Is Oil Refining a Zombie Industry? (DAL, PSX, VLO, MPC, TSO, HFC, WNR, CVI, CG, XOM, CVX, BP, PBR)

When Delta Air Lines Co. (NYSE: DAL) agreed to buy an oil refinery from Phillips 66 (NYSE: PSX), the transaction underscored a shift that has been taking place in refinery ownership. Pure refiners like Valero Energy Corp. (NYSE: VLO), Marathon Petroleum Corp. (NYSE: MPC), Tesoro Corp. (NYSE: TSO), HollyFrontier Corp. (NYSE: HFC), Western Refining Inc. (NYSE: WNR), and CVR Energy Inc. (NYSE: CVI) were struggling to post a profit, but here came European commodities trading houses like Vitol, private-equity firms like The Carlyle Group (NASDAQ: CG), and now an airlines buying up refineries that were old, with some in need of serious upgrades before they could be brought back online profitably.

The supermajor integrated firms like Exxon Mobil Corp. (NYSE: XOM), Chevron Corp. (NYSE: CVX), BP plc (NYSE: BP), and Petroleo Brasileiro SA (NYSE: PBR), known as Petrobras, had determined to keep their refineries and were nearing completion of major upgrades to some. Petrobras reported a new refinery throughput record of 2.03 million barrels/day earlier this week.

It’s true that non-energy sector buyers are getting bargain prices for what could be very valuable assets. But it’s also true that refining is beginning to shift out of North America and Europe to the Middle East and Asia. An article at streetinsider.com refers to a note from analysts at BofA/ML that includes this startling conclusion:

The refining complex will need to see the shutdown of at least another 2 million barrels a day of refining capacity before refinery utilization rates nudge back up toward the attractive levels seen between 2004 to 2008. … Market consolidation will have to continue amid falling demand, the return of some previously closed capacity and the arrival of new, sophisticated refineries.

Between closures on the East Coast of the US and in Europe, about half that total has already been shut down.But the market is still oversupplied, with both crude and refined products. So why are trading houses, private-equity firms, and airlines buying refineries?

The only reasonable answer is that these bargain priced assets will become more valuable when the global economy starts growing at a better and more consistent rate. Demand and prices for energy have dropped because the outlook for the global economy is dreadful for at least the rest of this year. Assuming a return to some sort of normalcy in the global economy, crude prices will have to rise, and refined products prices will have to rise with them.

It’s also much cheaper and probably a little safer to buy a refinery than it is to buy into a smallish exploration and production company. Yes, there’s a risk that these older refineries will never return to production, but the amount gambled is reasonably small and the potential payoff could be unreasonably large. Even flipping a refinery for loss won’t be the worst thing that could happen to Vitol or Carlyle.

So in an energy regime that often doesn’t make a lot of sense, this hankering for refineries is just another example.

Paul Ausick