Another Merger
Yesterday Valero Energy Corp. announced it was buying Premcor Inc. Neither of these companies are exactly household names, unless you live in a part of the country where Valero has service stations. Nevertheless, the combined company will control about 13% of US oil refining capacity. The logic behind this merger is entirely different from that of the recently announced ChevronTexaco/Unocal deal. While the latter is driven by geopolitics and the need to boost oil reserves, this transaction is simply another in a series of consolidation plays by Valero, which will end up with 19 refineries, assuming no significant divestitures are required to gain approval.

Premcor wasn't new to the consolidation game, either. Its Port Arthur plant, for example, was ex-Gulf, ex-Chevron, and ex-Clark Oil (the precursor of Premcor.) Delaware City, its crown jewel in terms of upgrading capacity, was ex-Getty, ex-Texaco, ex-Star Enterprise (Texaco/Saudi Aramco JV) and ex-Motiva (Shell/Saudi/Texaco.) The beauty of this approach was that facilities that cost billions to build from scratch could be had for pennies on the dollar, sometimes for little more than the value of the inventories in their tanks.

Refining earnings haven't always been as strong as in the last couple of years. For most of the 1990s and early 2000s the disappointing returns in this segment induced the major oil companies to reduce their exposure and sell off many of the plants that are now in Valero's or Premcor's inventory. This made sense, because for most of the majors "integration" has been merely notional--essentially just financial--for some time. These plants were often not running the companies' own crude production, nor were they critical to supplying their marketing networks; instead, they were widely seen as a portfolio drag, and the equity analysts were clamoring for disposals. The absence of integration benefits made it possible for Valero and Premcor to buy these facilities and replicate the rest of the value chain through astute trading, running whatever crude oil made sense each day and selling products to a combination of term and spot customers.

The really significant outcome of this deal would have seemed unthinkable a generation ago: the largest oil refiner in the US will be a company without a single oil well or high-profile brand. The future course of Valero will be an excellent test of that idea from a stock market perspective. When refining margins weaken again, or refineries become subject to another wave of expensive environmental regulations, it will be interesting to see how the market then regards this giant one-trick pony.