With their exploration and production brethren getting killed while the price of oil is down 50% from last summer, there's a lot of interest in refiners. Two of the most dominant companies in the space are Valero Energy Corp. (NYSE:VLO) and Phillips 66 (NYSE:PSX). Which is the king of the refining hill?
More important, which is the better buy now? We asked two of our top minds to weigh in on the question. Here's what they had to say.
Jason Hall (Phillips 66): I'm actually a big fan of both companies, but for slightly different reasons. As Dan alludes to below, Valero is geographically well located to process cheaper U.S. crude than Phillips 66 is, and the company's refineries can handle just about any kind of crude you throw its way.
Gas, diesel, and jet fuel prices tend to track more closely to Brent spot prices, the international benchmark for crude oil, while Valero's refineries are both well-located and technically capable of processing lower-cost American crude oils:
This gives it a serious edge in making profits, with West Texas Intermediate trading $10 or more per barrel less than Brent, even before factoring in the cost savings for shipping with better located refineries.
So now that I've agreed with Dan on Valero, why am I going with Phillips 66? In short, I love the company's exposure to two non-refining segments of the oil business: midstream and petrochemical manufacturing. As I wrote in this piece a few days ago, refining and the marketing business that sells the refined products are major cash cows for the company, but a refining business just can't grow as quickly as other segments of the energy business. Refineries are expensive, and adding more refineries doesn't necessarily equal more profit.
However, Phillips 66 can capitalize on massive demand for cheap and abundant U.S. natural gas by expanding its pipeline and storage business to connect production areas to demand centers. Furthermore, the company's chemical manufacturing business is already growing profits by using U.S. natural gas as a feedstock for ethylene and polyethylene production.
Ethylene and polyethylene may not sound very familiar, but they are key ingredients to many of the things you use every day, from tires to plastics to fabrics. Even if demand for refined fuels declines, demand for the products made from oil and gas isn't likely go away for years to come.
Phillips 66's refining business is producing strong cash flows, but it's the growth in the midstream and chemicals business -- which could produce more than half the company's profits in three years -- make it a better buy than Valero today.
Dan Caplinger (Valero Energy): Refining stocks have received a lot of attention lately because they're among the only companies in the energy sector that have the potential to benefit from lower oil prices. Valero stands out among its refinery peers because of its size and concentration on refining for the bulk of its profits.
Valero has more refining capacity than any other U.S. independent refinery company, with its 2.9 million barrel daily capacity easily topping Phillips 66's 2.2 million barrel capacity. In addition, Valero is incredibly efficient, with operational costs per barrel that rank among the lowest in the refining industry. With 95% refinery utilization in its most recent quarter, Valero's operational costs were more than $1 per barrel lower than Phillips 66's -- or about a sixth less than what its rival pays.
On top of that, Valero's geographical location gives it better access to cheaper crude than Phillips 66. In particular, Valero has extensive refining operations on the Gulf Coast, which puts it closer to key production areas including the Eagle Ford shale play. By contrast, Phillips 66 has had to make pricey moves like transporting crude all the way from the Bakken shale play in North Dakota to its East Coast refining facilities. With potential moves to unlock shareholder value including moving more properties to its master limited partnership, Valero has the capacity to keep delivering outsized gains to shareholders for the foreseeable future.