Western Refining, Inc. (WNR)

[scstocks]

Location, Location, Location: The Rules Of Oil Refining And Who's Benefiting

http://seekingalpha.com/article/309923-location-location-location-the-rules-of-oil-refining-and-who-s-benefiting

7 comments | by: James Shell November 23, 2011 | includes: COP, CVX, HFC, MPC, TLLP, TSO, VLO, WNR

At the request of one of my followers, I've done a little work to try to put some numbers on the supply and logistic situations that have been going on in Oil Refining for the past few months. This is useful to try to understand why differences in feedstock costs and access to certain markets allows some of these independent refiners to prosper in niche situations.

Here is a table of spot prices for various crude oil grades:

$/Barrel
West Texas Intermediate 97
Light Louisiana Sweet 109
Gulf Coast Sour 105
Brent 108
Alaska North Slope 112
Syncrude 102
Arabian Extra Light 107

This link to Chevron (CVX) is also quite useful in understanding the price differentials for various crude oil prices which are driven by their suitability for refining.

Next, here are some of the wholesale gasoline prices around the country. I have derived most of this data from Gasbuddy.com.

Retail Price Local Tax Fed Tax Distribution Est. Whol Price $/bbl
Los Angeles 3.75 0.405 0.184 0.05 3.11 131
Denver 3.35 0.205 0.184 0.05 2.91 122
Chicago 3.50 0.506 0.184 0.05 2.76 116
Phoenix 3.35 0.200 0.184 0.05 2.92 122
Houston 3.00 0.200 0.184 0.05 2.57 108
Seattle 3.70 0.375 0.184 0.05 3.09 130
Atlanta 3.20 0.292 0.184 0.05 2.67 112
New York 3.70 0.319 0.184 0.05 3.15 132

The wholesale unleaded gas crack spread is just the selling price of gasoline, dollars per barrel, minus the crude oil price. That is the spread between feedstock costs and wholesale selling price for the product. Note that this does not include conversion cost, the cost to turn the oil into gasoline, nor does it include any transportation costs or other expenses associated with the activity.

Based on this, we can derive a little table of feedstock cost versus crack spread:

Estimated Fuel Price/$/bbl (wholesale)
Los Angeles Denver Chicago Phoenix Houston Seattle Atlanta New York
Crude Oil/Price 130.66 122.3 115.9 122.5 108 130 112 132
West Texas Intermediate 97 33 25 18 25 10 32 15 35
Light Louisiana Sweet 109 21 13 6 13 -2 20 3 23
Gulf Coast Sour 105 26 17 11 17 3 25 7 27
Brent 108 23 14 8 15 0 22 4 24
Alaska North Slope 112 19 10 4 10 -4 18 0 20
Syncrude 102 28 20 13 20 5 27 10 30
Arabian Extra Light 107 24 15 9 15 1 23 5 25

Example: A refiner in Los Angeles, selling to the local market can have a crack spread of $19 per barrel (minus transportation costs) using North Slope oil, but can improve to $33 per barrel if he can magically get West Texas Intermediate to appear at the back door without additional cost.

Interestingly, Houston appears to be the least profitable place in the country to make gasoline, which is probably correct if one considers that there are so many refineries in the area, and all of the major integrated oil companies, that do not necessarily pay the spot price for feedstock are participants in the market, and so the preferred strategy in that case would be to pay the transportation cost and put the product into the pipeline system and sell it in places like New York, rather than locally or alternately, use lower cost heavier feedstock than those listed here.

We can look at a sampling of specific cases, as laid out for us in the recent quarterly reports:

Company Refinery Market Crude Oil Source Conv Cost Gross Marg/bbl Comments
Holly Frontier (HFC) Cheyenne Denver Canada/Bakken 6.25 $ 26.5 49% Sweet
Holly Frontier El Dorado Denver/KC Texas/Canada 4.23 $ 22.1 75% Sweet
Western Refining (WNR) El Paso Phoenix West Texas 5.41 $ 20.0 82% Sweet
Tesoro Los Angeles Los Angeles California/Foreign 6.51 $ 14.9 20% Light
Tesoro (TSO) Anacortes West Coast Alaska 3.32 $ 15.0 80% Light
Marathon (MPC) Robinson IL Chicago Various NA $ 13.2 Varies

The favorite example of a logistical advantage is Western Refining (WNR), which has refineries in El Paso, and near Gallup, N.M., and is using "landlocked" local feedstocks from West Texas, and selling the finished products into the Phoenix area.

The gross crack spread using WTI and the Phoenix marketing area is around $25, and if the processing costs are subtracted, which for them is about $5.41, minus a little more for transportation, that company's reported gross margin of $20 is in the ballpark. Keep in mind also that these gross margins also include the 40% or so of the output of the refinery that is diesel, heating oil or other distillates, and for a thorough analysis one should include that in the calculation.

Also, per the above chart, the heavier and more sour the feedstock is, the more expensive it is to process.

Transportation is a significant problem, and most of these companies are engaging in some kind of pipeline or logistics business, and a little industry has developed to take advantage of the WTI pricing differential situation. One interesting one of these is Tesoro Logistics, which is involved in a system to deliver crude oil from the Bakken in North Dakota, to Anacortes, WA. This presentation (pdf) from Marathon Petroleum (MPC) talks a little about transportation economics: To transport Syncrude from Alberta, to the middle of the US, costs somewhere on the order of $5 to $7 per barrel depending on the route, so they are working on the logistics and converting the refinery to Detroit, to more economically process this feedstock.

While converting crude oil into gasoline is an important skill, what we as investors are really interested in is how good these companies are in turning crude oil into money. One of the factors on this is the method of financing:

Interest Exp MRQ Throughput BPD Interest Exp $/Barrel
Delek US (DK) $ 16,400,000 59,812 3.05
Western Refining (WNR) $ 33,195,000 149,556 2.47
Holly/Frontier (HFC) $ 25,074,000 435,110 0.64
Tesoro (TSO) $ 38,000,000 609,000 0.69
Marathon Petroleum (MPC) $ 15,000,000 1,368,000 0.12
Valero (VLO) $ 88,000,000 2,317,000 0.42

This table is the interest expense reported on last quarter's 10K for each of the companies, per unit of throughput. I have also thrown in a couple of the other companies in this group for comparison. The Western Refining and Delek US high rates of financing have significant effects on the bottom line that are not included in the above favorable gross margins.

The Delek US case is interesting. It is operating a refinery in El Dorado OK, which uses "sour" Oklahoma feedstock, which can be an additional $5-$10 less expensive than WTI, and selling the finished products into West Texas, where the prices are more like they are in Phoenix, per the above chart. The conversion cost is a little more than $5, and the El Dorado refiinery has a gross margin of $14.33, which is pretty comparable to the bigger participants in this group. The gross margin of the refinery in Tyler, Texas, is in the mid $20s per barrel range.

One final chart: Here is the ability of each of these companies to make money, based on Earnings Available to Shareholders per unit of throughput:

Company Throughput BPD Earnings MRQ Earnings per Barrel
Western Refining (WNR) 149,556 84,928,000 6.31
Holly Frontier (HFC) 435,110 523,088,000 13.36
Tesoro (TSO) 609,000 352,000,000 6.42
Marathon (MPC) 1,368,000 1,133,000,000 9.20
Valero (VLO) 2,317,000 1,203,000,000 5.77
Delek US (DK) 142,129 92,500,000 7.23

I have omitted two companies, Sunoco (SUN), which took a big writeoff for discontinued operations in the last quarter, like all of these companies do from time to time, and my favorite Calumet Specialty Products Partners (CLMT), which had an unrealized hedging loss on its last quarterly report that affected its bottom line, as that company frequently does.

So what are we to make of all of this?

First of all, it is quite true that location is an important factor in this industry, and right now, being favorably located to take advantage of lower feedstock prices has been helpful to a couple of these companies.

However, it is not the total picture. The conversion costs, which are driven by feedstock quality and the financing costs, can also affect how much money goes to the bottom line. HollyFrontier Corp. did a particularly good job of this in the last quarter. Marathon Petroleum, despite not having any particular advantage on logistics but running an efficient, flexible operation with little debt is second most on this list.

The world is chaotic, and there are no guarantees on anything. This is particularly true as it applies to the WTI price relative to the rest of the feedstocks. We will check back in a quarter and see who the winners were.

Disclosure: I am long CLMT.