Independent refiners could merge

New York: Small to mid-sized refiners may look to combine their businesses as dismal margins from gasoline production and flagging demand weigh on their results.

The refiners would undoubtedly benefit from the cost savings in these deals, but the lack of available credit could stall them before they get off the ground.

Refining margins have slumped this year, driven down first by high oil prices and then by weak demand. The shares of refining companies have also suffered, dropping about 70 per cent since July of last year. "With those pressures, it would be an environment where small and mid-cap refiners would certainly contemplate consolidation as a way to achieve some synergies and cost savings, and as a way to enhance margins," said Stephen Trauber, a managing director at UBS.

Opportunity

Downturns have historically provided opportunities for players to snap up assets at bargain prices.

Valero Energy Corp, now the largest independent refiner in the United States, bought up many of the refineries it owns today under similar conditions in the late 1990s and early 2000s. "It's an extremely tough environment out there," said oil analyst Jim Ritterbusch, noting that refineries were probably looking to curtail operations in order to "stop the bleeding".

Moreover, consolidation among some of the smaller refiners may be necessary for survival, according to one energy banker who asked to remain anonymous.

The banker said independent refiners, such as Frontier Corp, Holly Corp and Western Refining Inc, could combine to take advantage of cost savings squeezed out of a combination.

Larger refiners formed by these marriages might also be better prepared to weather the current economic storm because they'd have more liquidity and diversity.

As refiners are battered by weak margins, refinery shutdowns are also a realistic possibility, said Mark Gilman, an oil analyst for Benchmark Co in New York.

"The fuse is running out" for plants that are delaying environmental spending through temporary waivers as their deadline for upgrading coincides with challenging economic times, Gilman said.

Sunoco Inc's refinery in Tulsa, Oklahoma, is the most likely closure candidate, but other smaller refiners might also fit the bill, according to Gilman.

The dearth in credit due to the global economic downturn could delay consolidation.

"I think there are comparatively few, one might even say very few, potential buyers of refining assets under the current circumstances. It's credit issues, it's dramatically altered perceptions regarding the immediate to longer term margin outlook. It's a lot of things," Gilman said.

Another factor is the heavy consolidation that has occurred in the last few decades.

Consolidation

In 1982, the US had more than 250 refineries, but by 2008, the number dropped to 146, according to the US Energy Department. Moreover, many of the larger refiners would have trouble doing big deals due to antitrust and market power regulations.

Still, when credit markets open up, there could very well be deals - both single-asset sales and combinations between smaller independent refiners - said Rob Wheeler, managing director in Deutsche Bank's natural resources group.

And refiners might be motivated to sell, despite valuations that have dropped sharply over the last year. "The general view is that the margins we saw in 2006 and 2007 will fade away," Wheeler said. "No one seems to think they can wait it out until things get better."