SAN ANTONIO, Texas -- While high crude costs may be weighing on its profits, Valero is bullish in a few areas—namely Mexico, octane and a shift in the point of obligation under the Renewable Fuels Standard (RFS).
In its first-quarter 2017 earnings call, Valero Energy Corp., the United States’ largest refiner, reported a 38% drop in profits thanks to higher crude prices. That said, the San Antonio, Texas-based company saw a few bright spots in its short- and long-term outlook.
Read on for five areas where Valero expects progress in the years ahead.
1. Global fuel demand
Valero is expecting U.S. gasoline demand trends in 2017 to basically be a repeat of 2016.
“Earlier in the year, we saw that gasoline demand looked to be down a little bit, and when we looked at the data more specifically, you could see it was a lot weather-related,” said Gary Simmons, senior vice president of crude, feedstocks, supply and trading for Valero. He said this was especially true on the West Coast, where rainy weather flattened demand.
Volumes for the remainder of the first quarter were consistent with the year prior. Valero expects domestic demand to be "fairly consistent with what we saw last year," said Simmons. Demand for exports, meanwhile, is trending stronger than in 2016, particularly in Mexico and South America.
On a longer-term basis, Valero is expecting a flat trend line at home, but opportunities abroad.
“Our forecast would be that in the next five to 10 years you might see a slight decline in gasoline demand in the U.S.,” said Joseph Gorder, the chairman, president and CEO of Valero. “Diesel will be determined by economic activity, and so we'll just see how that goes.”
“If you think longer term and you think about where demand is going to grow, everything we read is that, globally, you're going to have increased demand for all of our products,” said Gorder. “And so our focus will go beyond the U.S. borders.”
2. Point of obligation shift
Valero was among the parties that petitioned the Environmental Protection Agency (EPA) in 2016 to shift the point of obligation downstream under the RFS. They argued that the escalating prices of Renewable Identification Numbers (RINs), credits that obligated parties such as refiners use to comply with RFS biofuel blending obligations, were harming their business. Last fall, the EPA under President Barack Obama proposed to deny the petitions, but under President Donald Trump it has since signaled it may reconsider the petitions. A comment period for the public and other stakeholders to weigh in on the proposed denial ended on Feb. 22, and the EPA is currently reviewing the feedback.
RIN prices have since fallen from 2016 highs on the speculation of a change; Valero’s own RIN costs slipped 9.3% compared to first-quarter 2016. The refiner paid $749 million for RINs in 2016. Execs were optimistic that the point of obligation would also ultimately shift downward.
“We think the majority of the comments that were filed are in favor of our position and with the new team at the EPA we're really hopeful,” said Jason Fraser, vice president of public policy and strategic planning for Valero. “When they look at the facts we expect them to resolve this question in our favor.”
In terms of a timeline for a decision, “There's no specific deadline on the EPA,” said Fraser. “We think they're diligently looking at this and there's a lot of concern and urgency because of the harm the high RIN prices are doing to the refining sector, so we think it could be done in the next six months if they push it.”
3. BAT adjustment
Some Republicans have proposed a 20% tax on imports to help pay for corporate rate tax cuts; this has also been suggested as a way to pay for Trump’s planned border wall between Mexico and the United States. Early versions of this border adjustment tax (BAT) do not exempt crude oil. Assuming oil imports were subjected to the tax, this could lead to a 13% increase in costs for refiners, according to one analyst’s estimate, and could raise retail gasoline prices up to 30 cents per gallon.
Trump unveiled the outlines of his new tax reform proposal this week, without mention of the BAT. Valero execs did not expect it to resurface, at least in terms of the current tax reform discussion.
“We think the likelihood of the BAT being included in tax reforms declined substantially,” said Fraser. “It's definitely one of the more controversial aspects of tax reform. And with the difficulties the Republicans had with healthcare, we don't see them wanting to take on another fight or create another fight within the party, and the BAT clearly splits the business community.”
Oil analysts have suggested that octane will be the next big battle in the fuel industry for the next 10 years, as fuel refiners and the ethanol industry compete on who is best poised to raise gasoline’s octane to meet the needs of efficient, turbocharged engines coming to the market.
Valero execs were bullish on the potential.
“We think octane is going to be valuable” in the long term, said Lane Riggs, executive vice president of refining operations and engineering for Valero. He pointed to the company’s $300 million investment in an alkylation unit at its Houston refinery, which will enable it to expand production of high-octane gasoline components. “We're looking at other octane capability throughout our system,” Riggs said.
As Mexico deregulates its fuel market, global fuel suppliers are finding an opportunity to expand. In March, BP opened its first of 1,500 planned branded gas stations in the country. Valero also sees opportunity—for its wholesale business.
“Everybody out there is going to be looking at Mexico as a growth opportunity,” said Gorder. “And it's certainly one that is very logical for us to pursue. And so, I think you should assume that it's something that we plan to be involved in. And not only Mexico, but other Latin American countries also.”