U.S. refiners find benefits in JVs with foreign partners

Former Texaco Inc. refinery at Delaware City, Del., is among assets included in a joint venture Texaco formed with Saudi Aramco in 1988, giving Aramco a 50% share in Texaco's refining/marketing business in 23 U.S. East and Gulf Coast states and Washington, D.C. Photo courtesy Texaco.

The search among U.S. refiners for an edge in domestic processing economics and products markets has spawned a handful of joint ventures with foreign partners.

Driven by dismal refining margins and increasingly competitive retail markets, a handful of U.S. refiners have joined forces with state oil companies from Latin American and Middle Eastern countries.

Texaco Inc. and Saudi Arabian Oil Co. (Saudi Aramco) in 1988 created Star Enterprise through two operating units. Unocal Corp. and Petroleos de Venezuela SA (Pdvsa) followed suit in 1989, establishing Uno-Ven Co.

Shell Oil Co. and Petroleos Mexicanos (Pemex) agreed in 1992 to form Deer Park Refining LP. In 1993, Lyondell Petrochemical Co. and Pdvsa unit Citgo Petroleum Corp. formed Lyondell-Citgo Refining Co. (LCR).

In essence, parties to the U.S.-foreign refining JVs all are trying to improve operating and financial performances through two basic paths.

By combining assets, they aim to cut unit costs by eliminating some logistical and operating inefficiencies. Yet simply putting two organizations together won't necessarily improve margins.

What refining JVs offer prospective partners are opportunities to overcome specific disadvantages. Matching one partner's strengths with the other's weaknesses can create an organization with broader refining capabilities, more capital, access to better crude oil supplies, and better market positions.

A competitive edge

Although U.S. Gulf Coast refiners maintained an average utilization rate of more than 93% in 1995, growth in refined products demand was flat and margins were at their lowest level since 1987. Adding to poor industry performance in the U.S. were incremental growth in distillation capacity and refiners' growing deep conversion capability.

Calvin Cobb, president of Ernst & Young Wright Killen (EYWK), Houston, says that given the underperforming nature of many refining assets, refiners are looking beyond internal strategies to improve business results.

"They're also looking to joint ventures, alliances, and other combinations with other refiners to try to improve performance," he said.

Cobb agrees refiners can gain some administrative and overhead efficiencies by entering into JVs. Incremental gains can also accrue from combining strategic advantages such as advanced processing technology, crude slates, or geographic market coverage.

"If two companies can weave themselves together in a way that one's advantage offsets a disadvantage of the other, they can effectively enhance revenue or reduce costs," Cobb said. "The characteristics of the assets and the businesses that each company operates have a lot to do with whether one of these ventures can really enhance value."

Ernst & Young Wright Killen expects to see more restructuring and changes of ownership in the U.S. refining industry in the next 4 years.

"That restructuring will take place primarily as joint ventures between companies already operating here in the refining and marketing business, and as ventures between foreign oil producers and U.S. refiner/marketers," Cobb said. "We think U.S. refiners are entering the next round of industry restructuring for enhanced performance and increased value creation."

Partners' perspectives

John Jenkins, Pace Consultants Inc., Houston, says two basic factors motivate state oil companies to acquire interests in U.S. refining assets: producers' fear of having no outlet for their crude oil and earnings stabilization through diversification.

For U.S. partners, essentially, the motivations mainly have been need of a secure crude supply and lack of investment capital.

However, because each prospective partner to a U.S. refining JV brings a different set of assets, needs, and goals, the entity created by each JV transaction is a unique reflection of diverse internal organizations, processing capabilities, and market positions.

LCR and Deer Park Refining partnerships are distinctive because they carried the added benefit of an influx of capital from the non-U.S. partner for the purpose of upgrading the refineries. These two arrangements involve major Gulf Coast refineries: Lyondell's 265,000 b/d Houston refinery and Shell's 222,000 b/d plant at Deer Park, Tex.

Both plants were in need of bottoms conversion capacity. An $800 million upgrade at Deer Park, completed last spring, positioned the plant to compete with any refinery on the Gulf Coast, the world's most sophisticated refining center. A $1 billion upgrade program at the Lyondell complex is expected to have similar effects.

Conversely, Star Enterprise, the 50-50 JV of Texaco Refining & Marketing Inc. (TRMI) and Saudi Refining Inc. (SRI) unit of Saudi Aramco, from the start was formed as an integrated refining and marketing partnership.

In addition to three Texaco refineries with combined crude charge capacity of more than 600,000 b/d, one of the main factors motivating SRI to form Star with TRMI was the right to market Texaco products.

"They also bought the brand," said J.W. Burnitt, Star Enterprise vice-president of marketing.

Today the oldest and largest U.S. refining JV involving domestic and foreign partners, with assets valued at $3.5-4 billion, Star Enterprise owns and operates refineries at Delaware City, Del., Convent, La., and Port Arthur, Tex., as well as more than 30 products distribution terminals. The company supplies Texaco products to more than 9,400 Texaco branded service stations in 26 states, including about 1,500 outlets either owned or leased by Star.

The tanker New Assurance in April 1995 delivered the first shipment of Mexican Maya heavy crude from Petroleos Mexicanos to Shell Oil Co.'s Deer Park, Tex., refinery. The 500,000 bbl shipment was fed to a crude unit upgraded by a joint venture of Shell and Pemex to accommodate heavy crudes. Pemex in 1992 acquired a 50% interest in the Deer Park refinery. Photo courtesy Shell.

Lyondell-Citgo

LCR, a limited liability company, was formed in 1993 to upgrade the Houston refinery of Lyondell Petrochemical Co. (LPC) to enable the plant to process more heavy Venezuelan crude oil.

Under the agreement, Pdvsa subsidiary Lagoven SA is to supply crude to LCR under a long-term contract, and Citgo will purchase all plant output.

In return for the products contract, Citgo provided a major portion of the funds for the upgrade project and $100 million in funding for other capital projects.

Citgo is to reinvest its portion of the JV's operating cash flow during the upgrade, scheduled for completion early next year (OGJ, Mar. 21, 1994, p. 60). LPC has unrestricted access to its share of LCR's cash flow.

The upgrade at the Lyondell-Citgo refinery includes modifications to three hydrotreaters, a new gas oil hydrotreater, a new sulfur plant, new crude oil distillation units, and modifications to an existing still. The final unit to be commissioned will be a second coker, scheduled for start-up in early 1997.

A maintenance turnaround on the fluid catalytic cracking unit in the fourth quarter 1996 is to precede start-up of the new coker and distillation unit. When the modified hydrodesulfurization units start up this year, 100% of distillate output will be low sulfur diesel.

As of Jan. 1, 1996, LPC held about a 90% interest in LCR. Citgo's interest will increase upon completion of the upgrade to an as yet undisclosed level.

LCR said, "The repositioning of our refining assets into LCR...has enhanced earnings and cash flow from our refining business-especially in the recent poor refining industry environment-and has reduced overall volatility."

LCR processed a record 138,000 b/d of heavy Venezuelan crude last year. Of this quantity, 114,000 b/d of 22° gravity blended Venezuelan crude was processed in a coking mode. Ultimately, the project will enable the refinery to convert 200,000 b/d of heavy Venezuelan crude to more than 100,000 b/d of gasoline, 70% of which will be reformulated gasoline (RFG).

Although throughput in the existing coker was about 12% less than planned, the unit demonstrated improvements made in 1994 unit turnaround. The refinery also benefited from modifications to its largest distillation tower.

Operating income of LPC's refining segment was $124 million in 1995, compared with $54 million in 1994 and $81 million in 1993. Record aromatics profitability-especially from paraxylene-and increased ability to process heavy crudes enabled LCR to perform well in 1995 despite poor refining margins.

LCR says the structure of its crude oil supply agreement makes its refinery less sensitive to low margins.

Setting the stage

The 50-50 Deer Park partnership of Shell and Pemex shows how a refining joint venture can ease or eliminate significant logistical or operating impediments.

Shell since the 1970s has been a steady buyer of Pemex's heavy Mayan crude. In the course of day-to-day business, the two companies had talked informally about the possible benefits of limited strategic alliances.

Pemex by the early 1990s had been producing more than 2 million b/d of oil for more than a decade, essentially holding output at more than 2.5 million b/d since 1982.

In August 1990, as Pemex oil output was pressing 2.7 million b/d, Iraq invaded Kuwait, resulting in a loss of nearly 4.5 million b/d of supply from world markets. The resultant price shocks subsided in a few months. But the race to replace lost Iraqi and Kuwaiti oil heightened a wave of market realignment already in progress, notably soaring demand in Asia and the collapse in production in the former Soviet Union.

World oil market trends placed a premium on supply security, and refiners became more eager to secure crude. For most U.S. refiners, problems raised by oil market realignment were overshadowed by a funding dilemma.

Amendments in 1990 to the Clean Air Act had instituted a timetable requiring refiners to radically reduce processing emissions while at the same time retooling to produce RFG and low sulfur diesel fuel. U.S. refiners were facing the prospect of spending tens of billions of dollars in only a few years to meet the new standards.

Pemex, meantime, was finding prices unexpectedly soft for Maya crude. Though only a fraction of world oil production, supplies of heavy crude exceeded capacity of refineries to process it. As a result, Pemex was seeking ways to bolster prices for heavy crude while at the same time solidifying Mayan crude's position on world markets.

Pemex had imported 60,000-70,000 b/d of gasoline for some years when in 1991 it was forced to close its 105,000 b/d Azcapotzalco refinery near Mexico City because of environmental problems. With that, Mexico's gasoline import volumes jumped to more than 100,000 b/d.

Forces had aligned to tip the scale for Shell and Pemex to form the Deer Park refining JV.

JV at Deer Park

Pemex in an August 1992 memo of understanding agreed to buy a 50% interest in the Deer Park plant (OGJ, Aug. 31, 1992, p. 28). The purchase did not include the complex's lubricating oils and chemicals plants.

Pemex also agreed to join Shell in a $1 billion program aimed at upgrading the facility's ability to refine heavy oils like Mayan crude into the cleaner fuels mandated by the CAA.

Benefits of the JV were many for both partners. Pemex:

• Secured a market for 150,000 b/d of Mayan crude oil.
• Obtained a steady supply of unleaded gasoline to replace volumes lost with the closure of the Azcapotzalco refinery.
• Staked out a position in downstream markets outside Mexico.
• Positioned itself to begin benchmarking its domestic refining activities. The JV enabled Shell to:
• Gain access to a new source of capital to help pay for upgrades.
• Improve the competitiveness of Deer Park refinery by enabling it to process heavy crude
• Tie up under contract a secure supply of heavy Mayan crude.
• Increase gasoline exports as a hedge against soft domestic demand.
• Position itself to enhance its relationship with Mexico, opening the door to other alliance opportunities that might arise.

By first quarter 1993, partners had kicked off the planned Deer Park upgrade.

Key new process units in the program to refine heavy oil included a 50,000 b/d delayed coker, 32,000 b/d gas oil hydrotreater, two 200 ton/day sulfur recovery units, and a cogeneration plant with capacity to produce as much as 150,000 kw of electrical power and 1 million lb/hr of steam. In addition, a crude distillation unit was revamped (OGJ, July 19, 1993, p. 28).

Partners also installed a 16,800 b/d alkylation unit and a 5,000 b/d methyl tertiary butyl ether plant to enable Deer Park to produce clean fuels components. Work was to be completed by summer 1995.

Mike Dossey, vice-president and business manager of Shell Deer Park Refining Co. (SDPR), says the upgrades were completed ahead of schedule and about $200 million under budget. SDPR operates Deer Park refinery for the Shell-Pemex JV.

How the JV is faring

Since the start-up of JV operations in spring 1995, Dossey estimates, Mexican oil has accounted for about 80% of the crude feed to Deer Park's distillation units.

Shell provides and transports crudes needed for the refinery that are not supplied through the JV agreement. Supplemental oil feedstocks come mostly from other sources in North and South America.

"But as it has developed, in perhaps a natural fit, we're buying a lot of the non-Maya crudes from Pemex, as well," Dossey said.

Deer Park refinery needs a shipment of Mayan crude every 3.3 days, and Pemex has made timely deliveries on all but three occasions. In the first week of January 1996, storms struck Campeche Bay, disrupting lifting operations, and two shipments were delayed. A third shipment was delayed later that quarter when storms rendered Houston Ship Channel impassable.

The late deliveries touched off a series of adjustments at Deer Park. But Dossey says a refiner could run into similar supply problems regardless of his feedstock sources.

Pemex purchases of unleaded gasoline since formation of the JV gradually have declined to 20,000-45,000 b/d. Dossey says the gasoline volumes have decreased mainly because of Mexico's economic slowdown and because Pemex had embarked on a refinery expansion after shutting down the Mexico City plant, reusing a lot of the idled process equipment at other locations.

Rather than cause a big increase in output, the partnership's upgrade created a more environmentally friendly products slate. Dossey says some gasoline and distillate capacity has been added. Installation of hydrotreating technology gave the plant some low sulfur diesel capacity, as well.

Marketing role expands

Underscoring its status as an integrated refining and marketing JV, Star Enterprise in March became a full participant in Texaco's global brand initiative (GBI).

Star's Burnitt was named to chair Texaco's GBI committee.

GBI is a worldwide, comprehensive brand management program aimed at strengthening recognition of the red and white Texaco Star logo and associating it with quality products and services. Main activities of the program include facilities design, training, retail automation, research, and advertising and sales promotion.

The initiative targets several key market segments, including working women and younger, higher mileage drivers.

GBI participants in Texaco's distribution and marketing units developed a prototype retail service station, with the goal of presenting a standardized, uniform image to prospective customers, no matter where in the world they buy or from what type of retail outlet. In addition to Star Enterprise and TRMI in the U.S., Texaco units in Europe, Latin America, and West Africa also are participating in GBI.

Burnitt says GBI began in 1994 as an effort to expand best distribution and retail practices throughout the company. Texaco determined each Texaco marketing group was doing some good things within its own areas.

"But we weren't working as closely as we could at developing efficiencies and achieving synergies as a brand that it was possible to capture in the marketplace," Burnitt said. "GBI became a real driving force for us to basically build on our strengths and minimize our weaknesses."

Seamless brand identity

In a sense, Star and TRMI already have achieved a seamless brand identity.

Star since its creation has distributed and sold Texaco branded products on the U.S. Gulf Coast and the eastern U.S. TRMI's activities are confined to the U.S Midcontinent and West.

But that distinction is lost on most motorists.

John Price, TRMI vice-president of marketing, says the fact that TRMI markets Texaco products in the western U.S. and Star Enterprise in the eastern U.S. is transparent to Texaco customers, from coast to coast.

"Despite all the behind the scenes ownership differences, as far as the format of the brand presentation to the public, there is no difference between TRMI and Star," Price said.

Texaco seeks to extend that uniform image worldwide.

"Whether a motorist drives to Montana, Virginia, or anyplace else where we market, we're looking to standardize our presentation to the best of our ability, no matter what class of trade or which company," Burnitt said. "That was a key factor we are focusing on in our GBI research program."

Burnitt says Star and TRMI are in lock step when it comes to facilities, training, advertising, sales, promotions, and products. Affiliated food brands at Texaco service stations vary because of market differences.

"But from the customer's point of view," Burnitt said, "he looks at the Texaco star."

As part of Texaco's GBI, both Star and TRMI are building Star 21 prototype service stations. By yearend 1996, the units will have more than 500 prototype retail outlets in operaiton.

Assessing JVs' effects

Critics of U.S.-foreign refining JVs say significant questions remain about the effectiveness of the option in boosting performance.

During 1995, all three Star Enterprise refineries completed major upgrades of FCC units expected to boost output of gasoline and other high end refined products by more than 22,000 b/d.

Costs of the upgrades, together with scheduled maintenance programs, masked efficiency gains.

Burnitt acknowledges Star has struggled the past 2-3 years to remain profitable, mostly because of problems confronting all U.S. refiners.

Star's marketing segment, by comparison, has sustained its performance.

"We're happy with our progress but never satisfied," Burnitt said. "We'd like to be building more locations and growing faster. We think we have to have a growth strategy just to survive in the marketplace today."

SDPR's Dossey says it's still a little early to judge the effectiveness of the Deer Park JV, in part because Shell in forming the partnership wanted more than just a partner to help upgrade the plant. "We wanted a relationship that, perhaps, could grow into a strategic alliance," he said.

While the relationship between the partners is on the high side of Shell's expectations, Dossey says decades will be needed to fully assess the JV's effects.

Among the early results, Shell-Pemex JV distributes a higher share of products internationally than Deer Park did before the partnership was formed. Some of the exports in- crease-volumes going to the Asia Pacific, for example-would have occurred anyway because of worldwide demand trends. Whether Deer Park would have been able to serve new regional products had there been no partnership or upgrading program is an open question.

"The upgrading program might or might not have happened without the access to more funding created by the JV," Dossey said. "But the ability to move high quality distillates into the Far East is the result of a design feature of the upgrading."

In any case, forming an international refining JV is difficult enough in its own right. Maintaining the JV and making it successful is a separate concern.

"It doesn't just happen," Dossey said, "and we think we've both worked pretty hard at it."

Dossey said the refining business recently has been so tough that refiners have been forced to find ways to harden their ability to hunker down during business cycle troughs.

"Certainly, the business climate recently has been so awful that it's a good thing we did it this way," he said. "We likely wouldn't have liked the results if we had gone our separate ways."

Copyright 1996 Oil & Gas Journal. All Rights Reserved.