Valero to Buy Rival Oil Refiner for $6.9 Billion

By James F. Peltz

April 26, 2005 12 AM PT

Times Staff Writer

Riding the crest of high gasoline prices, Valero Energy Corp. agreed Monday to buy rival Premcor Inc. for $6.9 billion in a deal that would make Valero the nation’s largest refiner of gas and other fuels.

The proposed acquisition underlines how, in just a few years, refining has evolved from a neglected, low-margin business to one that’s gushing profit because tight supplies and growing demand have sent fuel prices soaring.

Valero, based in San Antonio, has gained more than most. The company specializes in refining heavier -- and cheaper -- grades of crude oil into gasoline, diesel and jet fuel. That provides a wider profit margin per barrel of oil processed.

The company, led by Chief Executive William Greehey, has used a chunk of those earnings to buy other refiners in recent years. It defied skeptics who initially doubted whether prices would climb high enough to justify the buying spree.

Four years ago, for example, Valero acquired Ultramar Diamond Shamrock Corp. for $4 billion, which gave it a much bigger presence in California.

The purchase of Premcor, based in Old Greenwich, Conn., would add four refineries in Texas, Tennessee, Delaware and Ohio to Valero’s current stable of 15 refineries, which includes two California facilities, one in Wilmington and one in Benicia. Two of Premcor’s refineries also process “sour” crude oil, which contains more sulfur than the more expensive and easier-to-refine light sweet crudes.

The transaction would give Valero total refining capacity of 3.3 million barrels a day, surpassing Exxon Mobil Corp. and ConocoPhillips. With Premcor, Valero’s total annual revenue would reach $70 billion.

It’s unlikely that the takeover would have much effect on the red-hot fuel market in California, where state laws require cleaner-burning blends of gasoline and diesel that can’t be imported easily from other states.

That helps keep supplies tight in California, and Valero’s Greehey told The Times in November that his company’s two refineries in the state were near their production limits.

The acquisition is subject to approval by the Federal Trade Commission, and, with the number of refiners shrinking, the deal could get a close look on antitrust grounds, analysts said. Valero said it planned to make investments in the Premcor refineries that could boost their production.

Valero’s latest deal has brought out some skeptics again, this time over whether Valero might be buying Premcor at the top of the market if oil and gasoline prices keep backing from their recent record highs. Valero not only is paying a relatively hefty price for Premcor, but it also would assume about $1.8 billion of Premcor’s debt, less its cash of $800 million.

If prices keep retreating, “refining margins could weaken considerably” before Valero completes the Premcor purchase late this year, Standard & Poor’s Corp. credit analyst John Thieroff said in a conference call with investors. As a result, S&P; lowered Valero’s credit rating Monday.

But investors cheered the proposal as they bid up the prices of both companies’ shares, and some analysts said the refining business should remain strong and buttress Valero’s purchase.

The market “will continue to be tight and robust going forward,” said Colm McDermott, a vice president at John S. Herold Inc., an energy investment firm.

The deal calls for Premcor stockholders to receive either 0.99 share of Valero stock or $72.76 in cash for each share they own, or a prorated combination of the two, because Valero said its overall payment for Premcor would be half in stock and half in cash.

When a company announces an acquisition, its stock price typically falls as investors account for the deal’s added cost to their company. But Valero’s shares rose 83 cents to $75.87. Premcor soared $10.70, or 18%, to $69.70. Both trade on the New York Stock Exchange.

Among the Premcor investors that would receive a windfall from the acquisition is Occidental Petroleum Corp., the Westwood-based oil company, which owns about 9 million, or 10%, of Premcor’s stock.

Starting with one refinery in the mid-1990s, when the refining business was in the doldrums, Valero began making several acquisitions -- at bargain-basement prices -- on the grounds that prices and refining margins were sure to rise.

They did, reaching record highs this month. The lighter, or sweet, benchmark U.S. crude oil hit a record close of $57.27 a barrel April 1, and the average price of U.S. retail regular gasoline reached a high of $2.28 a gallon in the week ended April 11. The California average hit a record $2.592 the same week.

The price hikes have showered cash on the oil companies. Valero’s first-quarter profit more than doubled from a year earlier to $534 million from $248 million, while its revenue climbed to $15 billion from $11.1 billion.

Prices have fallen a bit in the last month, with oil closing Monday at $54.57 a barrel, down 82 cents on the day. The average pump prices for self-serve gas in California slipped 1.9 cents to $2.565 in the week ended Monday, the Energy Department said.

But with no new refineries being built, Greehey said “there is limited refining capacity” to meet the rising demand for gasoline and other fuels, “and it’s going to be that way for quite some time.”

Even if a new refinery was proposed today, it would take four or five years to complete, and “as a result, refining margins should remain strong for the foreseeable future,” he said in a statement.

Yet there’s also the prospect that demand could drop as more consumers tire of high gas prices, which could leave supplies so ample as to bring prices and profits down, said Thieroff of S&P.;

“We’re not necessarily forecasting that,” he said, but “it’s something we have to consider.”

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How the refinery companies stack up

Valero Energy Corp.

* Founded: 1980

* Headquarters: San Antonio

* Types of businesses: Oil refineries, pipelines, storage and fuel retail

* Service area: U.S., Canada and the Caribbean

* No. of refineries: 15

* Daily refining capacity: 2.5 million barrels a day

* 2004 revenue: $54.6 billion

* 2004 net income: $1.8 billion