Valero's grim earnings report typical for refining

The "golden age" didn't last very long, just a few years. But it stood out after years of refining being a horrendous business, so it was notable.

But this past week,Valero Energy, North America's biggest refiner, said it would "severely" cut its 2009 budget and keep run rates in check to deal with "a headwind against demand growth for refined products."

Valero CEO Bill Klesse, usually an optimist during his company's earnings calls, sounded considerably toned down on the Q4 call. He pleaded with industry to cut run rates to help restore margins: "If the industry does not balance supply with demand we will have negative margins again," he said.

Gasoline demand has been especially problematic, with Valero now running its gasoline-making FCC units at about 70-75% of capacity.

To weather the current environment, refiners must "use discipline in matching production with demand," said Klesse. Valero has decided to completely shut its 245,000 b/d Texas City refinery rather than running portions of it while performing maintenance and said a gasoline-making FCC unit has been shut at the Corpus Christi East refinery.

In addition, the company has slashed this year's spending $800 million below the previous $3.5 billion forecast to $2.7 billion, and $1.8 billion below its initial estimate last July. Projects deemed discretionary have been eliminated while others have been delayed, including a St Charles, Louisiana, hydrocracker project and a Memphis, Tennessee, fluid catalytic cracker project that have both been pushed into 2012.

Capex could be cut further, since Valero's "absolute minimum" spending level is $1.8 billion, according to Chief Operating Officer Rich Marcogliese.

There is a silver lining, according to Tristone Capital analyst Chi Chow. He said US first quarter refinery maintenance will be heavy as usual, but with a focus on gasoline-making units like FCCs, along with reforming and alkylation units. "Investors should watch for unplanned outage activity and additional economic-driven run cuts in February as indicators for potential further refining margin upside," he said in a report.

Meanwhile, Valero's budget tightening may include cutting 10% of its 5,000-member contractor workforce for a savings of $50 million/year, Marcogliese said.

Valero spokesman Bill Day noted the company has been looking at staff "efficiencies" for the past two years that has included a reorganization in its retail division. "That process continues, especially in light of the reduction in capital projects we have announced," said Day in an e-mail. "We are also asking managers to take a closer look at underperforming employees. But there are no specific targets for staff reductions, etc."

Valero, formerly a big buyer of assets, will not be "aggressive" in looking for any new refinery purchases in the current market and could close any refineries it is trying to sell that fail to find buyers, said Klesse. Another option would be to convert the refineries into terminals if they can't be sold, he said.

The company has so far been unable to sell three plants it had been marketing including one in Memphis; Ardmore, Oklahoma; and the Caribbean island of Aruba.

"If you don't want them, and you can't sell them, I guess the answer would be 'yes,'" that Valero could close or turn those refineries into terminals, Klesse said in response to a question from an analyst on the call.

Fellow independent refiner Sunoco has said it will turn its 85,000 b/d refinery in Tulsa, Oklahoma, into a terminal by the end of this year if it fails to sell it or find another alternative.