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A New Golden Age for Refiners? Valero Energy Corporation (VLO), Marathon Petroleum Corp (MPC)

Location, location, location
For instance, refineries on the East Coast, which lack access to cheap inland oil due to insufficient pipeline infrastructure, have languished. Several were even forced to close down last year. In fact, Hess Corp. (NYSE:HES) recently announced that it will be shutting down a refinery in Port Reading, N.J., by the end of this month.

In sharp contrast, refiners with access to cheaper grades of oil – many of them located in the Midwest – have benefited tremendously because they can sell the refined product at higher globally determined prices.

For instance, Valero, whose fourth-quarter results blew consensus estimates out of the water, chalked up its impressive profit growth to cheaper input costs. At its Gulf Coast and Memphis refineries, the company replaced all of its imported crude with significantly cheaper domestic oil.

Marathon Petroleum, which also had a stellar fourth quarter, acknowledged that similar factors drove its solid performance. The company’s access to lower-priced crude inputs boosted margins substantially, with its refining and marketing gross margin averaging $10.45 per barrel for 2012, up significantly from $7.75 per barrel in 2011.

These refiners’ improved margins, due to a wide Brent-WTI spread, mark an important development. Historically, WTI actually traded at a slight premium to Brent. But since 2010, Brent prices have been on the rise and, at times, reached a $25 premium to WTI. And certain grades of inland oil have been even cheaper than WTI, at times trading below Brent by as much as $40.

What’s next?
While the Brent-WTI spread has been falling since December, it recently rose sharply following an announcement that Seaway, a major crude oil pipeline, is encountering some setbacks as it aims to expand capacity from 150,000 barrels per day to 400,000 barrels per day. But some analysts are suggesting that this is a short-term issue and expect the spread to narrow meaningfully by year’s end as new pipeline capacity is brought online.

However, we saw this exact same argument last year, when analysts expected the reversal of the Seaway pipeline in May to dramatically lower the Brent-WTI spread by the end of the year. Seaway, which is operated as a 50/50 joint venture between Enterprise Products Partners L.P. (NYSE:EPD) and Enbridge, was expected to substantially alleviate the glut of oil in the Midwest once the direction of its flow was reversed, hence causing the spread to narrow.

But that theory didn’t pan out at all. Instead, the spread steadily increased from July all the way to December, suggesting that many people either underestimated the true size of the crude oversupply or overestimated the speed with which Seaway would alleviate it. With the U.S. Energy Information Administration projecting another record year of oil production, there is a good chance that the spread may not contract as quickly as some are expecting.

The article A New Golden Age for Refiners? originally appeared on Fool.com and is written by Arjun Sreekumar.

Fool contributor Arjun Sreekumar has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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