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Valero Energy (VLO)Stock (Energy Industry, Oil & Gas Refining Industry)
 Valero Energy Corporation (NYSE: VLO) is one of the largest petroleum refiners in North America. The companies operating in the petroleum refining industry process crude oil to produce products, such as gasoline, kerosene, lubricants, etc. The company’s operations are primarily based in the U.S., which is one of the largest markets for petroleum products in the world. As petroleum is the primary source of energy for transportation, industrial, electric utility and residential/commercial sectors, the demand for petroleum has experienced sustained growth over a period of time. The demand for petroleum grew by 2 percent in 2004-05 to reach approximately 30 million barrels per day in 2005. The market becomes even more lucrative for the players operating in this industry because of the critical shortage of refining capacity in the U.S. No new refineries have been set up in the U.S. since 1976 due to the high cost of setting up refineries as well as very strict environmental restrictions. Even the cost of expanding the capacity of existing refineries is high. Players have increased production primarily by making technical improvements in their existing refineries as well as by acquiring other older refineries. This has limited the supply and led to an increase in price. All these factors together have contributed to a rapid growth for Valero, whose revenues increased from USD 29 billion in 2002 to USD 95 billion in 2007. In addition to this, Valero also boasts of having a cost advantage over its competitors because unlike any of its rivals, approximately 70 percent of the crude oil processed by Valero is sour crude, i.e., low quality crude oil with high sulphur content, which is cheaper than the sweet crude (low-sulphur crude oil) used by its competitors. However, growth of companies operating in this sector is susceptible to an economic downturn as the demand for petroleum products is highly dependent on the overall economic growth in the country. As the pace of economic growth in a country slows down, the demand from primary consumers of petroleum products also reduces, which has a negative impact on refining companies. Rising interest rates also result in an economic slowdown, thereby affecting the demand for petroleum products. Damage caused to the refineries by natural disasters (such as Hurricanes Katrina and Rita) is an additional issue the company needs to confront from time to time. For example, 367,000 barrels per day of capacity was shut down in the Gulf of Mexico due to the damage caused to petroleum refineries by Hurricane Rita while Hurricane Katrina resulted in the closure of 20 percent of the country’s refining capacity in a single day.
[edit] Company DescriptionValero Energy Corporation is one of the largest refiners in North America. Of late, Valero has been striving to expand its presence in the North Eastern markets in the U.S. as the demand for petroleum products, such as gasoline is the highest in this region, as compared to other parts in the U.S. For example, 135 million gallons per day of gasoline was supplied to the East coast in 2005 as compared to the 104 million gallons per day supplied to the Midwest region, which has the second largest demand in the U.S. Valero’s acquisition of the Paulsboro refinery (situated in New Jersey) in 1998 was a step in this direction, providing the company with greater access to the North Eastern markets in the U.S. During the last few years, Valero has made a string of acquisitions to expand its network of refineries as well as enter new business segments (such as starting retail gas stations). In 2000, Valero acquired Mobil Corporation’s Benicia refinery, along with its retail distribution chain (comprising 270 stores) and company-operated retail sites, which enabled it to establish a presence in the new business segment. The acquisition of Premcor in 2005 provided Valero with eight additional refineries, which enhanced its network of refineries and crude oil capacity. Corporation operates as a crude oil refining and marketing company in the United States and internationally. Its refining activities include refining operations, wholesale marketing, product supply and distribution, and transportation operations primarily in the Gulf Coast, Mid-Continent, West Coast, and northeast regions. The company produces conventional gasoline, distillates, jet fuel, asphalt, petrochemicals, lubricants, and other refined products, as well as reformulated gasoline mixture, gasoline meeting the specifications of the California Air Resources Board (CARB), CARB diesel fuel, low-sulfur and ultra-low-sulfur diesel fuel, and oxygenates. As of 31 December 2007, Valero Energy owned and operated 17 refineries in the United States, Canada, and Aruba with a combined throughput capacity of approximately 3.1 million barrels per day. The company's retailing activities include the sale of transportation fuels at retail stores and unattended self-service cardlock sites; sale of convenience store merchandise in retail stores; and sale of home heating oil to residential customers in the United States and Canada. As of the above date, it operated approximately 5,800 retail and wholesale branded outlets under various brand names, including Valero, Diamond Shamrock, Shamrock, Ultramar, and Beacon. For full year 2007, the company posted operating revenues of $95.327 billion and an operating income of $6.918 billion. 2006 revenue was lower, at $87.64 billion, but operating income was higher, at $7.722 billion[1]. Since Valero is a refining company, and not an exploration and production company, it is hurt when oil prices rise, since it must pay more for its primary input. By the end of 2007, oil was hovering in the $90/bbl range, touching $100/bbl after the new year, and this is probably how Valero's revenues increased but income declined. In the first quarter of 2008, Valero's profits fell 77% from the first quarter of 2007, thanks to oil prices rising over 70% in the last year and refinery outages that slowed production by 100,000 BPD. In the second quarter of 2008, Valero's revenue increased by 51% year on year, from $24.2 billion to $36.6 billion, thanks to rising gasoline prices.[2] Because oil prices rose faster than gasoline prices, however, the company's year-on-year net income fell from $2.25 billion to $734 million.[2] [edit] Business DriversComparable refining capacity (volume in terms of barrels per day – BPD), expansion in distribution network and presence across different geographies are the main drivers of revenue in the oil and energy sector. The table provided below tracks the historical performance of Valero.
Source: Company Data Valero has a total of 17 refineries with a capacity of 3.1 million BPD, though production varies from quarter to quarter depending on maintenance activities. In 4Q07, for example, Valero only produced 2.8 million bbls/day, because of maintenance costs and shutdowns associated with a fire at the Aruba facility[4]. Valero's refineries can produce low-sulphur products even from sour crude, i.e., low quality crude oil with high sulphur content. Sour crude costs much less than sweet crude and other oils (trading in the fourth quarter of 2007 at $14 less than the WTI price[5]). This provides Valero with a cost advantage over its competitors because unlike any of its rivals, approximately 70 percent of the crude oil processed by Valero is sour crude, which is cheaper than the sweet crude (low-sulphur crude oil) used by its competitors. In the current high-cost refining environment, the company is focusing on exploiting this advantage, even going as far as selling its Aruba refinery because of the facility's need for higher quality crude. Valero has one of the largest retail operations (i.e. retail gas stations) in the U.S. with approximately 5,800 retail and branded wholesale outlets spread across the U.S., Canada and the Caribbean under various brand names, and almost $250 million in operating income for 2007[6]. This widespread distribution network provides it with access to the end-customer. As the company controls distribution, it does not have to share any commissions with middle-men for the company, which drives growth in revenues as well as margins for the company. Valero is the only independent refiner having a presence in almost all the regions in the U.S. This presence across different geographies provides Valero with greater flexibility to manage logistics and enables it to supply its products in a more efficient manner. For example, even if a hurricane, such as Hurricane Rita, damages Valero’s refineries in the Gulf Coast, Valero can meet the demand in this region by supplying oil from its refineries present in other regions, such as the Midwest or the West Coast. However, in addition to the advantages enjoyed by Valero in terms of refining capacity, distribution network and geographical presence, the company also faces challenges related to natural disasters, environmental hazards and regulatory issues. As examples, Valero’s infrastructure was damaged during the hurricanes Katrina and Rita, which had an adverse effect on the company’s earnings; the company also had to incur additional expenditures to comply with safety norms specified by the Federal Regulatory Commission (FERC), and a fire at the company's Aruba refinery at the end of the 2007 fourth quarter caused enough damage to hamper production until March 2008. Regulatory concerns related to antitrust and competition laws raised by the Federal Trade Commission (FTC) have also emerged as a challenge for Valero Energy Corporation. Due to the concerns raised by FTC, Valero L.P. had to part ways from its original promoters, Valero Energy Corporation. This inhibits the ability of Valero to expand its business operations as approvals are required from FTC for any acquisitions made by the company. [edit] Business Segments and ProductsThe operations of Valero Energy Corporation can be divided into two segments, namely refining and retailing. Refining contributes the largest share of revenue to the company (91 percent of the total revenue in 2006) and comprises operations, such as refining of crude oil, wholesale marketing, product supply and distribution, and transportation. The retail segment constitutes only a small part of the company’s revenues (9 percent of total revenue in 2006) and comprises operations, such as sale of transportation fuels, convenience store merchandise and home heating oil (for residential customers) at retail gas stations. The product portfolio of Valero Energy Corporation is marketed under several brands, namely Valero, Diamond Shamrock, Shamrock, Ultramar, Beacon, Corner Store and Stop N Go. Although the retail segment constitutes only a small share of the total revenue as compared to the refining segment, it provides the company with access to the end-consumer of its products, which in turn enables the company to exercise direct control over the supply chain. With the ability to monitor demand levels closely, Valero has the ability to determine where to increase and decrease output; after sensing European demand increases for low-sulfur diesel, for instance, the company has made expansion of its diesel output a priority by funding greater investment in diesel-refining capital, an example of which lies in the company's 3Q07 investment in expanding a St. Charles refinery to produce 49,000 more barrels of diesel per day. [edit] Customer DemandValero Energy Corporation has chosen the most desirable geographies as markets for its products. The operations of the company are primarily based in the U.S, which has one of the highest demands for petroleum products in the world. However, Valero is susceptible to a decline in the demand for energy and other related products as a result of an economic downturn in the country because the demand for energy is closely linked to overall economic growth. Thus, an economic downturn would lead to lower earnings and reduced cash flow for oil/energy companies such as Valero. The customers of Valero Energy Corporation primarily include power generating companies, cement manufacturers, customers in agricultural sector, chemical industry and paving and roofing industry. As the demand from most of these consumer segments would reduce during an economic downturn, it further aggravates the risk faced by oil/energy companies such as Valero. [edit] Natural DisastersNatural disasters can significantly disrupt Vakero's oil refinery operations. hurricane activity can damage and destroy refineries, oil rigs, pipelines, and other equipment. For instance, in 2007 Hurricane Humberto knocked out the power at one of Valero's Port Arthur refineries, stalling production at the 325,000 barrel per day facility. [edit] Oil PricesBecause Valero is primarily a petroleum refiner, the company does little of its own exploration and drilling. This makes crude oil an input for the company, so higher oil prices mean higher costs, while lower oil prices mean lower costs. The 3Q07 upswing in oil prices was the primary factor in Valero's dramatic drop in Q3 operating income, from $2.3 billion in 3Q06 to $1.2 billion in 3Q07. [edit] Valero Often has to Pay Recompense for Environmental DamagesOil refining can have a terrible effect on the environment, as chemicals used to turn oil into various types of fuel are released into the air and groundwater. When the environmental damages caused by Valero's operations occur to the extent that they break environmental protection laws, the company is often sued by NGOs or government agencies like the Environmental Protection Agency. These lawsuits are usually settled out of court; on May 7th, 2008, for example, Valero, Shell, ConocoPhillips, Chevron, Marathon Oil, BP, and Sunoco agreed to pay $423 million in damages for contaminating groundwater with methyl tertiary butyl ether, an oxygenate used to increase octane levels in gasoline that has been replaced in recent years with ethanol. Exxon Mobil, along with five other companies named in the lawsuit, are not settling and will continue to contest. [edit] Diesel Demand is Growing AbroadDiesel demand has skyrocketed internationally, especially in Europe, thanks to the fuel's higher better efficiency; globally, diesel prices have risen 56% in the last year[7] - much faster than gasoline prices. Because of this, refiners like Valero are shifting their refining capacity to produce more diesel over the summer of 2008, rather than gasoline: prices are up, demand is up, and diesel is more efficient to make, allowing refiners to capture higher margins. [edit] Competitive LandscapeCompanies in the oil and energy sector operate and compete with each other in different areas, such as chemicals, refining, oil exploration, etc. Valero faces direct competition from companies, such as BP, Chevron, ConocoPhillips, Western Refining, Marathon Oil (MRO), Motiva Enterprises, Sunoco etc. Valero has resorted to various measures, such as expanding presence across different geographies, increasing refinery capacity, and establishing the capability to upgrade sour crude into high value products (also known as conversion capacity) in order to gain an advantage over its competitors. It has achieved all the above-mentioned objectives through a number of acquisitions over the last few years, including the acquisition of Paulsboro refinery, Mobil Corporation’s Benicia refinery, and Premcor. Also, since Valero’s refineries can process the cheaper "heavy sour" crude oil, the company has a sustainable competitive advantage over other refiners, giving its refineries staying power through rough times like these. However, unlike the larger players operating in this industry, Valero is not present across all stages of the value chain. Valero is involved in only refining and retailing, unlike a player, such as Exxon, which finds new oil reserves (exploration), produces crude oil, refines it and then sells it through its retail gas stations. The table provided below compares the operational metrics for Valero vis-à-vis its competitors in 2007.
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