Valero's Major Announcement a Telling Economic Indicator

November 22, 2009 | about: VLO  

Valero Energy (VLO) has just announced it is shutting down its Delaware City Refinery. This is a major news announcement because refiners should be seen as a canary in the coalmine for end-user demand and Valero is one company in the oil patch which has been loath to cut workers to improve the bottom line. This announcement is an indicator that, despite a technical recovery, the economy still has major obstacles to overcome.

Business Wire reports:

Valero Energy Corporation announced today it intends to permanently shut down its Delaware City refinery due to financial losses caused by very poor economic conditions, significant capital spending requirements and high operating costs. The shutdown will affect approximately 550 employees at the plant.

“The decision to permanently close the Delaware City refinery was a very difficult one,” said Valero Chairman and CEO Bill Klesse. “We have spent the last year diligently trying to avoid this situation, and I have worked closely with Gov. Markell in an effort to find a different outcome. Earlier this fall, we shut down the gasifier and coking operations in an attempt to improve reliability and financial performance, but the refinery’s profitability did not improve enough. Additionally, we have sought a buyer for the refinery, but feasible opportunities have not materialized. At this point, we have exhausted all viable options.

In the fourth quarter of 2009, the company expects to report a pre-tax charge of approximately $1.7 billion to $1.8 billion, or $2.00 to $2.15 per share after taxes, related primarily to asset impairment, employee severance and other shutdown costs. The company estimates the cash portion of the pre-tax charge will be in the range of $125 million to $150 million. The current and historical financial results of the affected operations will be shown as discontinued operations in the company’s financial statements.

The new CEO Bill Klesse came to Valero via Ultramar Diamond Shamrock (UDS), which Valero acquired at the top of the market in 2001. So, company ethos may be different than under Bill Greehey, who was very committed to community. And Delaware City is an old Getty/Shell-Motiva oil refinery and a legacy asset of Blackstone-controlled Premcor, the company run by former Tosco head and Salomon Brothers commodities trader Tom O’Malley. So, it was not core to Valero’s operations. Valero already cut staff there in September. And the Shell-Motiva JV had serious operating difficulties with the asset before offloading it to Premcor.

Nevertheless, this was a refinery which has been upgraded significantly to process less expensive heavy, sour crude oil. The fact that Valero is laying off workers and shuttering the entire site tells you that the situation is bad. They are saying in effect “we cannot continue to operate at a loss through this business cycle.” If Valero can’t make money, no oil refiner can.

I see this in a macro context as a sign of cyclically weak end-user demand. I do think peak oil is for real but the world is awash in oil and oil products right now. Witness the recent post by FT Alphaville’s Izabella Kaminska, which points to a glut of distillate entering the season of high distillate demand:

We feel it’s Olivier Jakob at Petromatrix who really expressed the matter best on Friday. As he wrote (emphasis FT Alphaville’s):

As per our Tuesday ad hoc note on floating stocks; on a crude equivalent basis all of the OPEC and half of the IEA estimated oil demand growth for 2010 is already parked at anchor in floating stocks and these idled cargoes filled with oil are getting more and more attention.

By the end of the winter there is likely to be as much distillates afloat as in the total US at the end of winter 2007 and we expect that it will be more and more difficult for some of the Wall Street commodity banks to avoid

mentioning the subject and to continue to hide the floating storage fill-up as “demand from emerging economies”.

The ICE Gasoil contango is currently widening and this will not work towards the reduction of these floating stocks. In an environment of spare refining capacity the only solver to the growing floating stocks of Distillates is a sharp reduction in OPEC supplies [ahem…Daily Mail], but only lower prices would trigger that.

The fact that oil is trading at $80 a barrel in this climate should tell you that it is trading more as a financial asset than on supply/demand imbalances. Is this why Warren Buffett is buying yet more oil assets? Watch refining margins; they are telling indicators.

Disclosure: I have owned owned shares and call options in Valero and other refiners for a number of years, but I sold all positions in 2007.

Source: http://seekingalpha.com/article/174658-valero-s-major-announcement-a-telling-economic-indicator?