For Valero and HollyFrontier, the Gravy Train Continues

With the Brent-WTI spread expected to remain strong, U.S. refiners HollyFrontier and Valero will keep pumping out big profits.

Joshua Bondy
Joshua Bondy
Apr 14, 2014 at 1:35PM
Energy, Materials, and Utilities

Buying low and selling high is the age-old mantra of capitalism, and the U.S. oil industry has really taken it to heart. America's WTI oil is cheap and Europe's Brent oil is expensive, giving U.S. refiners the golden key to lucrative export markets. Recent projections show that refiners and investors can expect fat profits for the next couple years thanks to a wide Brent-WTI spread.

  Brent ($) WTI ($) spread ($)
2013 108.64 97.91 10.73
2014 104.88 95.60 9.28
2015 100.92 89.75 11.17

Source: EIA projections

Why is the spread expected to stay so wide?
US Crude Oil Production Chart

US Crude Oil Production data by YCharts

U.S. net imports are falling, production is rising, and U.S. crude cannot legally leave the U.S. without being processed into refined products like gasoline. Still, the spread is expected to eventually shrink as more pipelines and export capacity are built. The EIA projects that the Brent-WTI premium will shrink to $2 per barrel by 2020. If the U.S. were to suddenly repeal its ban on raw crude exports then the prices would equalize very quickly, but such a political act is pure speculation at this point.

Bring on the dividends
Thanks in part to the Brent-WTI, spread investors in HollyFrontier (NYSE:HFC) can expect to continue seeing fat dividends for the next couple years. Its base dividend is $0.30 per share per quarter, but in 2012 and 2013 it paid out special dividends of $0.50 per share per quarter to return more cash to shareholders. Even in the fourth quarter of 2013 when issues at its Navajo plant depressed earnings, its EPS of $0.33 exceeded its base dividend.

HollyFrontier's special dividends offer juicy returns in the current situation where high international oil spreads create high profits. The company's yield of 2.5% doesn't look very high, but it is calculated on its base annual dividend of $1.20. If HollyFrontier chooses to pay its special dividend during two of 2014's quarters then its effective yield almost doubles to 4.6%. With analysts expecting that its 2014 EPS will grow to $4.19, thanks in part to support from the Brent-WTI spread, you can expect more special dividends in the near future.

Valero (NYSE:VLO) is a bigger and more conservative refiner. It has increased its quarterly per share dividend from $0.05 in the third quarter of 2011 to $0.23 in the third quarter of 2013, but in 2013 its total dividend payments amounted to just 17% of its earnings. HollyFrontier, on the other hand, made its total dividend payments 88% of its 2013 earnings. It is important to note that HollyFrontier's management considers their extra dividends special for a reason.

Valero is putting more of its earnings back into its business. From 2013 to 2014, it increased its growth capex from $1.255 billion to $1.525 billion to improve its light crude processing and ability to take advantage of other advantaged feedstocks like natural gas and NGLs.

The downside of being big
ExxonMobil (NYSE:XOM) runs a big operation with 4.6 million barrels of daily global upstream throughput in 2013. The problem is that ExxonMobil has little to benefit from a wide Brent-WTI spread. 

Its upstream drilling operations provide the majority of its income, around $26.8 billion in 2013. Its downstream operations only provided $3.5 billion of income in 2013, of which $1.25 billion came from outside the U.S. Even if you add in its chemical earnings of $3.8 billion, its upstream operations are its biggest driver of earnings. Higher oil prices mean more profits, so it's no surprise that ExxonMobil is one of the biggest advocates of ending the ban on raw U.S. crude exports.

Even Phillips 66 (NYSE:PSX) is stuck in a hard place. It doesn't have to worry about upstream interests as it was spun off from ConocoPhillips, but Phillips 66 is stuck with a number of overseas refineries that are on the other side of the Brent-WTI equation. Three of its Atlantic Basin's four refineries are on European soil, and it also has one refinery in Malaysia.

Phillips 66 is hard at work to eliminate Brent completely from its U.S. operations within four years, but its overseas operations will still be a drag on growth. The fourth quarter of 2013 provides a great example. The Atlantic Basin's net loss of $185 million dragged Phillips 66's total earnings down to $450 million.

Follow the growth
The EIA sees a strong Brent-WTI spread for the next couple of years, pointing to healthy cash flows for Valero and HollyFrontier. If you are looking for immediate income, HollyFrontier is a good company because of its special dividends. Valero, on the other hand, is plugging a significant portion of its profits back into operations, making for a strong long-term growth profile.