Time to Refine Balance Sheets Instead of Gasoline

I recently flew over a massive oil refinery complex near Houston on a beautifully clear day and marveled at the stillness of the adjacent Gulf of Mexico. I imagined an entirely different scene as Hurricanes Ike and Gustav came ashore last month, and after analyzing that refiner's third-quarter earnings, I'm amazed that the damage was not more notable.

Valero Energy (NYSE: VLO  ) had to shut down four refineries in the aftermath of those storms, and saw its gasoline production decline just as gas prices (and therefore refining margins) temporarily spiked on regional supply disruptions. Along with ConocoPhillips (NYSE: COP  ) , Valero took those storms on the chin, but it managed to escape severe damage to facilities and to earnings. I'll be curious to see results next week from storm-spared Holly (NYSE: HOC  ) and Western Refining (NYSE: WNR  ) .

Excluding a $305 million pre-tax gain from the sale of a Louisiana refinery called Krotz Springs, Valero's net income rose 16% from the prior year, to $982 million. Income from operations rose by 50%, due in large measure to the refinery sale, but also owing to a continuation of the trend toward higher margins for non-gasoline distillates like diesel and jet fuel. That trend is music to the ears of niche refiners like Calumet Specialty Products (Nasdaq: CLMT  ) , which faces some severe debt-related challenges at about the worst possible point in modern financial history.

Gasoline prices have reacted quickly to the incredible 50%-plus correction in the price of oil. That's great news for drivers, and Valero believes that will bolster demand, but overall, the lower crude prices have not yet augmented profits for refiners like Valero. In fact, Valero's third-quarter gasoline margin contracted further from the prior quarter, despite marked volatility.

Noting substantial economic uncertainty, Valero announced major reductions to capital expenditures. The company now intends to invest only $3 billion of the $4.5 billion previously budgeted for 2008, and instead intends to place greater emphasis on maintaining sizable cash reserves. Under the circumstances, a shareholder can hardly argue with a predilection for hoarding cash, but over the long-term, such moves may lead to some loss of market share, unless major competitors like Tesoro (NYSE: TSO  ) follow suit. So far, both companies have moved in tandem to curtail some gasoline production until market conditions improve.

For now, I advise Fools to watch carefully ... from the sidelines.

Further Foolishness:

An incredible 3,930 Motley Fool CAPS members expect five-star pick Valero to outperform the S&P 500. Join the free community of talented investors today, and share your thoughts on this beleaguered stock. Calumet Specialty Products is a Motley Fool Income Investor recommendation. If income streams float your boat, hop aboard with a free 30-day trial subscription.

Fool contributor Christopher Barker thinks refiners are interesting here, but that better options abound. He can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He owns shares of Valero Energy. The Motley Fool has a disclosure policy.


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