Opinion

Regulations mean profits for refiners like Valero -- but uneasy profits

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Beltway Confidential,Opinion,Timothy P. Carney,Free Market,Oil Exports

Sometimes I think, "Man, I'd love to get my friends in government to rig policy in such a way that nearly guarantees me huge profits."

Then I remember what a dangerous game that is. Today's case study: oil refining giant Valero Energy.

Valero buys crude oil in the U.S., refines it into gasoline, diesel, jet fuel, and propane. It then sells those fuels around the world. So, as a seller of finished petroleum products (fuel), Valero competes in a free market. But as a purchaser of crude oil, Valero competes in a very non-free market. You see, U.S. law basically prohibits the export of crude oil.

The result is that the price of crude oil in the U.S. is lesser than the price of crude oil in Europe. Valero buys its feedstock at a government-suppressed price and sells its final product at the market price. Nice work if you can get it, huh?

But here's a Wall Street analyst explaining why Valero is his "Least favorite commodity stock for 2014":

Over the past few months, momentum has developed in Washington behind a plan to lift the U.S. export ban on crude oil. The result of lifting the ban would almost certainly be a dramatic tightening of the Brent/WTI spread. ...

At the moment, it is too difficult to say how this political game will play out. However, I believe there is a good chance that the export ban is lifted sometime soon. ...

In my opinion being long VLO is a poor risk/reward. If the U.S. government lifts the oil export ban, then refiners such as VLO may have considerable downside.

This is why Valero's spokesman speaks ambivalently about the free market. As I wrote in my column earlier this month:

They don’t oppose free trade, but “Valero’s position is a little bit more nuanced,” [Bill] Day tells me. “Free markets sound great in theory, but … we have to deal with realities, not theories.”

Day points to U.S. restrictions on oil exploration and shipment, and government-protected cartels in the global oil market (such as OPEC) and says, “The reality is there is no such thing as free trade in crude oil.”

Let me finish by reprinting a great discussion, in the L.A. Times last decade, on how environmental regulations profit refiners:

Thomas D. O'Malley, whose Tosco Corp. owned a refinery in Northern California, was among the first to see how he and others would profit from the new regulations.

In a speech to fellow oil executives in Reno less than two years before the new gas was introduced, O'Malley, then Tosco's chairman, predicted that the in-state supply would barely cover demand and that the new formula would command 6 cents a gallon more than the old.

"This is a very finely balanced system," O'Malley told the group. "If any of the large refiners in California experiences an unplanned shutdown, the premium of 6 cents could easily be two or three times that number."

O'Malley underestimated: The premium in times of duress has been more than 40 cents a gallon, Energy Department statistics show.

"My view for the industry was: Why in the world would you fight clean fuels? That's what the consumer wants," O'Malley, now the chairman of Connecticut refiner Premcor Inc., said in an interview. Make no mistake about it, the more stringent you make specifications, those become barriers to entry…. Strong companies would have an advantage."

The state's move to strict new fuel formulas helped put 10 of 31 refineries out of business, cutting oil-refining capacity by 20%, according to the state Energy Commission.

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