Valero's Big Opportunity in the U.S. Gulf Coast

U.S. refiners, especially those with access to heavily discounted inland crudes, have been one of the main beneficiaries of the rapid surge in U.S. crude oil production over the past few years. By buying cheap domestic crude, refining it, and selling the refined product at more expensive, Brent-linked prices, they've been able to earn hefty profits.

With roughly two-thirds of its feedstock consisting of these cost-advantaged crudes, Valero (VLO -0.32%) has been a big winner, with shares up nearly 200% over the past two years. Going forward, the company stands out as especially well positioned in the U.S. Gulf Coast, where new and expanded pipelines are set to bring a deluge of crude oil this year. Let's take a closer look.

Valero's big advantage in the Gulf Coast
Valero is the world's largest independent refiner, with 16 refineries in the U.S., the U.K., and Aruba that have a total throughput capacity of 2.8 million barrels per day. Though the company's refineries are diversified geographically throughout the U.S., it does have a heavy concentration of refineries along the U.S. Gulf Coast, which combined account for more than half of its total throughput capacity.

These refineries, including Three Rivers and Corpus Christi, enjoy a huge advantage thanks to their close geographical proximity to the Eagle Ford Shale, one of the fastest-growing shale oil plays in the country. The surge in Eagle Ford production over the past few years has resulted in dramatically improved profitability at Valero's Gulf Coast refineries. Consider its Three Rivers refinery, for instance.

Just a few years ago, Three Rivers relied almost entirely on more expansive foreign crude feedstocks, earned extremely thin margins, and was on the verge of being shut down. But today, the refinery receives roughly 90% of its crude from the Eagle Ford, allowing it to realize much higher margins. With a total throughput capacity of roughly 100,000 barrels per day, it is one of Valero's most profitable plants.

Going forward, Valero has major ambitions to further improve its access to cost-advantage feedstocks and is investing heavily to upgrade its Gulf Coast refineries to boost light oil processing capacity. The company is currently evaluating  the addition of a 90,000-barrel-per-day (bpd) topping unit at its Houston refinery and a 70,000 bpd topping unit at a refinery in Corpus Christi.

Though these facilities are already configured to run primarily light sweet crude, a topper will allow the refineries' crude units to process even lighter Eagle Ford crudes, thereby increasing the production of refined products such as gasoline and diesel. These planned upgrades, which Valero says could come online in late 2015, are expected to generate returns in excess of 30%.

Rail investments
The company is also investing in logistics projects elsewhere to boost access to cost-advantaged crudes, most notably at its 270,000-barrel-per-day St. Charles refinery in Louisiana and its 135,000-barrel-per-day Wilmington refinery in California. Last year, the company ordered 5,320 new railcars to help ship discounted crudes to these refineries and is also pursuing a 70,000 bpd crude oil offloading facility at its Benicia refinery in California.

Several of Valero's peers have also invested heavily in railcars and rail offloading facilities to improve access to cheap North American oil. For instance, Phillips 66 (PSX -0.66%) recently received the first batch of the 2,000 railcars it ordered in 2012 to ship greater volumes of Bakken crude to its Ferndale refinery in Washington and its Bayway refinery in New Jersey. The company is currently in the process of constructing offloading facilities at both refineries that will significantly boost processing capacity when they go into service later this year.

Similarly, Tesoro (ANDV) and BP (BP 0.13%) are also involved in rail projects along the U.S. West Coast to improve access to discounted crudes from the Bakken Shale. BP is almost finished building a two-mile-long rail loop at its Cherry Point refinery in Washington, while Tesoro recently upgraded its Anacortes refinery by installing a $50 million rail unloading system.

The bottom line
As new and expanded pipelines deliver growing quantities of light crude oil to the U.S. Gulf Coast in the months and years ahead, Valero's Gulf Coast refineries suited for light oil are ideally positioned. Though refining margins are likely to remain pressured in the near term, Valero's strong position in the Gulf Coast, the Mid-Continent, and its growing production of more profitable distillates should allow the company to remain highly competitive and outperform most peers.