R&M firms turning more to mergers to cope

Anne Rhodes
Associate Managing Editor-News

Thi Chang
Refining/Petrochemical Editor

Refiner/marketers increasingly are turning to mergers and acquisitions (M&A) to cope with an industry beset by low margins, increased competition, and greater environmental regulation.

That was evident in a panel discussion on downstream M&A activity and press briefing at the National Petroleum Refiners Association's annual meeting in San Francisco last week.

M&A factors

According to Steve F. Venner, vice-president of Bonner & Moore Associates Inc., Houston, several factors are responsible for increased M&A activity. These include rising environmental compliance costs, regulatory uncertainty, global overcapacity leading to cheap imports, and fierce competition among domestic markets.

"There is a tremendous amount of competition in this industry," said Roger Hemminghaus, outgoing NPRA chairman and chairman of Ultramar Diamond Shamrock Corp. "We could undergo significant consolidation, and there still would be tremendous competition."

Venner said he has seen estimates of savings as a result of mergers in the range of $0.25-1.30/bbl. Because merged companies will need to rely on expensive outsourcing, however, Venner speculates that the actual savings are probably 15-50% less than the estimated amount.

Consolidation

The recent spate of M&A activity is the result of what Hemminghaus calls the "tough rates of return" experienced by refiners in recent years. "The rate of return in this industry has been very anemic for a number of years," he said.

As a result of consolidation, there are now only about 75 refining companies in the U.S., he said.

According to Calvin Cobb, managing director of Ernst & Young Wright Killen, Houston, joint ventures will eliminate average-sized refiners.

"Our current future industry model suggests that 12 companies will have 80% of crude processing capacity and one half of the refineries."

Despite industry consolidation, NPRA's membership roster continues to grow. The growth is the result of the addition of members from the petrochemical industry and of an increase in the number of non-U.S. refiners that are NPRA members.

These growth areas are indicative of two important industry trends: integration with related industries and globalization.

Gasoline sulfur

Hemminghaus outlined a number of environmental initiatives that could have important consequences for the refining industry.

These include reductions in gasoline sulfur levels, tightening of the U.S. National Ambient Air Quality Standards (Naaqs), and the effect on fossil fuel use of the Kyoto climate change protocol.

The U.S. Environmental Protection Agency plans to submit to Congress this summer a report on future vehicle emissions standards. These Tier 2 emissions levels will apply to new vehicles starting in 2004-06.

Although the Tier 2 gasoline sulfur specification has not yet been determined, an auto industry study of low-emission vehicles (LEVs) and ultralow-emission vehicles looked at the effects of reducing gasoline sulfur to 40 ppm.

Such a move would cost the refining industry $5-6 billion/year, or 5¢/gal of gasoline, said Clint Ensign, vice-president, government relations for Sinclair Oil Corp., Salt Lake City. This is roughly equal to President Clinton's estimate of the total cost to the U.S. of the Kyoto climate change proposal, casting further doubt on Clinton's figures.

"Stringent gasoline sulfur control requirements may be a means of helping demonstrate U.S. commitment on global climate change," said Ensign. But, he said, "because 90% of the U.S. population, excluding California, lives in a county that meets all of the Naaqs, 40 ppm gasoline sulfur-control nationwide could be fuel over-regulation." In addition, LEVs will meet most emission standards when burning gasoline containing 330 ppm of sulfur-today's average.

NPRA is conducting a survey of its members in order to determine a consensus on appropriate gasoline sulfur levels. A task force will then devise a recommended gasoline sulfur level for the U.S. refining industry.

"Sulfur in gasoline, at the levels at which it exists today, is not necessarily an environmental issue," said Robert H. Campbell, incoming NPRA chairman and chairman of Sun Co. Inc.

Consequently, said Campbell, when dealing with the issue of sulfur in gasoline, industry must work with the automobile companies to determine the most economic way to address the issue.

It's going to take a combination of fuel and automobile changes to solve this problem, said Hemminghaus. But, whatever happens, it will mean significant expenditures on the part of fuel manufacturers, he predicted.

Climate change

NPRA also has formed a strategic planning committee to help it deal with issues such as the Kyoto climate change initiative.

Hemminghaus said, "I think that most of the people in the industry are concerned that there is no good science with which to develop a common position. And so we really need some additional research on what is the effect of greenhouse gases that are emitted by mankind.

"It's very difficult to reach a consensus without good science," said Hemminghaus, "because we are a technical industry, a scientific industry. We all are aware of the additional greenhouse gases that all of mankind is putting into the atmosphere. But many of us question whether there is any science whatsoever that indicates that that is really causing any kind of global warming."

"That (Kyoto) protocol will certainly put the U.S. at a significant disadvantage relative to developing countries and relative to European countries," said Hemminghaus. "Unless developing countries are included in that protocol, we won't be accomplishing anything."

Given the record of the international community on matters of common importance, Campbell said it may be another century before the U.S. Congress approves the Kyoto protocol. Before that happens, industry will probably take steps on its own initiative, on a voluntary basis, he predicted.

Outlook

In addition to increased competition, U.S. refining margins haven't picked up much, in spite of recent low oil prices, said Hemminghaus.

"Most of us are processing crude oil that we acquired 45 days ago and selling that into a falling marketplace. The real margins that we see are relatively squeezed."

Despite this and other challenges, however, the overall outlook for the U.S. refining industry is reasonably positive, said NPRA President Urvan Sternfels. "Demand is up, and oil prices do not appear to be poised to increase in the near term."

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