WASHINGTON, DC (November 24, 2009)— In September 2009 Valero announced two unit shutdowns at the Delaware City refinery, citing significant disruption related in part to the difficult operating environment in 2009 as well as operational reliability. While both shutdowns were driven by management’s desire to stem refinery losses over the near-term, the decision to permanently shut down the gasification unit drove an asset impairment loss of US$ 340 m (pre-tax) in 3Q09. Valero announced plans to evaluate potential strategic alternatives, including a possible sale. However, instead of moving forward with finding a buyer for the refinery, on November 20, 2009, the company announced that it intends to permanently shut down the refinery due to financial losses and cash flow constraints. "The announcement appears favorable.  We estimate a combination of both the tax benefit associated with the announced accounting charges and the strategic benefits that may accompany this reduction in unprofitable refining capacity," said Alexandra Kirk, Manager, Downstream & Petrochemicals Group at PFC Energy.

This removal of some 190 mb/d of refining capacity in PADD 1 sends a strong signal regarding Valero’s outlook on the US market. PADD 1 has been one of the regions most negatively impacted by the economic downturn and subsequent drop in product demand. Just last month, Sunoco, another independent downstream player, announced plans to idle its Eagle Point facility in order to run its other two refineries in the area a higher utilization rate with no disruption to its branded supply requirements. Much like Sunoco, Valero will be able to operate its remaining PADD 1 refinery at a higher rate, although it will not enjoy similar integrative benefits. By shutting down this capacity, the company has improved the competitive standing of Paulsboro, already one of the most sophisticated refineries in the East Coast, thereby raising its value on the market should Valero still consider selling this asset.
 

A staggered departure


Valero’s decision to close Delaware City was the culmination of several smaller, ultimately unsuccessful, attempts to react to the steadily worsening market conditions. In response to waning US demand for gasoline, Valero took offline a variety of refinery units throughout its portfolio beginning in early 2008. This strategy appeared to work and others in the US refining industry soon followed suit. However, the prolonged weakness of the operating environment increased pressure on this strategy. Valero, the largest refiner in the US, proved especially vulnerable to this breakdown given the scale of its operatings and its lack of branded retail and upstream operations.


When it became apparent that a temporary reduction in throughputs would not be enough for Valero to weather the current operating environment, the company decided to idle Delaware City’s coker and coke gasification complex, leading it to record an impairment of US$ 340 m in 3Q09. Almost immediately following, the company announced that it would begin the process of searching for a buyer for Delaware City. Ultimately, however, Valero decided to take a different approach to better serve its long-term position in the region.


To divest or not to divest?
The Delaware City refinery, while highly complex with both a sizeable coker and hydrocracker, was consistently plagued by serious operational difficulties. These well-known operational issues inevitably decreased Delaware City’s value in the eyes of potential bidders. However, that alone can not explain Valero’s decision to shutter the refinery, since any sale price would have provided Valero with a greater influx of cash as shown in the table below.
 

Valero likely could have received an EDC equivalent of between US$ 0.20/bbl and US$ 0.40/bbl for Delaware City (between US$ 420 m and US$ 830 m, excluding inventory).  "Even the low end price represents a gain of just under US$ 400 m versus simply closing the refinery.  The higher end price would net Valero around US$ 650 m more than it will receive now," added Alexandra Kirk, Manager, Downstream & Petrochemicals Group at PFC Energy.  However, there are other ways Valero could recoup the difference between selling and closing the refinery.  The elimination of Delaware City’s supply from the market may raise refining margins.  Based on the production capacity of Valero’s remaining network in PADDs 1, 2, and 3 (including Canada), the company would need an additional margin of US$ 0.05/bbl – US$ 0.10/bbl to recoup the difference between selling the refinery and closing it.  Alternatively,  Valero may fill the supply gap caused by Delaware City’s closure by running its Paulsboro refinery, and any of the company’s other refineries that supply the East Coast, at higher utilization rates.  The company has already stated that it intends to raise throughputs, which means that margins may not increase but Valero would effectively be able to sell the same amount of product at a lower overall operating cost.

The question remains, since Valero does not have an integrated position on the East Coast equivalent to a competitor like Sunoco, will the company be able to replace this volume or will others fill this gap.  The answer is probably somewhere in between.  Valero will likely be able to increase its production at its other refineries to some extent while all competitors in the region may be able to benefit from an improvement in margins arising from the net reduction in supply.  Capacity additions in the Gulf Coast, such as Marathon’s Garyville refinery expansion (scheduled for a December 2009 start-up), will also potentially fill some of the gap due to the strong pipeline linkages that exist between that region and PADD 1.  "Ultimately though, unless demand rebounds significantly, all of Delaware City’s volumes will probably not be replaced and refiners in the region should benefit from an improved supply/demand picture and slightly stronger overall margins going forward.

PFC Energy, headquartered in Washington, DC, is a leading strategic advisory firm in global energy with main offices in Houston, Kuala Lumpur, Paris, Beijing, Bahrain, Lausanne and Buenos Aires.  PFC Energy's clients include all major international oil and gas companies, many national oil companies, oilfield service companies, financial institutions and government agencies and ministries involved in energy policy and energy-driven economic development.  PFC Energy's coverage includes competitor analysis, energy sector strategies (exploration and production, natural gas, refining and marketing), commercial opportunities, short and long-term oil, gas and product market projections, carbon strategy and geopolitical forces affecting energy policy and energy economics.