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Will Banks Let Struggling Refiners Off The Hook?

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It's no secret that the recession has choked gasoline demand and squeezed profits for independent refiners. But it's less well-known that anemic earnings might soon undermine refiners' debt covenants. That could make CEOs, creditors, and investors alike feel like jumping from the nearest distillate tower.  

Little is fine for these refiners
According to a Bloomberg story released last week, bankers and analysts have fingered Western Refining (NYSE: WNR  ) , Tesoro (NYSE: TSO  ) , and Alon USA Energy among the at-risk group. Essentially, loan terms often include minimum ratios based on trailing-12-month earnings. As paltry quarterly results mount through the end of the year -- eclipsing the strong second half of 2008 -- the likelihood that companies can maintain those ratios sinks like so much heavy sour crude.

For the moment, however, refiners may be spared forced asset sales, share issuances, and other value-destroying measures. A Bank of America (NYSE: BAC  ) energy chief interviewed by Bloomberg described a forgiving approach to the situation: “We will continue to work with companies on a case-by-case basis to get them through this period of time.”

Experts see other lenders following suit. But keeping the credit tap turned on will likely involve modified terms, possibly including current-spending restrictions and requirements that future cash flow be redirected from expansion plans and dividends to debt reduction. In other words, while any announcement of amended loan terms would be cause for relief, outright optimism could later be linked to investors having inhaled a lungful of fumes.

Crack spreads in rehab?
The problem with this whole picture is that temporary debt modifications rest on the expectation that refiners will soon enjoy a sustained recovery. Reality, I'm afraid, challenges that assumption.

The Energy Information Administration (EIA) sees 2010 gasoline demand rising a modest 0.6%, versus a roughly 1.9% year-to-date decline and a 2.2% drop in 2008. Depending on the direction of crude prices, that may not be enough to restore crack spreads -- the difference between the price of a barrel of crude and a barrel of finished product -- to historical averages. Regarding additional headwinds, Barron's recently cited sustained unemployment, fuel-efficiency improvements courtesy of the cash for clunkers program, and a decline in miles driven by graying baby boomers.

Moreover, with ample spare capacity in the system, any inspiring uptick in gasoline demand could be met with additional supply, in turn depressing prices once again.

All in all, investors might want to cap their refinery exposure to integrated majors such as Total (NYSE: TOT  ) or ExxonMobil (NYSE: XOM  ) , where E&P gains potentially offset refining losses. For those wedded to independent refiner exposure, I continue to favor Frontier Oil (NYSE: FTO  ) , whose conservative debt position potentially makes it a safer play than Valero (NYSE: VLO  ) and other competitors.

Ultimately, even if banks grant refiners immunity, the economy may not.

Pour some related Foolishness into your hydrocracker:

Fool contributor Mike Pienciak doesn't own shares of any company mentioned in this article. Total SA is a Motley Fool Income Investor pick. Try any of our Foolish newsletter services free for 30 days. The Fool has a disclosure policy.

Read/Post Comments (2) | Recommend This Article (5)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 06, 2009, at 5:26 PM, 64bitfool wrote:

    Foolishly, I'm astounded how the first two sentences almost try to make someone (probably in some domestic oil producer boardroom somewhere) "feel" apprehensive about any domestic refinery, since there hasn't been a single new expense since 1976 (beyond what they borrow to pay themselves to not build anything)!

    Talk about a no lose situation! Totally in the black in terms of COSTS by 1986.

    A frightened fool might forget to fret over corporate salaries and producer/refinery "hands in each others pockets" relationships which are ... staggering and disturbing.

    INDIVIDUAL fossil fuel refinery INVESTORS should probably ask themselves many questions about this questionable industry in general; including:

    When they finally expand and actually create a new expense (if ever) should I get out then are there better long term growth projections for any particular refinery?

    Is the exposure of these and other new comments from the financial sector indications (or ignorance) of someone finally asking "What are they (the oil and gas industry as a whole) doing?" questions.

    When the domestic industry finally does the right thing in expanding and upgrading (needed for many years to support the demands of 10 years ago), should I bail out then or stick with them?

    Is going green (solar, wind) now (finally) more appealing in terms of US Domestic (and global) energy production future(s)?

    What are the relationships in terms of Financial sector investments RELATIVE TO fossil fuels refinement versus green energy production?

    While a fool were at it, shouldn't one be asking why refineries have borrowed so much against future refinery demands in the first place? The subject in question above!

    Throughout the plentiful times of high production (more than what the plants were designed for in the first place) these companies allowed many existing refineries (that are paid for ten times over) to become dilapidated while at the same time borrowing on futures (in the name of building more plants to support that demand).

    Meanwhile, back in the boardrooms of producers and refiners alike, after failing to do anything, they counted their bonus dollars and huge profits (from not doing anything) and gleefully rewarding foolishly happy investors that didn't know (or didn't care about) the difference.

    So where which refineries should you invest in? Probably the ones that simply have no plans to build anything, and haven't borrowed themselves into the hole in the name of doing just that. Just my foolish thoughts.

  • Report this Comment On October 08, 2009, at 12:09 AM, Gasmanmt wrote:

    I don't know where HandsGrue is getting his information but the current average price of regular gasoline is $2.46 in this country according to Triple A and the EIA.

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