couple of things on this: The acquisition cost of just over $10K per BOD is right now about twice that of the average cost of petroleum refining capacity in the US.... however, keep in mind that on average, the margin for ethanol is about twice that as well, so as an investment, someone would be equally likely to get into the ethanol business as they would the petroleum refining business....

Stock Price $ 1
Shares Outstanding 83,000,000
Market Cap $ 83,000,000
Debt (Bal Sheet) $ 25,000,000
New Debt $ 53,000,000
Total Cost to Buy Co $ 161,000,000


Capacity Gal/Yr 240,000,000
Capacity Gal/Day 657,534
Capacity Barrels/Day 15,656
Margin@.25/gal 60,000,000
Acquisition Cost $ 10,284
One year ROR 37%




The potential buyout scenario suggests that if Valero or some other refiner wanted to, given the margins that exist in the industry and knowing what the investment per BOD of capacity is, you could expect a really attractive ROR.... In fact, to make this an equal investment to a greenfield oil refinery project, Valero or someone else would be willing to pay up to $6 per share, and still get the same rate of return....

So based on the current margins in this industry, the really interesting way to look at PEIX is as a potential takeover target..a buyer of PEIX could make on the order of 37% in the first year on such an investment. This is comparable to the ROR that Valero could see when it did its original ethanol deal at the end of 2009. Valero, or anybody else that wanted to get into ethanol, would be delighted to get this deal done.

Chances are the management knows this. They recently took on some debt with the idea of buying back some of their stock, and the debt itself will make the potential takeover less likely....

However, at the current margins for ethanol, and the current price of refining capacity in the oil industry, PEIX is a potential opportunity, of course much more so than it was when the plants were originally built.

Friday, October 22, 2010

Western Refining Debt Restructuring

We wrote in a previous blog entry about the epic catastrophe that befell WNR's decision to buy a 72Kb/d refinery in Yorktown VA.

To recap, these fellows borrowed $1.12B and bought this refinery at the absolute peak of the market, paying on the order of $20,000 per barrel of capacity. This spring, they finally gave in and shut the doors on the place, they are going to use the location as a terminal, and they are going to "monitor conditions", with the idea that they could restart the place.

In the meantime they have the ongoing problem of the $1B of long term debt.

They had a stock offering this spring which managed to raise $150M thus paying off the current portion.....

Their interest expense is $34M per Quarter, as of the most recent quarter. this amounts to approximately $2.75 per barrel of refined product....

So....

As long as the refining margins stay high enough so that they can continue to service the debt, plus provide a little profit, they can make the current situation last for a long time. This is obviously not a desirable situation, but they have some prospects to make it work.

Their strategy also involves rolling out the long term debt that is coming due by issuance of five-year notes, at high interest rates. The notes issued in the first quarter this year had a face value of more than 11%, so on that basis, if you really, really had confidence in this business, this would be a pretty interesting way to play it.

The question comes up: Could the sell the plant for some amount of money, and based on the analysis we did earlier on the current value in the marketplace for refinery capacity, it is unlikely they could get more than 4000 per BOD of capacity, or about $280M for the plant. This is so far below the value of this place on WNR's books that the likelihood of it happening is practically zero.

WNR has also been quite successful with working with their bankers using a revolving credit arrangement to roll out the remainder of their long term debt as it comes due. I suppose if you look at it from the bank's point of view, as long as WNR is able to service the debt, it makes no sense to pull the rug out from under them under the theory that if you owe someone $100 you and cannot pay it back you have a problem but if you owe someone $1B and cannot pay it back, THEY have a problem.... so as long as the margins are strong enough that WNR can continue to service the debt, the game will continue.

At some point, in theory, refining margins will go back up to some reasonable level, the light/heavy crude oil differential will re-widen again, and they will be able to start this refinery back up, and at that point it will have some value in the marketplace.

Until then, nothing is going to happen on this, the situation is not good, but it is stable, and a plan is in place for the medium term survival of the company, until such time, if any, that the margins get back to where they were.

Note: If we do have a double dip, or even worse, if we get into a situation where the feedstock costs go way up but the refining margins stay stable, then these guys are going to be in a heap of trouble, like they used to say.

In the meantime, Morgan Stanley likes their plan, they have upgraded the stock, and that is another interesting development. We will see what happens.

Monday, October 18, 2010

MRO: What to do with $900M

Marathon Oil (MRO) recently unloaded a lot of gas stations and a small refinery up in Minnesota, and now have on their hands $900M. There are a few alternatives as to what to do with the extra cash.... and MRO being the conservative types that they are have no doubt considered the following alternatives:


Share Buyback

709,000,000 Shares Outstanding
$ 2,390,000,000 Current Anticipated Earnings
$ 3.37 Current Anticipated EPS
$ 36 Current Stock Price

684,000,000 Shares Outstanding After Buyback
$ 2,390,000,000 Anticipated Earnings
$ 3.49 EPS after Buyback
13.5 PE
$ 47 Anticipated Stock Price after Buyback



Currently at 36 the market is anticipating earnings of about $2.3B for the year, and by reducing the number of outstanding shares to 684 million by buying back $900B at the current price, at the current PE, should result in a stock price of about 47 per share.

Increased Dividend

Current Dividend Yield 2.8%
Dividend $1.00 per share
Stock Price $35.71 Current Stock Price



Current Yield 2.8%
New Dividend $1.25 per share
New Stock Price $44.64 After Dividend Increase

At the current stock price of about 36, and a current dividend of about $1 per share, the yield on this conservative stock is about 2.8%. The question is: how much, if any, to increase the dividend? An increase of 25 cents/share would be sustainable with the business currently like it is for 4 years (at the current number of shares outstanding) and at the same yield, should result in an increase in the stock price to about $45 per share. Note: At the current price and yield, the market is assuming that MRO will have zero growth going forward, with the economy in its current state. Any growth prospects in this business could be factored in for some additional pricing improvements.

Acquisition

Shares Outstanding 709,670,000
Investment $ 900,000,000
Investment ROI 0.1
Increased Earnings/Yr $ 90,000,000
Increased Earnings/Share $ 0.13
PE 13.2
Increased Mkt Cap 1.67
Current Stock Price $ 36.00
New Stock Price $ 37.67

Using the optimistic assumption that MRO could buy some business that has a 10% ROI in the first year, which is a wildly optimistic assumption, the value in increased earnings for the company will be $90M per year, which at 709 million shares comes out to a mere 13 cents per share. At the current PE, 13.2 times earnings, the increased stock price from this type of investment would only be $1.67 per share.

Note: Using the $900M to pay down their long term debt would theoretically have exactly the same impact on the stock if, and it is also a big if, the reduced interest expense by retiring the debt made its way similarly to the bottom line....

Note: Using the $900M to do some sort of debottlenecking project in their current operations will be evaluated on exactly this basis as well: If it is a more attractive investment, relative to the stock price, than just buying back their own shares, they will do so rather than make the investment internally.

The second question comes up: What ROI would an investment need to make in order for the impact on the stock price to be the same as buying back shares, and the answer is, something on the order of 50 percent ROI, which tells me, at least that the likelihood of this alternative happening ought to be next to zero, unless they are really confident..... for that matter, if they can find an investment that will return 50 percent, I hope sincerely that they tell us what it is, so we can invest in it ourselves.

The Bottom Line

Either the stock buyback or the increased dividend could happen, more likely the stock buyback, because the conservative management will correctly not want to get the widows and orphans accustomed to the extra 25 cents per share....

In either case, it makes sense for this stock to be trading up around 47, from its current 36.

Note: The world is chaotic, and there are no guarantees on anything.....

Side issue: What kind of an economy are we in where the management will be greatly advantaged to shrink the company rather than position itself for growth in some way....

Tuesday, August 3, 2010

Frontier Oil: Reliability Engineering Revisited

We are greeted with the following press release from Frontier Oil this morning:






HOUSTON, Jul 28, 2010 (BUSINESS WIRE) -- Frontier Oil Corporation (NYSE:FTO) experienced a fire this morning at approximately 5:40 a.m. MDT in the crude unit at its Cheyenne Refinery. The fire was extinguished within approximately one hour by refinery and city fire personnel. There were no injuries. The cause of the fire and extent of the damage is currently being assessed with preliminary estimates indicating the crude unit outage will be approximately two weeks.


Frontier operates a 135,000 barrel-per-day refinery located in El Dorado, Kansas, and a 52,000 barrel-per-day refinery located in Cheyenne, Wyoming, and markets its refined products principally along the eastern slope of the Rocky Mountains and in other neighboring plains states.




investor.shareholder.com/fto/releasedeta...



In light of our previous calculations on this company, based on the current crack spreads, the effect of this on NOI, if the unit is down for the two weeks suggested in the press release, about  41Kb/d times $11 per BOD crack spread somewhere in the neighborhood of $6.5MM in lost NOI due to the effect of the lost production at roughly 80% utiilization. With a forward PE of 10, this equates to less than a dollar on the stock price, which is still relatively small given the normal market fluctuations.



But here is an example of the very thing that we discussed in our instablog of June 17 on the importance of reliabiilty engineering directly influencing NOI and therefore the stock price. This company, linked intimately with the refining crack spread, needs to keep their equipment operating in order to have a business.



They will announce their earnings in early August, this issue will be reflected in the third quarter operating results.




Tuesday, July 20, 2010

Marathon Upstream vs. Apache and Andarko




Here is a little spreadsheet comparison between the Marathon Oil upstream business, vs. its competitors Andarko and Apache.

Andarko has a much higher debt load, market capitalization of the three are quite similar, but the profitability of MRO and APA are better, probably because Andarko has incurred a higher debt load.

Note: The Market Capitalization is for MRO total company, including the refining business, as is the long term debt amount.

Tuesday, July 13, 2010

Additional Analysis of the HOC Tulsa Refinery Acquisitions

Here is some detail on what appears to have been really a pretty good deal.

In April of 2009 the Sunoco deal was done. The product line included their line of lubricants and specialty materials, and the 85,000 bpd refinery was sold for $157 million, which is a bit more than $2000 per BOD capacity.

In October of 2009, the Sinclair deal was done, the additional 75,000 BOD of capacity was bought for $183 million, a rate of $2444 per BOD capacity...

By the time the rationalization and product line conversions are done, the project will have 135,000 BPD of capacity, which they bought for a total of just under $3000 per barrel, not including the cost of some of the conversion that they will have to do.

The company did have to incur some debt, $400M of notes that come due in 2017. They were able to raise another couple hundred million by the sales of their interest in a pipeline, and the issuance of stock. They also chipped in $54M in cash on the deal.

Keep in mind that per our earlier analysis, WNR paid $19000 per BOD of capacity in 2007, right before the big increase in margins, and there is an excellent chance that part or all of the company will have to be sold because the deal was so bad. Keep in mind also that this incremental capacity is valued at much lower than Valero's current capacity.

So this appears on the surface to be a much better deal despite the fact that it happened during a time when the company is going to have to take some lumps because of low utilization and poor margins. However, this doubled the size of the company, made them roughly the same size as WNR, and positioned themselves to take advantage of the upturn, if and when it comes.

Thursday, July 8, 2010

Calumet Specialty Products: The Costs and Benefits of Differentiation

Calumet Specialty Products (CLMT) fits the same basic mold as the rest of these conversion type companies, that is, you put crude oil in one end, and finished products come out the other. They run a handful of small refineries down around the Gulf, plus have a distribution center up in the midwest. About half of their product mix is typical refinery stuff, gasoline, jet fuel, and distillates, and the other half is a lot of specialty lubricants, plasticizers, process oils and that kind of thing that go into a variety of applications, including some medical. About 3/4 of their profits come from the specialty products division, and about 1/4 from the fuels, in a good month. Production, normally, is about 50/50.



Their average refinery throughput over the last few years has been about 54,000 bpd, which is a bad 45 minutes for Valero.



I did the calculation to compute the correlation between industry refining margins and their NOI and came up with the following:







We had developed a little model by which we were measuring the extent to which these companies' NOI is related to the industry refining margins, and for CLMT the R-squared value was .10, which means, their product mix is such that they have gotten completely away from the same commodity trap that some of the other companies in this business have been in. Valero was about .66, I think FTO was up around .85 when we used the same model to compare these refiners.



The comparison between VLO and CLMT is especially interesting:



 



Obviously these are on a completely different scale but you can see that when the economy was relatively strong, back in 2006 and 2007, they were doing just fine, but CLMT managed to mostly avoid the catastrophe at the end of 2008.



So, what is going on here?



If you take CLMT's top line, sales dollars, for their specialty products division, and divide by the crude oil throughput, it is on the order of $100 per barrel, which given $75 per barrel crude oil costs gives them a refining margin of $25 per barrel on these products, as opposed to the Valeros of the world who are delighted to break close to even right now after overhead.



CLMT's product differentiation does come at some expense. Their SG and A expenses of about $1.41 per barrel are about 100 times higher than Valero's, on a per-barrel basis because in a lot of the markets they are in they need to do some product development and technical service, and sales service activities. Also, because a lot of their products go into more technical markets downstream, such as FDA, they need to put more effort into regulatory compliance and quality control. Also, since they cannot be transported by pipeline, product transportation is a significant line item for them every quarter, hence the distribution center in the midwest. The sum of this, about $4 per barrel, is the cost of differentiation.



CLMT also engages in a lot of hedging/derivative activities to try to protect themselves from unexpected dramatic increases in the crude oil price. According to the quarterly reports, the effects of this on their balance sheet in any given quarter can be pretty substantial, and in fact, have a couple of times exceeded the amount of money they actually made running the plant.







This is a graph of their unrealized and realized hedging effects, per barrel, for CLMT during this time frame. If you take the total hedging effects, unrealized and realized ($68 million) and divide by the number of barrels they consumed during this period, the net effect was a cost of about $0.78 per barrel, which is cheap insurance against the cost of crude oil going out of sight, and it does confirm that they are not really trying to be a trading house, all they really want to do is build a little protection into their system so that they can make money doing what they do.



So they can inoculate themselves against crude oil pricing, but they cannot inoculate themselves against a general downturn in the end-use markets, and they are still down about 20% in crude oil throughput from the top of the economy.. Since they do have a little higher costs, they have to back off of their fuel production when the margins are low, which is what has happened over the last quarter or two. A lot of their end-use markets such as automotive are also still way down from their pre-recession high water marks.



There are a few other things in the background on this: The boss is a former chemical engineer, which is a point in his favor as far as I am concerned, and a lot of the management is from the refinery industry in various capacities. They have set up the company to be managed by a "partnership", which is to say, the common unitholders do not directly vote on the management. I suppose there are drawbacks and benefits to this but one of the real benefits is that if they happen to have a bad quarter, particularly if obscured by their hedging activities, they do not need to spend a lot of time explaining to a lot of pesky shareholders what happened and can run this thing for the long term. I think the instututional ownership of this place is 11%, much lower than the big players in this industry.



They have recently entered into an agreement with Lyondell, to do the marketing and distribution activities for some of its line of specialty products. This will allow them to use their already existing distribution network to expand their market of complimentary products without having to invest in capacity, which works for both Lyondell and Calumet.



They also are paying a dividend, which at the current moment, at a price of $17 per share might end up being around 10%, which is pretty substantial, and if you look at their two-year chart, they are trading within a dollar or two of what they were in 2008, although they were beaten down a little based on the last quarter results which reflected this curtailing of their production.







I couldn't resist posting this stock chart.... which reflects the 50% loss in stock value for Valero for this period of time.... but the potential drawback is that in the event the market and/or the economy returns to some normal state, the shareholders of CLMT are probably not going to see as much capital appreciation on the upside either.



So, if you are a bit conservative, and you still insist on being in this nasty, thankless refinery business, a small, stable, dividend paying alternative like CLMT  might be a better way if you are willing to give up volatility and/or some upside in exchange for a consistent return.



Keep in mind that the world is full of perils, and there are no guarantees, as we are finding out every day.



















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Disclosure: none

Tuesday, June 29, 2010

The WNR/Giant Epic Fail

Per my post on Seeking Alpha, here are some more details on this deal by WNR to borrow over $1B in long term debt to buy the Giant refinery in Yorktown VA in 2007: This was such a monumentally bad deal that business students will be studying it for generations....

At the time the deal was made, the 70,000 bpd heavy crude refiner sold at $1.12B, which is almost $19,000 per BOD capacity. I can understand the desire for the company to increase its heavy crude refining capability, but the $19000 per BOD is greater than a lot of the greenfield projects were going at the time of the deal...

As we mentioned earlier, just to service this debt, the company needs $1.45 per barrel refining margins for the foreseeable future just to pay the debt, and a total of $13-14 to approach being an investment. Current is about $11, Assuming they wanted to make a profit on the deal, their internal analysis must have been telling them that the refining margins were going to be much higher than that....We all know how that worked out. To be fair, a reasonable analyst might have known that this level was pretty close to the long-term industry average for refining margin.....so maybe they were a bit of a victim of the recession.

At the current price of $5.30 per share, WNR can literally be purchased for the value of what they have in the tank farm, and that is probably optimistic. Assuming for the moment that you did this, you would in effect be buying the refining capacity of 220,000 barrels per day for the price of the $1.1B in debt. This comes out to about $5100 per BOD capacity, laughable in light of the $19000 per BOD capacity that they paid for Giant.

To continue the laughability, the Giant facility was bought when WNR was at about 45 per share. Since then nearly 90% of the market capitalization of the company has vanished. Assuming that same ratio, the same deal today might have been only $100M or so and could have been financed out of cash. Recently Valero sold their Delaware City refinery for $220M, at 220,000 bpd capacity this amounts to $1000 per BOD capacity. Timing is everything.

To further the thought exercise, the current value of Valero's 2.8 million barrels of refining capacity is $10.1B in market capitalization, which equates to about $3600 per BOD capacity, which is still greatly lower than the $5100 that WNR would be worth if you incurred the $1.1B debt, so you can assume from that that WNR is at least 40% overvalued at the current price.

WNR only has about $25M of cash on hand. They are 100% at the mercy of the people that they are using to roll over their debt. This debt could be restructured from the 11.25% per year that it currently is down to something more reasonable...somebody is going to have to take a writeoff.

WNR could, at some level, maybe $3 per share, be a buy for someone with deep pockets that could afford to take on the debt, or someone with a lot of credit at the current lower interest rates. FTO might be a candidate, no debt, lots of cash, similar business but in a different part of the country, but why would they? They might be able to get the desirable refinery later on if the company is split up. Valero: Forget it. They have too much capacity as it is......

It's interesting, the company is owned 40% by insiders, the remainder by the mutual fund people. Most of this group is institutionally owned at about 80%. I am thinking if this had been the case for WNR someone would have been a bit more conservative in their analysis, and thought better of the deal, or waited for a better price.

Unless the refining margins get to the highest levels in history for a sustained period, giving people some money, this will not go on much longer

Monday, June 28, 2010

FinReg: Trying to Legislate Adulthood

To recap:



A lot of people wanted to have things, and didn't have the money. Houses, consumer goods, office buildings, government benefits. Instead of doing what an adult would do, which is wait, save some money, and buy the things they needed and wanted when they could afford them, they borrowed the money to get the things they wanted right away. To be fair, I suppose that there was a big system set up to encourage them to do this. Advertising, government policy of various types, some cultural pressure, political pressure, we can go into this if you want.



There were plenty of people around willing to loan them the money to do this. Mortgage brokers, credit card companies, commercial banks, government bond dealers, politicians. The adult thing to do would have been to say "no" to some of them, but once again, the system was set up for "yes", and a lot of these loans got written, and there were a lot of charges put onto credit cards.



So, what to do with all of these mortgages and credit card debt and soveriegn debt that were taken out by people that could not reasonably pay them back? Well, an adult thing to do would have been to take the high risk ones, bundle them together with other high risk ones, and charge enough interest to compensate the lenders for their risk. Instead, they were mixed in together with a lot of good loans, and then the ratings companies, and we all know who they are, gave them a nice high rating, and the interest rates were kept nice and low, and no one, well almost no one, could tell the good from the bad. Pretty immature, to hide all of those bad loans in with the good and not tell anybody about it but that's what happened.



These bundled loans of various types (CDO's, commercial paper, sovereign debt) were traded back and forth, and a whole system of insurance, derivatives, and other financial instruments were developed by the so-called financial engineers, and this whole system was basically done with play money, since the underlying financial instruments were only loosely connected with adult-based reality.



Then, when the system collapsed, the government(s) involved said to the people that perpetrated it: "Do-Over, you do not have to suffer the consequences of your childish actions, all is well, we will take care of this and you can go back to your play money game"  The governments fabricated a lot of money out of thin air, and the game started back up again. Where did the goverments involved get this money? Well, rather than doing the adult thing, and getting it from the people that benefited from the system by raising taxes or interest rates to re-adjust the system, they borrowed it from someone who would not know the difference, the nation's 3-year olds. Here is the big injustice, as I see it.



Now, a law has been passed, FinReg, so called financial regulations, which basically set out a few rules to re-introduce adulthood into each of the layers of the system: More regulations at the bottom levels, put some controls at the mid-levels. Was there any regulation put on at the top level, to keep the government from saying "do over" and bailing out the next catastrophe? There is no talk of this. There is also minimal talk of going back through the system and making people accountable for the collapse of the system as it previously existed.....



So will all of this work? Oh, maybe in a broad sense to at least put a bureaucratic drag on the system, maybe there is some benefit to that...but until a system is set up to encourage people to be adults, I think we have not seen the end of it.



I will go back to writing about oil. If I am wrong on any of this, please feel free to comment.







Disclosure: none

Wednesday, June 16, 2010

FTO: Maintenance People Need Love Too

Awhile back we developed a little model to predict the profitability of Valero, which worked quite well, based on the relationship between the company's net operating income (NOI) and a weighted average WTI/finished products crack spread. Maybe we can learn something by applying the same technique to Frontier:

Here is FTO's NOI and the same refining margin model that we developed earlier:



and when we adjust the model for industry refinery utilization and seasonality, we arrive at the following:



In fact, when you do the regression analysis, FTO's net operating income is even more strongly correlated to the refining margins than VLO's was. R-squared was 0.82, compared to Valero at around .66.

Based on the model, we would then expect them to benefit even more than VLO from the current improvement in refining margins, which as of a week or so ago were getting into the $11 per barrel range, and if you plug in the same assumptions we did earlier into FTO's NOI equation, you get earnings of about the same level as they saw in the the fourth quarter of 2006, or the first quarter of 2008, when they were earning somewhere in the mid-40's per share.

But, the consensus of the analysts right now are for earnings in the upper 20-s. What's happening?

If you look at the periods of time they deviated from the model, the second quarter of 2008 and also, really, the last two quarters, and review their management statements these are both periods during which they were experiencing some maintenance issues at their refinery in Cheyenne.

FTO is a lot smaller company. They do not have retail locations, a pipeline network, or any other noticeable diversification, and make their money, or not, on the basis of how good of a job they do of keeping their refineries running. Their Cheyenne refinery makes up 1/3 of the company's total capacity, and they are doing a lot of work to make this operation more efficient and deal in a better way with heavier crude oil.

So, in a real sense, the ability of FTO to get back to what they have been historically doing comes down to the ability of somebody to turn a wrench. Makes you want to give the maintenance people a little more respect doesn't it? Actually, it makes you want to invite the maintenance people to the next earnings conference call to find out how the work is going. It would not be completely unheard of for these guys to be overachievers and get their work done a little faster, and one of the analysts is actually optimistic that this can be done, and they will end up in the 40's somewhere for earnings this quarter.

The last question is: What would be the better investment, FTO or VLO? Well, at a price of 18 and expected earnings this year of about $1 per share, VLO is the less risky of the two. With a current price of 14 and earnings prediction in the mid $0.20-s, FTO is a bit more expensive right now. The possibility of a pleasant surprise for FTO is already in the price.



Keep in mind, of course, that the market does not always care how much money a company is making, and NOI does not always transfer down to EPS because of write offs, and various other things that are going on in a company, including where the refinery is, and what your prediction is going to be for refinery margins and crude oil pricing.

But, in this case, what we really need is the phone number of FTO's Cheyenne maintenance shop. If it rings and someone picks up, it means they have spare time to answer the phone, and things are nice and peaceful, which, if you are a maintenance guy, means you are good at doing your job. If it rolls to voice mail, it means they're busy. That can't be good, in this case.

Monday, June 7, 2010

Marginal Complexity in the Refining Industry



Am I the only guy still around that remembers that plate spinning act that used to be on TV?


Here it is:
http://www.youtube.com/watch?v=Zhoos1oY404

We used to watch this stuff in the 60's for entertainment....

Anyway, the essence of the act is that this guy has the capacity to spin X number of these plates and bowls on the sticks.... You have to keep the ones you have going, then gradually add complexity until you get the whole thing up and running. For you and I, spinning one plate would be difficult, but this guy is an expert, and he can do a lot of them.....By "marginal complexity", we mean that the problem gets increasingly difficult with the addition of the one plate...

So, would it be much of an act if he only spun four bowls instead of five? The system would be running at a state slightly below its maximum capacity. Well, the guy has to be talented, it is true, to do the four bowls, but you would not be quite as impressed, and perhaps for him, the act would be a bit more boring.

The situation in the refinery business right now is a lot like this. There are only four bowls spinning. It takes quite a bit of effort to keep the system spinning at its current level, but there is no need to add the extra complexity, which you can only do temporarily anyway, and so the guy is just going to stand there for awhile and keep the fourth bowl spinning without adding the fifth.....he could add another, but the system does not require it right now...

So I think we're going to go another week as follows: The capacity utilization will be 89 percent or so, the demand will be not quite what it was in 2007 but higher than 2009, and the imports will be about what is needed to keep inventories about where they are. Right now, there is plenty of fuel around, the contango is still in effect, but the market is well supplied and there is no compelling reason to store oil if the buyers think there will be a demand decline later because of a double dip or something.... I think a lot of the emotion in the marketplace to keep oil around went away a month ago when the price collapsed.....

So we will see what happens. Keep in mind that if he does not go back and do maintenance on his bowls, he will lose one.... so he will do that for awhile at least, even if he does not add the fifth bowl....and by fall, maybe he will go back down to 3 bowls and a couple of plates, and have some spare time, to fool with the spoons and glasses....

Thursday, May 27, 2010

Valero, Refining Margins, and Making Money

It's not too hard to develop a little model of a refiner's gross variable margin: You can approximate the cost of the feedstock with WTI and if you know roughly their product mix, you can estimate the average sale price of the output, which gives a weighted-average crack spread on the finished products.



Of course, the actual gross variable margin varies a lot by company, depending on the product mix, and even by individual production unit. But, without complicating the problem too much, the model for the past few years has looked like this:







As you can see, within the last few weeks, it has recovered from the beat down experienced in late 2009 and has been looking a little better. Within the last few days, it's fallen to a bit under $11 per barrel. Note that It's not exactly the RBOB or HO crack spread, because it's a weighted average of the product mix, but it is a pretty good approximation of whether people are making any money in this business, particularly if you know the conversion cost per barrel.



Valero is an interesting company to look at sometimes, it's the largest independent refiner, they do very little upstream, and their claim to fame is the refineries they run along with the retail operations in the western 2/3 of the country. The company was put together a few years ago to buy low-entry-cost but relatively inefficient refining assets, a move which looked brilliant in 2006 when capacity was short, but for the last couple of years has been really not very good at all. They are a high-cost producer, they have lost money 5 out of the last 6 quarters, and they have recently taken steps to get out of the rut they are in by diversifying into some ethanol and alternative fuels, plus sell their worst performing refinery in Delaware.







Our refinery margin calculation corresponds pretty closely to Valero's Net Operating Income (per their quarterly reports). In fact, you can see that it's the main driver of their profitability, This is not rocket science, no one is making money in retail so that is not much of a diversification.... You can see that in 2005-2006 they overachieved a little bit, in that period, capacity utilization was  higher than it is right now and they had a bit more pricing leeway. Valero's production cost, per their financials, is usually between $6.50 and $7 per barrel. Some of the more efficient majors can get their product converted for $5-6, which means that they can stay profitable while VLO bleeds money.







An even better approximation can be made by adjusting the model for the industry refinery utilization, which is a measurement of price strength (low utilization means terrible pricing) and by subtracting out the seasonality.  R-squared for this little model is about .66, pretty good. It is not at all unheard of for profitability to be off a bit in timing, like it was in 2008, and also not at all unheard of for people to dump costs into the books if they know they are going to have a bad quarter, so maybe that is what happened in late 2008 when the market collapsed.



The very fact that the profitability of this outfit is so predictable is just an indication that their business is so commoditized, and to the credit of the management they are trying to make some changes in their business to lower their conversion costs and get into some other line of business to get them out of the equation. In the meantime, we can use this information to try to predict what they're going to do in the upcoming few months. Of course it depends on what you expect the WTI and products prices to be between now and the end of the quarter, but based on a reasonable set of assumptions (an $11 dollar weighted average refinery margin and 87 percent utilization) the model suggests their NOI for the June quarter is going to be in the neighborhood of $900M, which is the kind of quarter they had in early 2008, when they made in the low 40's per share. The analyst consensus for VLO for the upcoming quarter: the low 40's per share. They have some prospects to do a little better. The refinery margin model has averaged $12.71 up until May 14th.... We'll check back at the end of June to see how they're doing. Also, we should be able to unearth this model in a couple of years and see how good of a job they did in diversifying...because their profitability will correlate less well with the model.



Of course,  all of this might or might not transfer directly to the stock price because these guys are bound to take a charge for discontinued operations, and the market itself is subject to chaos,  Still it is nice to know a little ahead of time whether they are going to make a little money, and as time goes on, I am sure the management hopes that the changes can get them more consistently profitable through all parts of the business cycle which, despite rumor to the contrary, obviously still exists.



































Disclosure: none

Thursday, May 20, 2010

Historic Dance: WTI and the DJIA


You probably noticed the unusually strong correlation between the changes in the WTI price and the DJIA average that has been occurring lately. The stat people can put a number on this, it's the correlation coefficient R-squared. A value of 1 is perfect, a value of 0 is no correlation. You can pretty easily get the number for any 10-day period as far back as you want to go. "Perfect" may be either in lock step, where one goes up followed by the other, or "perfectly divergent" in which an increase in one occurs with a decrease in the other.

Between 2000 and now, the correlation between the daily price change in WTI and the Dow has averaged 0.14, pretty weak. The prices of one typically do not move in conjunction with the prices of the other very much. The R-squared value for the above 10-day period was .82, quite strong, as we have noticed.

If you go back over the last couple of years, back to early 2008, there were seven time periods during which there was a strong correlation between the WTI price change and the Dow price change, and the baseline value is much higher than the historical average.





Of these "major instances", 6 of the 7 were similar to the case above, The lone exception was the period in May of 2008 during which the WTI price and the DJIA price were strongly divergent;


In fact, historically, this was the more common occurrence. Take this example, which occurred during the Iraq invasion of Kuwait and run up to Operation Desert Storm:






There were four instances between August of 1990 and September of 91 during which the two markets danced either together, or divergently.

But, the point is this: As far back as the WTI records go, to 1983, the incidences of the WTI and Dow being closely correlated (defined by an R-squared of greater than .7) are exceptionally rare. Even during the DJIA meltdown in 1987, WTI scarcely moved. Since 1983 there have only been 16 events of this nature, and 7 of them have occurred in the last 2 years, since the financial problems started to show up in the global economy.

So for the time being, the caution for parties interested in either index is: we are witnessing an unprecedented dance between the WTI price and other measurements of market value. No doubt both are being influenced by the same market emotion or other underlying factor, i.e. the strength of the dollar and general stability in the financial system. The strong correlation is undoubtedly a sign of continued stress in the financial system and other markets.

Tuesday, May 11, 2010

Nominal Capacity vs. Stated Capacity

The stated system capacity, by which the refinery utilization is computed, is about 17.4 mbpd.

If you take the stated refinery utilization, which last week was 89 percent, and compute the theoretical inputs (purple line) there is about a 2 percent gap, which means the system is not actually taking in as much crude oil as the nominal calculation says that it should.

This gap has increased in the last few weeks as the system comes out of its slumbering mode.....it represents some refinery inefficiency, and more likely, represents the fact that the system is not capable of taking as many barrels per day as the reports state.

Monday, May 3, 2010

Fun Week for the Inventory Report




First of all, we have the oil disaster unfolding before us out in the GOM. and we will finally start getting some kind of number associated with the lost production as well as the effects of the nearby pipeline that they had to shut down when this thing started to burn. We did not see it in last week's numbers but I think the domestic production will be down around 5.3 which is .1 mbpd less than it was.

No one is talking about it but the burning platform is only about 100 miles from the LOOP, and as that slick gets bigger and bigger, there will have to be some effects on the movements of tankers in this area.....Luckily the LOOP is farther west, and the current is pushing the slick east (toward Florida's pristine beaches) It is anyone's guess how big and deep this mess would have to be before they talk about shutting down the LOOP but if they do, we are talking about 3 mbpd not coming into the country via that path. I think about 1.4 mbpd typically comes in around Houston and the remaining roughly 1 mbpd elsewhere, just as a reference.

Secondly we have the issue of refinery utilization. We talked last week about the refiners now being up to 89 percent, which is as high as I thought they were going to be at the peak this year, but per the graph above, this is actually comparable to the pre-recession average, so that system is up and running at least for the moment. As a result we are going to have to see something approaching 15.3 crude oil inputs to refineries....

Thirdly, the driver behind the refiners gearing up is obviously this unleaded demand situation, which was up over 3% year on year, and not quite up to pre-recession levels but getting pretty close, I think. The archive of doom says that the 2008 products supplied for this week was 9.3 and we are talking about 9.2 as of last week....

So, assuming last week was not a blip we are looking at the potential for the crude oil inventory change being right about even and if the imports are not 10 mbpd we are talking about a drawdown, and that would really throw a bit of excitement into this marketplace which has seen 12 straight builds in inventory.

There is an underlying sub-plot on distillates: Unleaded demand has picked back up to the pre-recession levels, but diesel has not. You are going to see bigger and bigger builds in the distillate inventory because of this.


So, we will have to continue to watch the news and wait to see what happens but there may be some surprises on the report this week....

I see that the front contract is back up over 86. maybe you will see 90 in a few days.....More fun later..

Friday, April 30, 2010

The Real Cost of the Louisiana Oil Slick


The real cost will be in terms of "second thoughts"....

Say you are planning a project. It's risky enough, leasing one of these giant platforms, it costs you hundreds of thousands per day. You drill a hole in deep water, as much as 10,000 feet, and then downward into the geology from that. Costs money. You might or might not get as much product out of it as you originally planned.

The calculation you do is pretty simple: Cost of drilling versus expected payback, given the price you think you can get some years in the future for the crude oil, and the amount of crude oil is only an estimate.

Now, add to this calculation the possibility that you are found responsible for the biggest oil slick since the Exxon Valdez. Cleanup, fines, lawsuits.... It took Exxon a decade or more of legal fees to fight the fines they had for defiling Prince William Sound.

The boss might be a geologist, but the bean counters that are advising him are saying: "this business is stupidly risky. Let's just drill the least risky projects we have and leave this to Exxon"....

A further point: At this point, are you going to drill offshore South Beach in Florida? What about off the Florida Gulf Coast where all of the millionaire mansions are? Cape Cod? This did more to kill off "drill baby drill" than a years' worth of protests. The images in the next few weeks will start to come in: Oily water birds, dead alligators along all of that swampland, all of those docked shrimp boats..... it is going to be worse than Katrina for some of these communities.

Do you know what will turn a Republican into a Democrat? A big oil slick washing up in front of his beach house.

So the real cost will be: Second thoughts. People will rethink the projects they have and discount them based on the risk. People will see the extent of the catastrophe and rethink the wisdom of some of these other drilling projects.

What won't get rethought, for awhile yet, is the idea that we are dependent on this toxic mess for the lifeblood of our economy and our society. That's the real root cause. Maybe that is around the corner... if the Peak Oilers are right.

Monday, April 26, 2010

Spring Refinery Utilization and Import Model











I am in a graphing mood this morning. Note the above graph of unleaded products supplied, a.k.a "unleaded demand" for the last few years. The pattern was pretty consistent from 2005-2008 but in 2009 something really interesting happened: Everyone went out of town for Easter (April 15) and Memorial day, but aside from that, they parked the Family Truckster and stayed home.

You can see a really similar blip happening this year, since Easter was April 5th, it's offset by a couple of weeks, but we can sort of envision demand being more like last year than the previous two years. I am thinking unleaded products supplied will be about 9 this week, and eventually, in some trajectory, end up somewhere between 9.2 and 9.3 by the 4th of July. Maybe there will be a blip for Memorial Day like there was last year, with less traffic the weeks before and after....In another week or two we will have a lot better idea.

So to meet this demand, the refiners are going to scale up, because that is what they do, and people do what they do. They could probably satisfy any additional demand without running the refineries by increasing the imports around May 1, and that is indeed a possibility, but it seems pretty likely, based on our little observation, that the refinery utilization will be pretty close to what it was last year. The scale-up period this year happened a bit different than in 2008-2009, but I do not think they will be crazy enough to run at the same rate as the pre-Recession level.

So, if we make the educated guess that they are going to scale up from where they are now, which is 85.9% utilization to around 89, being a little generous because of the slightly higher demand this year, and this will happen in some sort of nearly linear trajectory, there will have to be some level of crude oil imports to support the increase. At the level of 9.3 mbpd, you can see that the overall crude oil inventory will decrease, at 9.8 a bit of a decrease, and at 10.3 a pretty substantial increase, assuming 5.4 mbpd domestic production, and inputs to refineries in about the same ratio as it is right now.

So, based on what we see here, what do you think imports will be over the next few weeks? Well, I think our friend the refinery manager went into the cubicle of his crude oil buyer sometime in the last month, and said the following: "I want you to order enough crude oil every month to keep our tank full. The reason for this is that the contango situation is telling us that crude oil will be more expensive in 2011 than it is in 2010. The way to minimize your cost over the next year is keep crude oil in storage. Here is our scale-up schedule. Make it happen. If the tank is not full, I want you to order a little extra every month and we will worry about finding a place for it later.".....

So, the third graph is three inventory scenarios, using different levels of crude oil imports, given the above assumptions about demand, refinery utilization, and inventory strategy....I did do the "goal seek" on this to determine that an import rate of 9.96 mbpd will be needed to keep the inventory of crude oil stable between now and the beginning of July, and I think that is exactly what is going to happen,

So, based on this, you turn the crank and get the forecast that we have posted in

http://usoilinventories.com/forecasts/default.html

The unleaded and distilate products supplied are running just about what our original model said, maybe a bit of fudging for Easter, but pretty close. The refiners are going to increase by about 0.3% per week, to get to 89% by July. Domestic production will be down a bit because of the platform disaster still unfolding out in the Gulf. Imports will have to increase to 10.0 at some point to keep the inventory stable, and I am guessing that this will happen sooner rather than later. We will continue to tilt the finished product ratio toward unleaded and away from distillates, because there are too many distillates around, with demand the way it is..... and summer around the corner.

So, I am seeing builds in all three of the categories this week. The post-Easter demand blip will hit unleaded and we will see a little build in that, and the rest is self-explanatory.

We science guys think like this. We can be like the meteorologists and come up with a theory about what is going to happen, and test it out by observation over the next couple of months. It will be interesting to see what happens.

Monday, April 19, 2010





Here is the validation of the demand model that we produced in early March. The unleaded demand is consistently running slightly over the model, and the distillate demand, with the exception of the week-to-week variability that we noticed in this data because of the variability in weather that causes some fluctuation in the five year averages, is pretty close to on-track.

Since these two models were developed based strictly on the seasonality, I think we can deduce from this that the demand for unleaded is actually about 91 tbpd greater than the seasonality suggests, so maybe the economy is a little stronger than we suspect. I have also adjusted my distillate model to smooth out some of the variability and assume that the demand will decrease roughly linearly between now and June....

So I agree with Geithner, that the economy is improving a little bit, but the depression conditions in the trucking industry are still continuing..... as evidenced by weak distillates demand.

Friday, April 9, 2010

Oil Price Back Over 87

So many questions:

If you are China and see Bernanke and Geithner pouring a trillion dollars into the economy based on nothing but the faith in the US government, do you not want to get out of dollars and into something that has some value?
http://news.yahoo.com/s/ap/20100409/ap_on_bi_ge/oil_prices#mwpphu-container

Oil prices rose above $86 a barrel Friday on a weaker dollar and after robust U.S. retail sales in March pointed to growing consumer demand in the world's biggest energy market.

By early afternoon in Europe, benchmark crude for May delivery was up 84 cents to $86.23 a barrel in electronic trading on the New York Mercantile Exchange. The contract fell 49 cents to settle at $85.39 on Thursday.



If you are OPEC, and you know that it is likely that your kids will be riding camels in a few years because you cannot pump any more oil, would you not want to control the rate of your pumping so that you can have some kind of a future?

If you are the US oil industry, that literally collapsed 18 months ago, putting a screeching halt to exploration activities and refiner modernization, do you not need the higher prices so that you can reinvest in your capital intense, risky business?

Why are the same people that whine about government intervention into the medical system also the ones complaining about the price of oil, which is as close to an open market as we now have? Given the system we now have, it's a market, not an entitlement. If you want it more than the Chinese millionaires, you're going to have to pay for it, as long as we have something that approaches a capitalistic system.

Thursday, April 8, 2010

Tesoro Refinery Fire

HOUSTON (Reuters) – A deadly Friday fire at Tesoro Corp's Anacortes, Washington, refinery was due to a catastrophic failure of a heat exchanger, sources familiar with the investigation said on Monday.

The heat exchanger that failed was in operation and was not the exchanger seven workers were working on when they were caught in the near instantaneous eruption of the blaze, the sources said.

A Tesoro spokesman said it was too early to determine causes of the fire.


http://news.yahoo.com/s/nm/20100405/us_nm/us_refinery_fire_tesoro_anacortes_1

For those who have never been around them, these refineries are controlled explosions anyway. They need to be shut down periodically and rebuilt to keep them from blowing up.

The current depression conditions in the refining industry, driven by low margins and the collapse of the jet fuel and diesel markets are forcing some of these companies to defer this stuff up until the absolute last minute. I do not happen to believe that these people would deliberately endanger the lives of themselves and their employees, but if the survival of the company is at stake, which in the case of Valero and Tesoro might be true, there is a terrible decision to have to make. Is it immoral? Of course it is. It's taking a known risk that one of these explosions will happen. Is it done anyway? Of course it is.

If you do not want these situations to happen, then re-regulate this industry. Require the companies to adhere to maintenance standards, and enforce a fixed refining margin to assure them of a reasonable rate of return so there is a safe, stable refinery system with much reduced risk of failure and so that the nation has a secure energy supply. Yes, that means you will have to pay more for gasoline, and the government will be inspecting every nook and cranny of these places. Is that what you want? It's socialism, of course, and I am sure that 90% of the readers of this would have no stomach for it.

So the situation is going to continue

Wednesday, March 31, 2010

Refinery Inputs and Outputs



While we are waiting for the report to come out this morning, here is a graph for you. If you add the sum of the finished products together, that is, unleaded, jet fuel, distillates, residual fuel oil, and propane, and then compare it to the inputs, here is what you get....

As you can see, there was a crossover event, in 2004, and since that time, there have actually been more refinery outputs than there have been inputs. Normally this would violate the law of conservation of matter except that we know that since that time, and especially since all of the pricing stuff in 2007, there have been non-crude-oil additions to the system, including ethanol and also probably more importantly GTL and other non-crude oil inputs that have increased the overall capacity of the system to produce finished products...

There are a couple of ramifications to this, including the most obvious one, which is that we don't need all of that refinery capacity anymore to produce the equivalent amount of finished products, and the situation is probably even worse than the weekly refinery utilization suggests, since the processes for the incremental 10% or so of products are quite different.

Anyway, our friend the plant manager of the refinery is probably thinking about this a lot this morning as he sits with his feet on the desk waiting for the morning staff meeting....

Thursday, March 18, 2010

Welcome

I hope to use this page for commentary about the current US oil inventory situation. Please feel free to add your comments below.