Refiners as proxy for demand: layoffs for first time at Valero

Refining margins have been absolutely decimated, especially for refiners of heavy, sour crude like Valero Energy (VLO) and Tesoro Petroleum (TSO).  This is taking a toll on profits in the oil and gas sector, with both oil majors highly leveraged to downstream operations like ConocoPhillips (COP) and independent refining outfits showing steep falloffs in operating margins.  I see this as a proxy for the underlying economic demand in the U.S. economy.


Refining is a cyclical business and this same pattern has been repeated for decades. When times are good, refining margins are high.  But, margins crash down at a moment’s notice, leaving some flat-footed and generating the waves of oil-sector busts of yesteryear. The desire of large firms to move away from Refining and Marketing reflects their desire to be insulated from these swings.

Independent refiners like Tosco, Valero, Premcor, Tesoro, and Giant grew up because of this vacuum left by the majors. Because the world’s refineries are leveraged to light sweet crudes like West Texas Intermediate (WTI), heavy and sour crudes like Maya and Alaska North Slope (ANS) normally sell for large discounts on the spot market. This generated a demand for complex refining capacity capable of processing these crude varieties and offers the independents a natural area of competitive advantage.

Refiners as a proxy

However, this cycle has been especially severe for refiners leveraged to heavy, sour crudes, with WTI-Sour Crude margins averaging $1.34 a barrel for all of 2009. Valero, the largest independent refiner had never had layoffs until now. Below is the beginning paragraphs of today’s VLO press release.

Valero Energy Corporation (NYSE: VLO) announced today that the company is continuing to take action to improve its profitability by rationalizing underperforming operations. As a result, the company’s subsidiary, The Premcor Refining Group Inc., intends to shut down the coker and gasifier complex at the Delaware City refinery. The coker is expected to be idle at least until the outlook for coking economics improves, while the closure of the gasifier complex is for an indefinite period. The company also noted that the plant-wide shutdown of the Valero Aruba refinery is now expected to be for an extended period, and, as announced earlier this year, the shutdown of a coker and a fluid catalytic cracking unit at the Corpus Christi refinery continues, and that cokers at certain of its refineries would run at reduced rates until coking margins improve.

The company expects that these decisions will reduce headcount at the Delaware City refinery by at least 150 employees and 100 contract workers. Valero has notified its employees and contractors along with the appropriate regulatory agencies and union officials. At the Aruba refinery, the company expects that more than 700 contract workers will be released in September.

I imagine this was a hard decision for Valero, a company that was #3 on the list of best companies to work for in America as recently as 2006 and prides itself on taking care of its employees. It is now #91.  But, this is the reality of the refining business in 2009 and it doesn’t speak well to underlying demand in the U.S. economy.

Back in July of 2008, before oil prices collapsed, I saw the reduction in refining margins as a telling sign of weak demand.  The fact that margins remain weak despite incipient signs of recovery suggests that underlying U.S. consumer demand remains weak.  In the last business cycle, margins did not improve materially until 2004 when the employment market picked up and underlying demand growth improved.

  1. aitrader says

    And oil is at $70 dollars a barrel? Color me confused.

    1. Edward Harrison says

      70 dollar oil has more to do with dollar weakness and inflation than it does
      with a resurgence of demand for crude. There a lot of so-called proxies for
      economic activity like FedEx or Cargo shipments or freight traffic. Another
      might be refining margins.

  2. Anonymous says

    nice work ed. what do you make of the sharp drop in consumer debt for june and july?

    1. Edward Harrison says

      It sounds a lot like the consumer deleveraging we expect is happening. The questions now are: 1. will it continue in the face of incipient asset price inflation 2. can it continue if the labor market does not turn around and 3. is it a credit demand or credit supply story?

      My thesis has been it is a credit demand story predicated on the need to deleverage. So far, this seems right.

      1. Anonymous says

        I think that it is truly a credit supply issue since many a dolt binge addicts would continue their ponzi like spending if the fraudulent securitization market practices continued. The retard consumer is feverishly reducing debt because it is plain survival tactics now imo.

      2. aitrader says

        I spell it d-e-f-l-a-t-i-o-n-a-r-y s-p-i-r-a-l.

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