It’s So Fine To Be a Refiner

Who you should really hate when you fill your tank.

Nothing could be finer 
        Click image to expand.
Nothing could be finer

When gasoline prices spike, the public and politicians tend to vent their anger at the two most obvious sources: 1) local gas stations, where people have to pay $60 to fill up their SUVs, and 2) the companies and countries sitting on giant pools of crude oil, like ExxonMobil and Saudi Arabia.

But those who are making the biggest profits in the oil business post-Katrina aren’t facing public wrath at all. In fact, they’ve been receiving sympathy and various forms of government aid, even though they’re doing better than anyone. For the refiners, long the overlooked middle child of the oil business, good times just got better.

Huge integrated oil companies such as ExxonMobil have refining operations. But the independent refiners like Valero and Tesoro are relatively anonymous. Since they occupy a spot in the middle of the supply chain, they don’t have well-known consumer brands, and they don’t make news by hitting big strikes of crude. Instead, they’re involved in a tough, low-margin, and capital-intensive processing enterprise—turning crude oil into gasoline or heating oil. And it can be a difficult business. It takes a lot of money to build and operate a refinery, and communities don’t exactly welcome them with open arms. According to this fact sheet from the National Petrochemicals and Refiners Association, no new refineries have been built in the United States since the 1970s.

But that doesn’t make it a bad business—especially in the past year. While giant industries like autos and airlines struggle with excess capacity and ruinous competition, refiners have been running full out. As this chart from the Department of Energy shows, refineries in May were running at 94 percent of capacity—which is good for profits. And since there are no new refineries being built, they face no domestic price-lowering competitors.

This summer, refiners’ profit margins began to expand. For much of the past year, the so-called “cracking spread”—the difference between what refiners pay per barrel of crude and what they charge per barrel of refined product—stood at around $10, higher than the recent historical average. As a result, refining stocks suddenly became hot. The Financial Times “Lex” column noted that the stock of Valero, the largest independent refiner, was up 226 percent in the past year, outpacing Google’s 186 percent rise. (Here’s a one-year chart of the two stocks.)

When Katrina plowed ashore, it looked like bad news for the refining industry. A bunch of Gulf Coast refineries—representing about 10 percent of the nation’s refining capacity—were knocked out of service and damaged. But this bad news for a few has outweighed by good news for the many.

The hurricane curtailed oil production along with refining capacity, but demand for gas didn’t contract. The result: The price of gasoline at the pump shot up rapidly, driven by distribution problems, panic buying, and perhaps some price gouging. The Department of Energy reported that as of Sept. 5, the average weekly retail gasoline price increased to $3.07—up 45.9 cents, or 18 percent, from the previous week. But in the same week, the price of crude actually fell. The spot-market price of a barrel of West Texas crude actually fell from $67.20 on Aug. 29 to $64.37 per barrel on Sept. 6, according to the Department of Energy.

In a matter of days, then, the spread between the cost of crude and the finished product expanded rapidly. And as a result, refiners’ margins have grown dramatically. In his column (subscription required) last week, Barron’s editor Alan Abelson posted a chart that showed the cracking spread spiking from about $10 per barrel in late August to above $40 per barrel in Katrina’s wake.

Which explains why the mood among refining executives at the Lehman Brothers Energy conference this week was one of quiet giddiness. “We expect we will have a long period of very good refining margins,” said William Klesse, chief operating officer of Valero, the nation’s largest refiner. (His remarks can be heard on a webcast here.) Citigroup analyst Doug Leggate on Tuesday urged clients to buy refiners Sunoco, Tesoro, and Valero, raising his price targets by about 50 percent on all three.

Meanwhile, the refining capacity knocked out last week is coming back on line. The Energy Department said yesterday that three downed refineries will be operating by the end of this week.

Even better, the refiners have benefited from the government’s belated response to the disaster. With gulf oil production hampered, President Bush ordered the release of crude oil from the Strategic Petroleum Reserve. That helped knock down the market price of crude (a plus for refiners) and ensured they’d have a supply of product to run through their machinery (another plus). At the same time, there’s been no sign of any sort of dramatic government action—a call for widespread conservation, a recommendation for greater fuel efficiency—that would bring down the retail price of gasoline.

Refiners are even getting a break on regulations and governmental oversight. The Financial Times reported today (subscription required), “The White House has told US refiners to postpone all scheduled maintenance in a drive to maximise petrol and diesel production.”

The refiners are enjoying the good times, but they know they have to stay out of the limelight. The worst thing that could happen to them is the public realizing just how much money they are making off the hurricane.