Valero Energy Corp: Oil and Trouble

Increased margins take their toll as refiner's operating income drops 65%.

It's easy to think that every company in the oil business has been getting a free ride lately, while the economy puts the hurt on pretty much everyone else. But San Antonio-based refiner Valero Energy Corp. recently helped provide an important reminder -- higher crude prices don't automatically translate into higher profits.

When the Best Manufacturer for 2008 released second quarter earnings a couple weeks of ago, the company reported a 65% decline in operating income compared with the same period last year. According to Valero, lower margins on refined products were mostly to blame for the fall, which brought the figure down from $2.1 billion all the way to $734 million.

"We expect gasoline margins to continue to be weak and industry utilization rates to decline. We [also] expect secondary products to have a margin recovery, particularly if the price of crude oil stabilizes or falls, as the prices of these products lag changes in the price of crude oil," noted Valero's chairman and CEO Bill Klesse.

Refinery operating expenses increased $148 million since the second quarter last year, which Valero said was due primarily to higher energy costs for electricity and natural gas. Also, throughput volumes decreased in the same time frame by an average of 48,000 barrels per day (bpd), in large part, due to maintenance and repairs at three of its refineries.

On the upside, Valero's low margins on refined products were slightly offset by significantly higher ones on distillates such as diesel and jet fuels. The company increased distillate production by 110,000 bpd between the first and second quarters, while maintaining steady gasoline production. Looking at market fundamentals, the company expects these margins to be strong for the rest of 2008 and to continue into next year.

"Despite the difficult environment for margins on gasoline and many secondary products, Valero continued to be profitable," said Klesse. "Wide differentials for the heavy and sour feedstocks that we can process in our refineries benefited us significantly in the second quarter."

Valero Energy Corp.
At A Glance


Valero Energy Corp.
San Antonio, Texas
Primary Industry: Petroleum & Coal Products
Number of Employees: 21,651
2007 In Review
Revenue: $95.3 billion
Profit Margin: 5.49%
Sales Turnover: 2.23
Inventory Turnover: 19.89
Revenue Growth: 3.80%
Return On Assets: 13.86%
Return On Equity: 28.13%

Recently Valero has received interest regarding the sale of its Ardmore and Memphis, Okla., refineries, but according to Klesse none of the proposals have been in the company's best interests. They have, however, agreed to participate as a prospective shipper on the 500,000-bpd expansion of the TransCanada's Keystone crude oil pipeline system, which stretches from Western Canada to the U.S. Gulf Coast at Port Arthur, Texas.

Plans were recently announced to increase the commercial design of the Keystone pipeline to 1.1 million bpd by 2012. On July 16, Valero affirmed its role in the project, which includes securing high volumes of heavy sour crude oil from several Canadian oil producers. According to Klesse, ample complex refining capacity already exists on the Gulf Coast, so this expansion is a logical step.

"Canada is the United States' leading trading partner and one of its closest allies, and it has very large undeveloped crude oil reserves, so bringing Canadian crude oil to the U.S. Gulf Coast makes sense on many different levels," he said.


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