2 Refiners Not Bothered by the EPA and 1 That Is

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Last month, the EPA released new requirements regarding the sulfur content of gasoline. Predictable peals of protest followed with claims that the new regulations would cost the refinery business upwards of $10 billion. Valero Energy (NYSE: VLO) immediately criticized the move, claiming it would have to spend $300 to $400 million to comply. Maybe that’s why Valero CEO William Klesse sold 50,000 shares in late March.

Two other refiners simply yawned. Let’s take a look at them all.

Capital gains and distributions, too
As Valero and other refinery stocks dived on the EPA announcement, Calumet Specialty Products Partners (NASDAQ: CLMT) basically shrugged and asked, “Yeah, so?” While Calumet refines crude oil into fuels, its product mix ranges from asphalt to solvents to gels used in personal hygiene products.  Crude oil transportation appeared on Calumet’s radar, possibly adding another dimension to the company.  Oil transportation is a steadily growing business in the American Midwest and would likely provide a solid source of revenue for the company.

Currently, Calumet pays a 7% distribution, sells at roughly 10 times earnings and reported a whopping increase of net income per unit in 2012 over 2011 ($3.50 vs $0.98). Earnings were driven by its fuels division, which more than offset modest declines in other divisions. Distributions also increased from $1.94 to $2.30.

While acquisitions helped the company grow last year, a new refinery should help the company expand in the future. Calumet joined with MDU Resources to build a diesel fuel refinery in North Dakota. Groundbreaking took place earlier this year and the refinery should begin production in about 20 months.

A refiner building its tank car fleet
Another firm forecasting absolutely no impact from the new EPA regulations is Delek US Holdings (NYSE: DK). Delek operates two refineries, logistics services and retail convenience stores. The logistics segment consists of a 62.4% beneficial ownership of Delek Logistics (NYSE: DKL), a master limited partnership that had its IPO last November. The logistics services center on Delek’s two refineries, but offers transportation services to third parties. Delek US Holdings is 68.5% owned by Israel’s Delek Group.

2012 saw Delek delivering great results compared to 2011. Its earnings for the year topped 2011 earnings by 64%. Debt declined significantly courtesy of improved cash flows and the Delek Logistics IPO. In their most recent earnings conference call, Delek management sounded positively glowing regarding their ability to further reduce crude oil expenses.

One aspect of Delek’s cost reduction plan centers on using relatively cheap Midland oil more and other sources of crude less. One way Delek plans to pull this off is to expand its use of rail tank cars to deliver more oil to its refineries. The company has improved its rail terminals and plans on further improvements and adding 100 tank cars per quarter to its fleet for the upcoming year. Delek expanded its tank car fleet from 50 to 500 over the past year, and these new cars should have no problem fitting into its operations.

So what’s the problem with Valero?
Surely, as the world’s largest independent refiner Valero can weather this EPA storm like its smaller competitors? Well, Valero operates 14 refineries, compared to six for Calumet and two for Delek. The current EPA proposal would give small refiners a three year compliance delay. Also, if Delek and Calumet produce sufficient hydrogen onsite for hydrotreating gasoline (the process that removes sulfur), that would give them an edge over a refiner that doesn’t.

So what impact will $400 million have? For 2012, Valero reported refinery related operating income of $4.45 billion. The new EPA regulations would put about a 8%-10% dent into that figure. How much will be passed on to consumers is hard to predict. Some believe the extra expense may force refinery closures that, in turn, will restrict gasoline supply and lead to higher prices.

Perhaps in the long run, Valero might benefit from these new EPA regulations. As pointed out by other Fools, countries in Europe and Asia require low sulfur gasoline. Compliance with these new EPA standards will allow Valero to export to these potentially lucrative markets. This, on top of Valero’s forays into ethanol and biofuel production, may help it perform well in an increasingly environmentally conscious world.

Final Foolish Thoughts
Since the EPA announcement and consequent drop in refining stocks, Calumet is down about 5%, Delek 10%, and Valero about 20%. As a result, Calumet and Valero sell at roughly 10 times earnings, Delek at about 7.5. I believe Calumet’s dividend and “Yeah, so?” announcement helped stem the stock’s decline. Calumet’s diverse businesses and plans for a new refinery in North Dakota position it well for the future regardless of the EPA. I plan to add this income and growth stock on the market’s current weakness.   


Robert Zimmerman owns shares of Calumet Specialty Products Partners, L.P. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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