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Refiners Awash in Shale Oil Offer 10 Times Exxon Returns

Refiners Awash in Shale Oil Offer 10 Times Exxon Returns
Valero and Marathon Petroleum Corp. are among refiners whose discount to stocks in an S&P 500 index of 45 energy companies have narrowed this year, showing that investors have growing confidence that their earnings will rise. Photographer: Eddie Seal/Bloomberg

Gasoline refiners, shunned by investors because of falling demand and rising regulation, now count Warren Buffett’s Berkshire Hathaway Inc. and billionaire Carl Icahn among shareholders as lower oil prices promise wider returns for fuel makers.

U.S. refiners such as Valero Energy Corp. have delivered 10 times the returns of Exxon Mobil Corp., gaining an average 43 percent to Exxon’s 4.2 percent and outperforming every other energy sector in the Standard & Poor’s 500 Index. Gushing shale wells from North Dakota to the U.S.-Mexico border have lowered costs and more than doubled profit margins on gasoline and diesel production.

Buffett’s firm and Icahn are among bullish investors buying into refining stocks as analysts forecast a new era of profits akin to the industry’s so-called “golden age” in the mid 2000’s, when rising global demand and tight capacity lifted earnings.

“The prospects for U.S. refiners have turned around dramatically,” said John Auers, senior vice president of Turner Mason & Co., a Dallas-based energy consulting company. “Cheap crude has given an advantage to the U.S. refining system, already the most advanced, most complex and most efficient in the world.”

Valero and Marathon Petroleum Corp. are among refiners whose discount to stocks in an S&P 500 index of 45 energy companies have narrowed this year, showing that investors have growing confidence that their earnings will rise. Since January, the gap has shrunk by more than 30 percent for both companies on a price to earnings basis, according to data compiled by Bloomberg.

Surpassing Estimates

Phillips 66, Tesoro Corp. and other independent refiners surpassed Wall Street expectations for second-quarter earnings, while big integrated oil companies such as Exxon Mobil Corp. and Chevron Corp. relied on their refineries to help counter the sting of declining crude and natural-gas profits.

It was a different picture just last year. Exxon, Chevron and Hess Corp. shed refining capacity by selling or closing plants in response to reduced fuel demand in the U.S. and western Europe. Marathon Oil Corp. spun off its refining unit to focus on production.

Refiners in Europe and the U.S. East Coast threatened to close or shut down more than 2 million barrels a day of capacity as rising oil prices overwhelmed profit margins and debt costs soared amid the financial crisis. Petroplus Holdings AG, a European refiner, filed for insolvency in January and shut or sold off its plants. Hovensa LLC, a partnership of Hess Corp. and Petroleos de Venezuela SA, shut its St. Croix refinery in the U.S. Virgin Islands in February. Valero idled its Aruba plant, which powers its operations with crude, in March.

Improving Value

The current rebound is driven by lower costs from abundant oil and gas supplies, increased exports and more willingness by refining companies to improve value through share buybacks and dividends, according to energy analysts including Deutsche Bank AG’s Paul Sankey and Barclays Plc’s Paul Cheng.

Icahn, an activist investor, in January bought a stake in CVR Energy Inc., a refiner formerly owned by Goldman Sachs Group Inc., and agitated for executives to put the company up for sale. He offered investors $30 a share and obtained an 82 percent stake in the company. After no buyer materialized, on Aug. 6 he offered to buy the remaining CVR shares for $29 apiece.

Buffett’s Bet

Buffett, Berkshire’s chairman and chief executive officer, said last month in an interview on Bloomberg Television that one of his deputies had invested in Phillips 66, which became the largest independent refiner in the U.S. after the Houston-based company was spun off from ConocoPhillips.

Icahn didn’t respond to a request for comment. Buffett didn’t respond to a request for comment sent to his assistant, Carrie Sova.

New drilling and production techniques used to crack shale rock brought a flood of new gas, deflating prices to a 10-year intraday low of $1.902 per million British thermal unit in April. The same methods now are being used to harvest oil, spurring three straight years of surging output in the U.S., the first time that’s happened since 1985, according to data compiled by Bloomberg.

The renaissance has caused U.S. crude prices to fall below other varieties of oil traded globally, giving refiners with operations near new U.S. oil production the advantage of paying less for each barrel they purchase. Refiners with access to growing supplies from North Dakota’s Bakken shale formation and other northwest oilfields, were the first to benefit.

Soaring Profit

Profit at HollyFrontier Corp., which owns refineries close to many new U.S. oil wells, jumped to $1.02 billion in 2011, seven times more than a year earlier. Marathon, which also has several plants in the Midwest, earned $2.39 billion in 2011, nearly four times higher than in 2010, according to data compiled by Bloomberg.

The competitive advantage has begun to extend to the U.S. Gulf Coast, where oil from Texas’s Permian basin and Eagle Ford formation is helping reduce imports and boost refining margins in a region that holds about half the country’s refining capacity. The margin between the cost of oil and the price at which Gulf Coast refiners sell fuel reached $25.10 a barrel in July, more than double the difference in December, according to data compiled by Bloomberg.

As domestic demand declined, the U.S. exported more gasoline, diesel and other fuels than it imported in 2011 for the first time since 1949, according to the U.S. Energy Department. Exports may rise by 450,000 barrels a day by 2015, according to energy research firm Wood Mackenzie Ltd.

Growing Exports

“Our most efficient refineries are located on the Gulf Coast, and that’s our access to world markets,” said Ed Hirs, a professor of energy economics at the University of Houston. “They can buy oil cheaply domestically, and they do, and they can sell it at the world price. That’s why refiners have such high profits right now.”

Investors are finding refining stocks more attractive as companies turn to share buybacks to reduce volatility and eschew the plant-buying sprees of years past in favor of higher dividends, said Timothy Parker, a Baltimore-based portfolio manager who oversees about $6.5 billion in natural-resource stocks for T. Rowe Price Group Inc. T. Rowe owns nearly 11 million Valero shares, or about 1.9 percent of the San Antonio-based company, according to data compiled by Bloomberg.

“They’ve been more shareholder friendly,” said Parker. T. Rowe owns nearly 11 million Valero shares, or about 1.9 percent of the San Antonio-based company. The firm increased its holdings in Valero by 8.4 million shares in the first quarter of this year, according to data compiled by Bloomberg.

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