Though advances in drilling technology have propelled U.S. crude oil production to levels not seen since the late 1980s, many U.S. refineries are poorly equipped to handle these growing volumes of mainly light, sweet crude oil -- a higher quality grade of crude as measured by API gravity and sulfur content.
Let's take a closer look at the main factors driving this growing mismatch between U.S. refining capacity and domestic crude production and why Valero (VLO 4.30%) may be the best positioned refiner to benefit from this trend.
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The refining capacity mismatch
U.S. crude oil production has surged from 5.7 million barrels per day (bbl/d) in 2011 to 7.4 million bbl/d in 2013. And output is expected to continue growing at a rapid clip, with the EIA forecasting that domestic crude production will reach 9.2 million bbl/d in 2015. But the vast majority of this growth has consisted of light, sweet crudes.
According to the EIA, approximately 96% of the 1.8 million bbl/d growth in output from 2011 to 2013 consisted of light, sweet crudes with API gravity of 40 or above. And more than 60% of forecast production growth through 2015 will consist of light sweet crudes with API gravity of 40 or above.
Many U.S. refiners are poorly equipped to handle these light sweet grades of crude mainly because they were upgraded over the past decade to process heavier, sour crudes. After all, nobody was expecting a shale revolution 10 years ago and refiners figured they would continue to rely on imports of heavier grades.
Therein lies the main issue -- the growing mismatch between surging light sweet crude production and refining capacity configured to process imported heavy, sour crudes. While some of these refineries do have the flexibility to modify their feedstock to process greater volumes of lighter crudes, doing so would generally reduce their utilization rate and, therefore, profitability.
In order to process higher volumes of lighter crudes, Gulf Coast refineries that have been configured to handle heavy, sour crudes would have to invest heavily in distillation towers, downstream conversion units, furnaces, and other equipment. Such an overhaul would require hundreds of millions of dollars and as long as five years to complete.
One stock to play growing mismatch
But there is one company that's ahead of the pack when it comes to handling large quantities of light oil -- Valero, the nation's largest independent refiner. The company boasts a massive refining footprint along the U.S. Gulf Coast, with seven refineries located in the region, representing roughly 55% of its total refining throughput capacity.
Of these seven, three are equipped to process light oil, which gives Valero a huge competitive advantage over many of its peers. To further expand its competitive advantage, Valero is planning major upgrades at two of its refineries in the region to process even greater volumes of cheap light crude sourced from the nearby Eagle Ford shale, which should provide a meaningful uplift to its margins.
The company said it plans to spend $390 million at its 160,000-barrel-per-day (b/d) Houston refinery and $340 million at its 325,000-b/d Corpus Christi refinery to add crude topping units to boost the refineries' light sweet crude processing capacities by an additional 90,000 b/d and 70,000 b/d, respectively. The expansion projects are slated for completion by the end of 2015.
Peer Marathon Petroleum (MPC 5.63%) is also constructing condensate splitters at its 78,000 bpd refinery in Canton, Ohio, and its 233,000 bpd refinery in Catlettsburg, Kentucky, to process growing supplies of condensate from the nearby Utica shale. The company expects the Canton splitter to start up by late this year and the Catlettsburg splitter to come online by mid-2015.
Investor takeaway
While the growing mismatch between U.S. refining capacity and production can only truly be fixed by lifting the nearly 40-year old ban on U.S. crude oil exports, Valero's concentrated refining footprint in the Gulf Coast and growing light oil processing capacity should allow it to realize peer-leading Gulf Coast margins, providing a major competitive advantage over its peers.
