Wall Street shows renewed interest in downstream sector

Maureen Lorenzetti
OGJ Online

WASHINGTON, DC, Sept. 7 -- Independent oil refiners are benefiting from a new wave of Wall Street buy recommendations this fall thanks to analysts's and company predictions that margins will be stronger this winter than normal because of tight gasoline inventories and refinery downtime.

Refining executives speaking at the Lehman Brothers Inc. Energy CEO Conference all predicted a robust short-term outlook. Frontier Oil Corp., Sunoco Inc., Tesoro Petroleum Corp., Valero Energy Corp. all are seeing investors return to the once moribund downstream sector because of worries that some independent E&P companies are too vulnerable to sudden price corrections in an increasingly unpredictable commodity cycle.

Independents, whether they are upstream or downstream in focus, often challenge analysts on that point. But in the meantime, institutional investors are listening to the analysts, not producers, so independent refiners are enjoying the stock market spotlight.

Thomas Hofmann, Sunoco's vice-president and CFO, made a presentation that was represented the elements attracting investors back to the refining business.

Hofmann said Sunoco has had record results over the past 6 quarters and has more assets and fewer shares. Earnings are expected to be strong for the sector for some time to come.

This week the company announced it would form a master limited partnership, Sunoco Logistics Partners LP, to own and operate a substantial part of its assets. It will file a registration statement in September for a public offering of partnership units.

For Sunoco, the refinery outlook is bright because the company sees increasingly tight supplies for US gasoline, particularly for reformulated gasoline, and Atlantic Basin distillates.

The company also appears to assume that the federal regulators will not change the product specifications for clean gasolines in the near future. Hoffman said regional specifications for those fuels as well as unrelated capacity disruptions will continue to cause spikes in the near term.

Tesoro also is making analysts happy. It completed the acquisition of BP PLC's refining and marketing assets at Salt Lake City, Utah, and Mandan, ND. Closure on a related North Dakota crude gathering system will be handled separately, pending federal regulatory approval (OGJ Online, Sept. 7, 2001).

Valero predicted that its third-quarter earnings will beat Wall Street estimates. It said net income will be $1-1.25/share for the third quarter, at least 20¢/share higher than analysts predicted.

In the long-term, however, Sunoco's Hofmann and other refiners want a clearer picture of what environmental rules will be on the books regarding gasoline and diesel so the right kind of investments are made.

"Tell us what the rules are," Hofmann said. "We can make cleaner fuels to meet air pollution goals but we don' t want have to follow a specific recipe."

Most refiners, whether independent or major, plan to meet low sulfur gasoline rules. The Environmental Protection Agency in 1999 issued a rule that requires industry to lower sulfur to an average level of 30 ppm by 2005.

Industry wide investment is expected to be $3-5 billion, causing a possible 3-5¢/gal increase in gasoline, according to refiners.

The agency earlier this year allowed two small refiners in Kansas and Wyoming up to 4 years longer to meet the specifications.

Diesel sulfur rules are another story.

Industry is still fighting the rules in court, and EPA has signaled it may reconsider its decision to move forward with a Clinton administration era goal of 2006 for the new rules. Refiners say the rules could add 15-50¢/gal to retail diesel prices.

Meanwhile, refiners are trying to predict which plants can meet the various timetables if EPA moves issues the diesel rule.

Frontier officials told Wall Street analysts the company will make low sulfur gasoline on schedule at its 41,000-b/d Cheyenne refinery but it will likely delay the manufacture of 15 ppm low sulfur diesel until 2010. Frontier does plan to make low sulfur diesel on schedule at its 110,000-b/d El Dorado, Kan., plant, but will delay 30 ppm low sulfur gasoline until 2011 so it can spread the capital expense over 10 years.

Contact Maureen Lorenzetti at Maureenl@ogjonline.com.

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