Magnifying Refinery Woes (CVX, XOM, XTO, COP, VLO, MRO, HES)

The notion that an integrated oil giant is issuing an earnings warning with oil above $80.00 per barrel may seem ludicrous to most on the Street.  Yet that is exactly what is happening at Chevron Corp. (NYSE: CVX).  Chevron said that its earnings drop was due to further deterioration in its refining margins, but the issue is that this is not really new and is part of an ongoing theme we have seen in the industry.  This will of course tie into Exxon Mobil Corp. (NYSE: XOM) and to ConocoPhillips (NYSE: COP) because of the refining and exploration and production, but the real issue is that this only further highlights some of the major refineries like Valero Energy Corp. (NYSE: VLO), and may highlight some of the issues to a lesser degree also at Marathon Oil Corporation (NYSE: MRO), and Hess Corporation (NYSE: HES).

You could perhaps make the same argument that Exxon Mobil Corp. (NYSE: XOM) and ConocoPhillips (NYSE: COP) are in the same boat, particularly if you consider that Exxon Mobil is making that huge buyout of XTO Energy (NYSE: XTO) to diversify more into natural gas.  But Chevron did note that exploration and production (drilling) were in line with its expectations.  The long and short of it is that the more refinery exposure, the more earnings risk exposure.  Chevron did note that exploration and production were looking in-line with expectations.

Valero Energy Corp. (NYSE: VLO) has been an awful performer of late, almost without regard to which direction oil prices are headed.   Marathon Oil Corporation (NYSE: MRO) and Hess Corporation (NYSE: HES) may have at least some of the same woes, but their stocks have held up far better and both are close to 52-week highs.  In fact, Marathon and Hess may even be improperly painted with the same brush in most comparative data if you look at how these companies have performed.  That really leaves Valero, and at $18.16 its 52-week trading range is $15.29 to $26.20.  As Valero is more and more of a refining pure-play each year, you can look at what Chevron was saying about its business and interpolate the same concerns at Valero.

The hardest part of the rising oil prices is that for refineries they actually have a hard time passing down the cost increases.  This is one of those issues that most of the people down on the retail level have a hard time fathoming because so many believe that oil prices are quasi-dictated by the oil companies.  It turns out that despite there being an inadequate refining capacity, these refineries just are not able to operate at the profit margins of before.  This is part of the reason why you see so many weak refining capacity figures at the weekly oil inventory reports on Wednesday… and last week was back under the 80% mark again.  Chevron noted that the refining margins were the lowest of the year in the fourth quarter.

The unfortunate side of this is that these stocks are all headed lower on the news, even if you try to attribute it just to the lower oil prices this morning. Right before the open we have the following indications:

• Chevron -1.9% at $79.40
• Exxon down 0.8% at $69.73
• XTO down 0.8% at $47.78
• ConocoPhillips down 1.2% at $52.92
• Valero down 2.5% at $18.03
• Marathon down 1.5% at $32.21
• Hess down 1.45% at $64.21

Without more refining capacity, our dependence upon foreign energy won’t go away.  If refining is not as profitable as it should be, then who is going to go through the ten-year process of permitting and opening more refineries?

JON C. OGG
DECEMBER 12, 2010