By John Auers and Robert Auers
It just so happened that I was Iistening to a Beatles tune when I received a text that Marathon Petroleum was acquiring Andeavor in a mega refining deal just over a week ago. While it wasn’t “Come Together”, that tune seems appropriate as we consider that news. While the $23 billion planned merger is dwarfed by the 1998 mergers of ExxonMobil ($74 billion) and BPAmoco ($48 million), along with the 2000 merger of Chevron and Texaco ($45 billion), if approved it will go down as the biggest deal in the history of the U.S. downstream industry to date. In addition to creating the largest U.S. refiner, it would also continue several trends which have drastically transformed the U.S. refining industry over the last few decades. One of the key shifts has been a movement away from being dominated by integrated majors to one where independent refiners (companies with no crude producing assets) operate the lion’s share of U.S. capacity. The Marathon Andeavor merger also continues the trend of consolidation, with the top five companies now controlling over 50% the domestic industry (vs. 30% 20 years ago) . Also, the merger agreement confirms another trend – refiners seeking to leverage logistics assets. Both Andeavor and Marathon have been active in developing and capturing value from midstream facilities, particularly those that allow their refineries to more cost effectively access crude oil, particularly the growing volumes coming from U.S. tight oil basins. A very attractive part of the planned merger is the synergy between Andeavor’s crude gathering and delivery assets in the Permian Basin and Marathon’s Gulf Coast refineries. In today’s blog, we take a look at how all these trends in the U.S. refining industry have evolved and how they have played a major role in improving the industry’s competitiveness and making it the most dominant refining sector in the world.
“He Say One and One, and One is Three” – A Look Back at the Transformation of the U.S. Refining Industry
The evolutions of both Marathon Petroleum and Andeavor in many ways mirror the overall changes in the corporate structures of the U.S. downstream petroleum industry we highlighted above. Until 2005, when it was spun off, Marathon Petroleum was part of an integrated (although non-major) oil company, Marathon Oil. Even before that spinoff, the refining segment of Marathon had grown significantly through consolidation, particularly the combination with Ashland Oil. As an independent refiner, Marathon grew further through acquisition with the purchase of the giant 450 MBPD Texas City refinery from integrated major BP.
Andeavor’s growth has been even more dramatic and has touched on the same themes of disposal of upstream assets, consolidation and acquisition of refineries from integrated majors. Andeavor, which until just last year, was known as Tesoro, owned only one small, simple refinery in Alaska in 1998 and was primarily known as a producer. Over the next two decades, while selling its upstream assets, it purchased ten refineries, culminated by the acquisition of Western Refining in 2016/17. Several of these plants were bought from major integrated companies, including BP, Shell and Amoco.
The stories behind the growth of Marathon and Andeavor have been repeated throughout the U.S. refining landscape. Valero, who is currently the nation’s largest refiner, has a similar background to Andeavor/Tesoro, down to its San Antonio headquarters location. Like Tesoro, it began life primarily devoted to upstream operations, and owned only a single small refinery in Corpus Christi when it was separated from the production assets in 1997. Through numerous mergers and acquisitions of individual refineries (including from integrated major ExxonMobil), it grew to own over 3 million BPD of capacity, including refineries in Canada and the U.K. The 4th largest refiner in the U.S., Phillips 66, also has a story similar to Marathon, having been spun off from its parent, integrated mid-major ConocoPhillips in 2012. Other independents, such as HollyFrontier, PBF, and Delek have histories more similar to Valero or Tesoro, having grown through either mergers or acquisitions (including from major integrated companies). For other independents (including PBF, PES and CVR), participation of private equity has been an important driving force. Throughout all of this transformation, the footprint of the integrated majors has declined significantly, as they have either spun off their downstream entirely (ConocoPhillips, Marathon) or sold off “non-core” assets to focus more on anchor properties and/or upstream activities. BP is a prime example of the latter, as their U.S. refining capacity has fallen by roughly 50% (from 1.6 million BPD to less than 0.8 million BPD) since 2003. Figure 1 below documents the changing corporate landscape of the U.S. refining industry and the extent to which it has concentrated and become “independent-centric”. (Note: In this chart, “large” independents are those with total capacities greater than 400 MBPD)
“One Thing I Can Tell You is You Got to Be Free” – Advantages of the New Refining Model
The corporate transformation of the U.S. downstream industry has been driven by free market forces, a dynamic which is not present in much of the rest of the world where the refining industry is in many cases either government controlled or highly regulated. Over the last few years we have seen some moves by governments around the world (Japan, Mexico, Brazil, etc.) to unleash free market drivers, but as we’ve experienced in the U.S., where the oil markets were deregulated in 1982, it will take a lot of time and a dedicated and consistent effort for those efforts to be successful.
In the U.S., the first effects of deregulation were a significant rationalization of capacity in the 1980’s, as inefficient plants were shutdown. What was left were larger and more complex plants, capable of running harder to process (and hence cheaper) crudes and turn those into higher valued products at lower operating costs.
The restructuring of the industry came next, as we’ve described above, with the goal toward moving to a more competitive, profit centered model. This is in contrast to the “cost centered” model under which the downstream segment functioned under the old integrated model. This profit center orientation has led to more efficient operations in two primary ways. First, refiners have become more market responsive, adjusting operations and production levels to better reflect market realities. This has led to both fewer product gluts and shortages. Also, there has been a more effective level of capital deployment, with the downstream not having to compete with the sometimes divergent interests of the upstream. It should be noted that even within integrated companies, the downstream segments have become much more independent than in the past and are realizing the same benefits from improved market response and more efficient utilization of capital investment.
Consolidation, both within the ranks of the independents and the majors, has also led to benefits. Among these are the ability to leverage economies of scale, both at the operating level and the corporate level. Inter-refinery synergies are another plus. These synergies can come from crude supply, intermediate product exchanges, better utilization of logistical assets, etc. Cost savings and synergies can be huge; in the case of the Marathon Andeavor combination, the companies have said that they are expected to reach greater than $1 billion per year.
U.S. refiners have benefited from a variety of factors, both in and out of their control in the past decades. These have allowed them to become world beaters when it comes to refining excellence and profitability. Certainly the trends we discussed in this blog – consolidation and a move to a more responsive, independent refinery model – have been key contributors. Another factor was given as a key synergy in the Marathon Andeavor agreement and has been trending across the industry – maximizing the value of logistics assets. We plan to discuss this in more detail in a future blog. The “Coming Together” of Marathon and Andeavor serves to send notice that refiners believe all of these trends will continue to serve them well in the years ahead.
The refining industry is the “bread and butter” of our consulting business here at Turner, Mason & Company. As such, we keenly follow industry developments and trends and attempt to “sniff out” any potential changes in their direction. And changes there certainly will be, all of which will present both challenges and opportunities to the industry. They will come from a variety of directions, including the market environment, government regulation, geopolitics, among others. We are aware of some of these “disrupters” such as the potential of “Peak Oil Demand”, possible new Climate Change Initiatives, IMO 2020 LS Bunker rules, and changing crude qualities, but many others which are yet to be identified could be even more important. We attempt to analyze the possible impacts to the industry of the changing dynamics in our biannual Crude and Refined Products Outlook, which was most recently released in February, with the next issue scheduled for release this summer. On the same schedule, we publish the The Worldwide Refinery Construction Outlook, which provides a detailed list of global proposed refinery construction projects and an estimated likelihood for the eventual completion of each. We are also continually involved in specific consulting engagements to help clients navigate the changing industry environment. If we can be of assistance to you in this way or if you are interested in our various studies, please feel free to call or email us.