A Steal of a Refinery Deal?

Valero Energy (NYSE: VLO  ) began as an independent firm, then built a refining empire by opportunistically snapping up bargain-priced assets from Big Oil barons like ExxonMobil (NYSE: XOM  ) and bankrupt competitors alike. Is Holly (NYSE: HOC  ) setting forth on a similar path with its purchase of Sunoco's (NYSE: SUN  ) Tulsa refinery?

Holly, which operates just two refineries -- one in New Mexico, and one in Utah -- certainly has a long way to go before reaching Valero-like volumes. In fact, the more concentrated structure of the market today probably precludes a second act. Still, by purchasing an asset with an ostensible $1.6 billion replacement value for only $65 million, Holly is certainly on the right track. The Tulsa refinery, coastally disadvantaged but close to Cushing and a Magellan Midstream Partners (NYSE: MMP  ) pipeline, would kick up Holly's total capacity by more than 60%. So this is a significant deal for Holly, even if the ticket price looks small.

At $745 per daily barrel of refining capacity, this is a cheap purchase, but it's not quite as cheap as a straight comparison to deals such as Valero's mid-2008 sale of its Krotz Springs refinery to Alon USA Energy (NYSE: ALJ  ) would imply. Here's why: The EPA requires refineries to crank out ultra-low sulfur diesel, and Tulsa requires an upgrade to remain compliant. Sunoco first put this cost at $400 million, but later calculated the savings from not proceeding with the job to be $375 million.

Holly, on the other hand, estimates a capital commitment of only $150 million. To gauge how good a deal this is for Holly, it really comes down to the cost of this project. Taking the firm's $1.6 billion estimate of the Tulsa refinery's replacement cost, Holly is either getting the asset for $0.13 or $0.28 on the dollar, after adding in the cost of the diesel desulfurizer, depending on whether we use Holly's or Sunoco's project cost estimate.

Both sound like deep discounts, but the latter would actually be much closer to historical norms. Given the company's stated ability to efficiently replicate the desulfurization work performed at its other two refineries, however, Holly may be getting a sweet deal indeed.

Further refined Foolishness:

• Is this the best bet among risky refiners?
• The group has been refining its collective balance sheet for months now.
• Valero's been known to get strung out on crack spreads.