Valero Energy agrees to buy Premcor for $8 billion

By OGJ editors
HOUSTON, Apr. 25 -- Valero Energy Corp. announced plans to buy Premcor Refining Group Inc. and its four refineries for $8 billion. Upon closing, Valero would operate 19 refineries with crude capacity totaling 2.7 million b/cd, according to Oil & Gas Journal's latest Worldwide Refining Survey (OGJ, Dec. 20, 2004, p. 46).

It would become the largest refiner in North America and the fifth largest refiner in the world.

The boards of both companies unanimously approved the acquisition, which must be approved by Premcor shareholders and regulators.

Premcor's assets are a 175,000-b/cd, high-conversion refinery of heavy, sour crude in Delaware City, Del.; a 190,000-b/cd, high-conversion refinery of sweet crude in Memphis, Tenn.; a 237,500-b/cd refinery of heavy, sour crude in Port Arthur, Tex.; and a 165,000-b/cd refinery of sweet crude in Lima, Ohio.

The Lima plant would give Valero, based in San Antonio, entry into the upper Midwest market. Closing is expected by Dec. 31. Premcor is based in Old Greenwich, Conn.

Terms call for the deal to be paid 50% in stock and 50% in cash. Upon closing, Premcor shareholders are to receive 46.7 million share of Valero stock, worth $3.5 billion as of Apr. 22, and $3.4 billion in cash.

In addition, Valero will assume $1.8 billion in Premcor debt. The merger agreement gives Premor shareholders the right to receive 0.99 share of Valero common stock or $72.76 for each Premcor share, or a combination of the two.

Valero Chairman and CEO Bill Greehey told reporters and analysts during an Apr. 25 conference call that he expects the US Federal Trade Commission to approve the acquisition.

Valero can call off the deal if the FTC required it to make any divestitures as a condition of approval. Valero has yet to discuss the matter with FTC officials.

"We feel confident that the FTC should approve this," Greehey said, adding that Valero would be the third largest refiner on the East Coast and the second largest refiner on the Gulf Coast.

Prudential Equity Group LLC analyst Andrew F. Rosenfeld of New York said he was "cautiously optimistic the deal can be approved without major political hurdles or interference."

Given high gasoline prices going into the summer driving season, Rosenfeld said investors should be aware that political factors might come into play.

Rosenfeld expects few reguatory concerns from the FTC based upon an analysis of the specific market that each refinery serves.

"Under our 2004 Refining Capacity Survey data, we estimate that the new Valero would not hold the number 1 market share positions in any US region," Rosenfeld said.

Conversion capacity
The acquisition will increase Valero's capacity to process heavy, sour crude oil, which sells at a discount to light, sweet crude.

"We will have the most conversion capacity of any US refiner," Greehey said. "Of course, the more conversion capacity that you have, the heavier and more sour feedstocks you can run, and the more gasoline and diesel you can make, which allows you to capture better margins."

Valero expects to be able to process more than 1,000 b/d of Mexican Maya and Maya-type crudes by 2007, he said, noting that strategic opportunities existing in both Valero and Premcor systems to increase sour crude processing.

Premcor, in a study with EnCana Midstream & Marketing, Calgary, is examining the feasibility of expanding Premcor's 170,000-b/d Lima refinery and configuring it to process heavy crude from EnCana's oil sands in northeastern Alberta (OGJ, Dec. 6, 2004, p. 9).

Greehey praised the Premcor-EnCana study, calling it "smart." He said Valero's leverage to sour crude discounts is boosting the company's earnings.

As oil demand grows, incremental crude supply is increasingly heavy and sour. Oil of that type makes up about 70% of Valero's crude slate, Greehey said.

Reaction
Standard & Poor's Rating Services lowered its corporate credit rating on Valero Energy and will monitor the company's creditworthiness.

The concern, said analyst John Thieroff, is that "refining margins could weaken considerably in advance of the close, jeopardizing Valero's plans for rapid deleveraging."

Thieroff said, "Additional sizable acquisitions in the near term, unless funded with a very large component of equity, would likely trigger a downgrade as would significant share repurchases done in advance of material deleveraging."

A number of factors, including potential lower commodity prices or slowing oil demand, could result in lower refining margins, Thieroff said, adding that Valero is counting on high margins for some time.

"We are not forecasting that the bottom of the cycle is going to happen next year," he said, adding that his intention was to take a "measured" approach to Valero's debt in case the market changed.

IRG Research analyst Ann Kohler of New York said she believes fundamentals for the refining sector remain "outstanding," particularly for companies like Valero that can process less expensive sour and heavier grades of crude oil.

She said the FTC's biggest concern regarding the Premcor acquisition could be the Delaware City refinery because Valero already has a 166,000 b/cd refinery in Paulsboro NJ.

"That could be a deal breaker," if the FTC asked Valero to divest the Delaware City refinery, Kohler said.

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