The recent financial crisis and recession marked some of the darkest days for US refinery operators. During this period, global oil demand contracted, pushing inventories of crude oil and refined petroleum products to elevated levels. Depressed profit margins in many developed economies prompted refiners to shutter their least efficient facilities to reduce capacity.

Over the past few years, integrated oil companies have sought to rationalize their downstream (i.e., refining and marketing) operations, divesting less profitable refineries in the US in favor of facilities in the Middle East and Asian emerging markets, two regions that offer superior margins and growth prospects. The list below provides an overview of what some of the world’s biggest oil and gas companies have in store for their downstream operations.

• BP (LSE: BP, NYSE: BP) in early 2011 announced plans to roughly halve its US refining capacity and has placed its Texas City and Carson, Calif. on the sales block.
• Chevron Corp (NYSE: CVX) is in the midst of a three-year plan to rationalize its downstream operations. At the end of 2010, the company had exited seven countries and most markets on the US East Coast. In the first quarter, Chevron announced the sale of its Pembroke refinery and associated marketing assets in the UK and Ireland. Meanwhile, the company completed the sale of its downstream operations in the eastern Caribbean and several African nations. Management also announced a deal to divest its downstream operations in Spain.
• ConocoPhillips (NYSE: COP) has established a goal of reducing its downstream exposure to 15 to 20 percent of overall revenue from 20 to 25 percent of revenue. In 2011 management plans to sell $1 billion worth of downstream assets.
• Royal Dutch Shell (NYSE: RDS.A) has been restructuring its downstream operations since 2009 to divest smaller facilities and focus on Asia-Pacific and other markets with high growth potential. By 2012, management expects to reduce its downstream portfolio by a further 700,000 barrels per day.
• Total (France: FP, NYSE: TOT) plans to lower its gasoline output by 60 percent and has placed its UK Lindsey refinery, which accounts for 20 percent of its overall capacity, on the sales block.

Independent US refiners have also moved to reduce capacity, selling or closing smaller (and therefore less-efficient) plants on the East Coast–a highly competitive region that lacks access to cheaper domestically produced crude oil. The majority of oil refined at East Coast facilities arrives via tanker from Nigeria, the North Sea and other international locations.

• Valero Energy Corp (NYSE: VLO), the largest US independent, sold its Delaware City and Paulsboro, N.J. refineries.
• Sunoco (NYSE: SUN) in 2009 shuttered its Eagle Point refinery in Westville, N.J.

These efforts to reduce US refining capacity–primarily by closing smaller, less-efficient facilities–have improved the industry’s profit margins, while a recovery in US oil demand has also contributed to refiners’ newfound profitability. As you can see, the market has picked up on these improving fundamentals.

Source: Bloomberg

Over the past year, the Bloomberg North American Refining & Marketing (a proxy for independent US refiners) has soared 68.1 percent year, compared to the 19.3 percent gain posted by the S&P 500. Readers of The Energy Strategist got in on this rally in early 2010, when Elliott highlighted his favorite independent refiner and noted that sentiment toward the sector was almost universally bearish despite its improving prospects–the ideal time to buy.

For some refiners, these favorable fundamentals have been augmented by a widening spread between the price of light, sweet crude oils and heavy, sour varieties such as Maya crude oil, which is produced in Latin America. Companies with “complex” refineries have the ability to process heavier grades of crude–varieties that often trade at a discount to West Texas Intermediate and Louisiana Light Sweet crude oil–typically enjoy superior margins.

At the same, the widening spread between the price of West Texas Intermediate (WTI) crude (a popular US benchmark) and Brent crude oil (a European benchmark that better reflects trends in global oil demand) has generated huge returns for some refiners. Check out the gaudy margins posted by Holly Corp (NYSE: HOC) and Frontier Oil (NYSE: FTO), two names with heavy exposure to the Mid-Continent region–Arkansas, Kansas, New Mexico and Texas. Note that these two refiners merged in a deal announced at the end of the first quarter.

Source: Bloomberg

Elliott Gue discussed this divergence at length in Oil Prices: Buy the Dip in Energy-Related Stocks, but here’s a refresher. WTI generally commands a slight premium to Brent crude oil, but that relationship has reversed over the past 12 months. Local supply conditions at the physical delivery point in Cushing, Okla. are the culprit: Rising US imports of Canadian oil, higher domestic output from shale oil fields and an uptick in ethanol production have prompted pipeline operators to add new lines or reverse the flow of existing lines to carry crude south to Cushing and other refinery centers.

This shift has not only glutted storage facilities at Cushing, but the reverse pipeline have limited flows out of the hub. When an influx of crude oil overwhelms refining capacity, stockpiles build, and the price of WTI declines. This logistical logjam can only be resolved by the construction of new pipelines to move crude oil from Cushing to the Gulf Coast, an area that’s home to about 30 percent of the nation’s refining capacity.

Needless to say, this tailwind should be in play for some time–a huge boon for companies whose operations are concentrated in the midcontinent area. The months in the lead up to summer driving season historically have been the strongest period for shares of independent refiners. At these levels, valuations are a bit rich for new money, but investors should focus on names with Mid-Continent exposure that also have the flexibility to refine heavier grades of crude oil.

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