Refineries take raw crude oil and refine it into usable fuels and other refined petroleum products. That puts refining companies in the last link of the oil industry's three-part value chain that works together to transform raw production into usable end products:
- The upstream oil and gas segment produces hydrocarbons -- oil, natural gas, and natural gas liquids (NGLs) -- by drilling wells into underground reservoirs.
- The midstream (pipeline) segment then transports, stores, and processes these hydrocarbons.
- Finally, oil and gas flow into downstream facilities such as refineries and petrochemical plants, which transform them into useful products such as fuels and plastics.
Because refiners consume oil in their plants, refining companies tend to benefit when oil prices fall. That often makes a refining stock an excellent complementary holding for investors who also have shares of an upstream oil producer in their portfolios. This investment pairing will help mute some of the effects of oil price volatility. It's one of the many factors that make refining stocks appealing to investors.
How oil is refined
How is oil refined?
Oil refiners play an essential role in the oil industry. These industrial complexes process raw crude oil into a variety of higher-value refined petroleum products. These products include liquid fuels (gasoline, diesel, kerosene, jet fuel, heating oil, and fuel oil) and other products (asphalt, tar, paraffin wax, and lubricating oil).
Oil refineries process crude into these various products using a three-step process:
- The separation process pipes crude oil through hot furnaces that discharge the liquids and vapors into distillation units. The oil then separates into fractions according to their boiling points.
- The conversion process, also known as cracking, uses heat, pressure, and a catalyst to crack heavy hydrocarbon molecules into lighter ones.
- In the treatment process, a refinery will combine different hydrocarbon streams to create a finished refined product (i.e., gasoline, diesel, etc.). Those refined products then go into storage until they're transported to end users like gas stations.
Key terms
Key refining industry terms
Investors who are new to the refining industry need to familiarize themselves with three key terms used in the sector:
- The crack spread is an oil industry term that refers to the difference in price between where a refinery buys raw crude oil and sells the petroleum products it makes from this oil. The spread is the profit margin made from "cracking" unrefined oil into higher-valued refined products.
- The Nelson Complexity Index (NCI) rates refineries on their ability to produce lighter, more refined, and more valuable products such as jet fuel and low-sulfur diesel. The scale goes from 1 to 20, with a higher number implying a more complex refinery. While high-NCI refineries cost more to build, operate, and maintain, they produce greater volumes of higher-valued refined products.
- The utilization rate is the percentage of a refinery's capacity that it uses in a particular period. For example, if a refinery has 500,000 barrels per day (bpd) of throughput capacity but only processed an average of 450,000 bpd for the period, its utilization rate was 90%. The higher the utilization rate, the more efficient a refinery is. Higher utilization enables a refinery to produce a larger quantity of refined products. That allows it both to make more money on the additional volumes and to spread its costs out over more barrels.
Making money
How oil refiners make money
Oil refineries typically buy raw crude oil from producers and have it shipped to their facilities via pipeline, truck, or rail. They process this oil into the following refined products:
- Gasoline
- Diesel
- Jet fuel
- Lubricants
- Waxes
- Asphalt
- Naphtha
- Kerosene
Each 42-gallon barrel of crude oil typically produces about 45 gallons of petroleum products because of refinery processing gains. The largest finished product is gasoline, at 19 gallons from each barrel of oil. Refiners then sell these products to end users, including at their own branded gas stations.
Refineries make money by way of the crack spread; as noted earlier, it's the difference between how much they pay to buy raw crude oil and how much they make when selling the finished refined petroleum products. This spread fluctuates with the price of oil and with demand for refined products.
When oil prices are high, the crack spread tends to shrink until market prices for refined products increase to reflect the rise in crude prices. Meanwhile, if refined product consumption is low, refining margins tend to contract, which means refiners make less money. Oil refineries, on the other hand, can make a lot of money when the demand for refined products is high while oil prices are low. That market environment causes the spread between where they buy oil and sell the associated refined petroleum products to widen considerably.
Types of refineries
Types of refining companies
Oil refining operations fall into two categories; they're integrated into large oil companies or operate independently.
Many large oil companies own oil refineries so that they can process a portion of their production into higher-valued refined products. These entities, known as integrated oil companies, operate refineries for two reasons. First, it enables them to maximize their per-barrel earnings. They can make money not only on producing oil but also on the crack spread as they refine their crude into higher-valued petroleum products. The other benefit of this integration is that oil refining acts as a natural hedge against falling oil prices since their refineries benefit from lower oil prices. That helps reduce their earnings volatility.
Independent oil refiners, meanwhile, focus mainly on operating refineries. Some independent refining companies will only operate refining complexes. Others, meanwhile, have some vertical integration but don't go all the way upstream. For example, many will own midstream assets like oil and refined products pipelines and other downstream assets such as petrochemical plants, ethanol production facilities, lubricant manufacturing plants, and retail gas stations.
Integrated oil companies typically make most of their money producing oil, using their refining assets to maximize their per-barrel profit as well as to help mute some of the volatility of oil prices. On the other hand, independent refining companies tend to make the bulk of their profits by refining oil into higher-valued petroleum products. Given that difference, investors who are interested in making money from the refining industry should focus on independent refining companies.
Another thing that sets the refining industry apart from the upstream oil and gas production sector is that it's less capital-intensive, meaning that refiners don't need to invest as much money to maintain their operations. Many large independent refiners, for example, aim to reinvest 40% to 60% of their cash flow in capital projects, with only about 40% of that spending typically on maintenance activities and the rest on growth-focused initiatives. That enables them to return 40% to 60% of their free cash flow to investors via dividends and share repurchases. Oil companies, on the other hand, need to reinvest a larger portion of their cash flow into sustaining their production by drilling new wells, especially when oil prices are lower. That leaves them with less money not only for drilling new wells that grow production but also for shareholder-friendly activities like dividends and buybacks.
Best refining stocks
Best oil refining stocks for 2024
Several energy companies operate refineries. Here's a list of some of the best refinery stocks to buy this year:
- Marathon Petroleum (MPC 3.8%): Marathon operates the country's largest refinery system. It also owns an interest in master limited partnership (MLP) MPLX (MPLX 2.34%). Those businesses generate lots of cash, a significant portion of which is returned to investors via share repurchases and dividend payments. Marathon also invests in enhancing its refinery business, including carbon reduction projects like renewable diesel.
- Valero (VLO 5.04%): Valero is a leading refining company with 15 facilities across the U.S., U.K., and Canada. It also owns 12 ethanol plants in the U.S. and a couple of renewable diesel plants. The company produces significant cash, which it returns to shareholders, and invests in expanding its operations, with a focus on more sustainable fuels.
- ExxonMobil (XOM 1.72%): Exxon is an integrated energy company. It operates upstream (oil and gas production), midstream (pipelines), and downstream (refining and chemicals) businesses. Exxon is investing heavily in expanding its downstream product solutions platform to reduce costs, boost capacity, and increase its earnings. It's investing in several strategic projects that will help grow its product solutions earnings by more than $4 billion by 2027.
- Phillips 66 (PSX 4.97%): Phillips 66 is a leading energy manufacturing and logistics company. It has refining, chemicals, midstream, marketing and specialties, and renewable fuels operations. The company has invested money to enhance its ability to refine lower-cost oil produced in North America and improve its profits. It uses its growing profits to increase its cash returns to investors and invest in high-return growth projects.
- Chevron (CVX 2.81%): Chevron is an integrated energy company. It has a globally diversified upstream, midstream, and downstream portfolio. The company is investing in expanding its advantaged assets, which are those that deliver the highest margins and lowest carbon content. Those investments should grow its cash flow, giving Chevron the fuel to increase its cash returns and continue investing in its expansion.
Related investing topics
Bringing balance
Refining stocks can help balance your portfolio
Oil refineries take raw crude oil and transform it into higher-value products, making money on the difference between the prices at which they buy oil and sell refined products. This process enables these companies to generate lots of cash, the bulk of which they use to either grow their operations or reward shareholders through dividends and buybacks.
These characteristics make refining stocks appealing options for investors because they offer exposure to the oil market without the extreme downside that can come from lower oil prices since refiners tend to benefit when crude declines. This factor should make refining stocks particularly appealing to investors who own shares of an oil-producing company. They might want to consider pairing that investment with a refining stock since it should help mute some of the impacts of oil price volatility.
Aside from that, refining companies tend to be excellent dividend stocks. Not only do they tend to pay above-average dividends, but they also increase their payouts each year. That combination makes refining stocks ideal options for income-seeking investors to consider.
FAQ
FAQ on refinery stocks
Are refineries a good investment?
Refinery stocks can be good investments. Here's a look at the total returns of the three largest U.S. refiners over the past decade (through late 2024):
- Marathon Petroleum: 18.5% annualized total return (compared to 14% for the S&P 500).
- Valero: 16.3%.
- Phillips 66: 10.3%.
While demand for refined petroleum products hasn't grown very much, the companies have continued to expand their earnings by reducing costs and investing in related sectors like midstream and ethanol production. Refiners produce a lot of cash, which they return to shareholders via dividends and share repurchases. They're also investing in new growth opportunities, like renewable fuels. That combination of cash returns and growth investment could enable refinery stocks to deliver good returns in the future.
What are the best stocks for oil?
There are many excellent oil stock investments. Some of the best oil stocks to buy are ConocoPhillips (NYSE: COP), Devon Energy (NYSE: DVN, Enbridge (NYSE: ENB), ExxonMobil (NYSE: XOM), and Phillips 66 (NYSE: PSX). They have large, diversified, and low-cost operations and strong balance sheets, which help them weather the sector's volatility better than others.
What are the big oil refining companies?
According to Statista, the five biggest oil refining companies by capacity in 2023 were:
- Sinopec (China): 5.2 million barrels per day (bpd) of capacity.
- ExxonMobil (U.S.): 4.5 million bpd.
- Saudi Aramco (Saudi Arabia): 4.1 million bpd.
- Valero (U.S.): 3.2 million bpd.
- Marathon Petroleum (U.S.): 3.0 million bpd.
What company builds oil refineries?
Marathon Petroleum built the last major U.S. refinery in 1977. It still operates the Garyville, La., facility, which it has expanded from its initial capacity of 200,000 bpd to its current capacity of 597,000 bpd.
However, several companies have built refinery expansions over the years. The most recent was ExxonMobil's Beaumont, Texas, refinery, which expanded in 2023 to 609,024 bpd, making it the country's third-largest refinery. Meanwhile, Motiva upgraded its Port Arthur, Texas, refinery in 2012 to 626,000 bpd, making it the country's second-largest facility.