It's no secret that refiners had a slow 2013. After a profitable 2012, when the spread between the international Brent oil benchmark and the U.S. WTI oil benchmark -- a key metric for refining profitability -widened to historic levels, it collapsed during 2013, squeezing profits. However, refiners such as HollyFrontier (HFC), Northern Tier (NYSE: NTI), and Western Refining (WNR) made use of this trend and are now primed to make a comeback this year.
A year of change
For example, Northern Tier spent most of 2013 investing in its operations to limit future downtime and increase output. The partnership successfully completed a major turnaround without any setbacks, increasing overall capacity by 10%. Unfortunately, there was a small fire at Northern's refinery during September, although damage was minimal; repairs cost in the region of $10 million. Still, Northern managed to leverage this downtime from the fire to its benefit as the company was able to get on with some essential maintenance on its fluid catalytic cracking (FCC) unit, previously scheduled to begin at the beginning of October.
All in all, despite maintenance and the unplanned fire, Northern's revenue actually increased from $4.7 billion to just under $5 billion during 2013, but higher crude prices compressed profitability. Nevertheless, Northern's 2013 performance was commendable and the company is well placed to profit throughout 2014.
A new partner
Northern Tier also acquired a new strategic partner during 2013, Western Refining. Overall, this deal was highly beneficial for Western. The company paid $775 million to acquire the general partner of Northern, giving Western a share of a refinery located near the Bakken, a hot spot of the domestic oil boom, and doubling the company's convenience store network.
Looking at the two businesses, it's easy to see why Western made this swoop. Western currently has two refineries located close to the Gulf Coast – a region that accounts for about half of U.S. refining capacity. Meanwhile, Northern's refinery is located in the midwest, giving the company access to cheap Canadian oil sands and Bakken crude.
In addition, and this is where I believe the real synergies will come across, Western owns and operates 200 convenience stores within Arizona, Colorado, New Mexico, and Texas; Northern operates 163 convenience stores and supports 73 franchised convenience stores, primarily in Minnesota and Wisconsin. So overall, the combined entity has three refineries and a total of 436 convenience stores across six states.
Indeed, Western's website lays out the synergies gained from the deal:
As a result of the acquisition, Western's platform will include:
- Refining capacity of 242,500 barrels per day
- Pipeline access to cost-advantaged crude oil sources in the Bakken, Permian, San Juan, and Western Canada regions
- Wholesale distribution of approximately 160,000 barrels per day to customers in the Southwest, mid-Atlantic, and upper Midwest
- Integrated network of 458 retail convenience stores
- Extensive crude oil and refined product logistics assets
For the three months ended December 31, Northern contributed $37 million to Western's operating income, roughly 6.5% of operating income for 2013. During 2014, the first full year of the two companies' combination, Northern will likely contribute 26% of operating income for Western, a sizable earnings boost.
Overall, this deal will provide extensive synergies for Western. With less than a 40% share, however, should we now consider a complete buyout, or is this asking too much?
Strong return on capital
In a continuation of the trend, HollyFrontier was another refiner that completed a year of turnaround activity and maintenance during 2013, leaving it well positioned to charge into 2014.
HollyFrontier is one of the better refiners on the market and while its share price may not show it, in business terms the company is best in class. In particular, during the past five years, HollyFrontier achieved an average return on invested capital, or ROIC, of 14.7%, the highest of its peer group. Phillips 66 only achieved an average ROIC of 9.9% and Valero Energy's return has been what can be described as an abysmal 1%. Part of this return can be attributed to HollyFrontier's strategically located refineries, which allow the company access to an advantaged crude slate.
HollyFrontier's refineries are located close to the Mississippi Lime, Permian/Eagle Ford Basins, and Uinta/Niobrara formations, all of which are expected to report strong production growth over the next few years. Effectively this means that the company has access to oils that trade at a discount to Brent and WTI, allowing better profit margins. Once again, according to numbers supplied by the company, HollyFrontier's net income per barrel of crude refined has been 22% higher than its closest comparable peer. Specifically, on average, during the past five years, HollyFrontier's average net income per barrel has been $4.57, Phillips 66's has only been $2.5, and Valero Energy has only been able to achieve a five-year average of $0.34.
In conclusion then, it would appear that the above refiners spent much of 2013 preparing to charge into 2014 and as a result profits should see a boost this year.