Frontier Oil (FTO)

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Chris McFarland

Frontier Oil Corporation is an oil refining and marketing company based in Houston, Texas. However, the bulk of its business is divided amongst the Rocky Mountains and Midwest regions of the United States. It supplies local customers with various types of gasoline, diesel, and asphalt cement. The company has two refineries: One in Cheyenne, Wyoming (52,000 barrels per day) and El Dorado, Kansas (110,000 bpd)^[1]. While it does not produce its own oil, it imports heavy crude oil from Canada as well as from producers in Texas. An increase in Canadian crude due to the weak dollar has decreased the premium it pays to local suppliers. High input prices, a decline in the local economy, increased environmental regulations, as well as several lawsuits may affect the financial health of this company. Finally, the company is well-poised to benefit from a rise in ethanol, which is becoming an increasingly attractive oil alternative due to the fundamental rise in oil prices. Frontier has refineries in the mid-west markets where much of the corn feedstock for ethanol is grown--this is a key advantage since ethanol transportation is difficult (it cannot be pumped through pipes like traditional petroleum).

Company Overview

A steady increase in global crude oil costs has increased Frontier Oil's operating costs. Furthermore, revenue decreases whenever one of its two refineries must close for routine maintenance^[2].

While new exporation is occuring in Canada, the Southern region of the United States has seen little increase in exploration. In fact, crude oil production in the United States dropped from 2005 to 2006 from 5.18 mbpd to 5.13 mbpd. Output has been in decline since 1985. Aside from that, the world in general has seen little increase for the past three years despite a surge in demand driven by large emerging economies such as China.

Over the past few years, Frontier Oil has been increasing the amount of crude oil it purchases from Canada. As the exploration and development of Canada's vast oil sand fields continue, Frontier Oil stands to greatly benefit from alternative source of crude as US exploration stagnates. Its purchases from domestic sources have either been erratic (Texas), in decline (Wyoming, Kansas, and Louisiana), or unchanged (Colorado). Canadian crude is the only source that has seen dependable growth in the past three years.

Trends and Forces

• Development of Canadian bitumen fields: The amount of crude oil FTO purchased from Canada continues to increase. Currently, it accounts for over 50% for the Cheyenne refinery and about 25% for the El Dorado Refinery, which otherwise obtains two-thirds of its crude from Texas. Drilling complications in either one of those two locations could hurt Frontier Oil's production. Its status as operator of a pipeline to Canada has allowed it to lower its purchasing cost and has forced its American suppliers to lower their costs accordingly. Although crude oil from Canadian tar sands are more expensive to refine, the surge in oil prices has kept it profitable.

• Global Climate Change and environmental legislation: Changes in environmental legislation could affect output. An increase in social and political awareness with regards to global warming could result in stricter pollution and waste disposal laws. In particular, the process of mining oil sands—known as strip mining—is considered highly detrimental to the environment. Public and legislative backlash against these kinds of processes may hinder Frontier from expanding or even continuing its oil sands operations.

• Localized markets: Frontier Oil's markets are extremely localized. About 97% of the Cheyenne refinery’s gasoline was sold to either Colorado or Wyoming. While the El Dorado refinery has a slightly more diverse customer base, it mainly covers the Plain states. An economic decline in either one of these regions could devastate Frontier Oil's sales^[3].

• Mid-west location an advantage for ethanol: Frontier is well-poised to benefit from a rise in ethanol, which is becoming an increasingly attractive oil alternative due to the fundamental rise in oil prices. Frontier has refineries in the mid-west markets where much of the corn feedstock for ethanol is grown--this is a key advantage since ethanol transportation is difficult and it cannot be pumped through pipes like traditional petroleum.

• Dependence on big volume buyers: In 1999, Royal Dutch Shell (RDS) bought all of the output from the El Dorado refinery. In an effort to diversify its customer base, Frontier has increased the amount of barrels retained each year. As of 2006, it retains 35,000 bpd and plans to increase that amount by at least 5,000 bpd until 2009. However, Shell remains that refinery's biggest customer, accounting for over 40% of the company's total sales^[4].

Competitors

Frontier Oil faces competition in both the refinement of crude oil as well as the sale of its products.

For the market serviced by the Cheyenne Refinery, it faces competition from Sinclair Oil Company (a privately held company), and Suncor Energy (SU). For the market serviced by the El Dorado refinery, it faces competition from a variety of companies in the Gulf Coast region. Although its Gulf Coast counterparts are able to produce more at a slightly cheaper price due to economies of scale, Frontier Oil makes up the difference by paying less in transportation costs due to its poximmity to its core markets^[5].

As the price breakdown shows, the more vertically integrated a company is, the bigger its share in the profits of oil sale revenue.

References

1. ↑ FTO Home Page
2. ↑ 2006 SEC Filing Item 1: Refining Operations
3. ↑ 2006 SEC Filing Item 1A: Risk
4. ↑ 2006 SEC Filing Item 1: Marketing and Distribution
5. ↑ 2006 SEC Filing Item 1: Competition