Common logic says that independent oil refiners are in a tough business. They compete against the Diamond Jims of the oil world -- the plump-with-cash major oil companies.
But in the investment world, the Diamond Jims like ExxonMobil
The key to the success of refineries like Frontier is that the difference between light and heavy crude oil prices was $13.34 per barrel in the fourth quarter, a significant increase from the $7.66 per barrel in the fourth quarter of 2003. Put another way, Frontier's profitability is increasing because the relative cost of its raw material is less than those who process sweet crude.
Heavy crude oil, also called sour crude, trades at a significant discount because it requires complex refining and yields less gasoline per barrel than does sweet crude from Saudi Arabia. But Frontier's CEO sees a niche for his company: "Not all refineries are created equal. Those that can process heavy and sour crude will have a distinct advantage." To simplify: Whether they process in sour or sweet form, refiners are able to charge the same price for the finished product, thus exploiting inefficiencies in pricing -- a capability that Frontier has.
Going forward, investors should note that 2005 capital spending will increase $100 million to $147 million. The bulk of that increase is slated for meeting the ultra-low-sulfur diesel regulations that go into effect in June 2006. Though the company's current level of cash, and its cash flow, can fund this massive capital investment, it will stop the company from building cash the way it did in 2004.
The company is also expanding its 110,000-barrels-per-day (bpd) Kansas refinery to allow it to handle 121,000 bpd in 2007 to take advantage of a planned crude pipeline by Enbridge
That said, the modest increase in expected earnings makes sense. There's only a small increase in capacity planned, so future earnings gains have to come from refining efficiency improvements, which will be modest, or even larger spreads, which are unlikely. If you're looking for more skyrocketing price appreciation, consider looking elsewhere. The fuel for that rocket -- strong earnings potential -- is not evident with Frontier.