Exxon Plans To Boost Its Downstream Profitability With Belgium Refinery Upgrade

Exxon Mobil (NYSE:XOM) recently announced plan to invest over $1 billion in the upgrade of its Belgian refinery. The company plans to install a new delayed coker unit at its Antwerp refinery that will convert heavy, high-sulfur residual oils into products such as marine gas oil and diesel fuel. We believe that the planned refinery upgrade would improve Exxon’s downstream margins in the long run by boosting its yield of higher-margin transportation fuels. ^[1]

Exxon Mobil is the world’s largest publicly traded international Oil and Gas Company. It generates annual sales revenue of more than $420 billion with a consolidated adjusted EBITDA margin of ~14.7% by our estimates. We currently have a $96/share price estimate for Exxon Mobil, which values it at around 11.9x our 2014 GAAP diluted EPS estimate of $8.05 for the company.

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Exxon’s Downstream Margins Have Been Under Significant Pressure

Thinner downstream margins weighed significantly on Exxon’s earnings last year. Almost 80% of the total year-on-year decline in its full-year operating earnings (earnings adjusted for divestment gains in 2012) could be attributed to thinner downstream margins. This was primarily due to industry overcapacity amid sluggish demand and higher crude oil prices. There were certain bright spots as well, such as refineries in the Midwest U.S. that gained from lower crude oil prices due to the fast-growing supply from unconventional plays in the U.S. and a lack of midstream infrastructure. However, the sharp decline in international crack spreads more than offset this advantage for Exxon. ^[2]

Going forward, we expect global refining margins to continue to remain under pressure in the short to medium term due to industry overcapacity, which stems from the fact that governments in different parts of the world are willing to run uncompetitive crude refineries at very low or no returns to sustain employment and reduce their reliance on imported fuels. (See: Key Trends Impacting Global Refining Margins)

Here’s Why Exxon’s Plan To Upgrade Belgium Refinery Makes Sense

Exxon’s decision to invest in a European refinery comes at a time when several refineries across the continent are closing down due to weak demand for petroleum products and increasing operating costs. While the weakness in demand for petroleum products could be attributed to macroeconomic headwinds in the region, the increase in operating costs is primarily due to higher crude oil prices and more stringent environmental regulations. ^[3]

The refining sector in Europe is also facing tough competition from new refineries in Asia and Middle East, which have lower operating costs due to less stringent environmental standards. In addition, refineries in the U.S. that are benefitting from lower operating costs due to cheap natural gas are also giving European refineries a hard time. According to Exxon, energy accounts for about 60% of the total operating costs of a refinery in Europe, but only 30% in the US. Because of these factors, as many as 15 refineries have closed in Europe since 2007 leading to more than 8% cut in the continent’s refining capacity from 15.8 million barrels per day (Mb/d) to 14.6 Mb/d currently. ^[3]

However, Exxon’s Belgian refinery upgrade plan makes sense primarily because of three factors. Firstly, the new delayed coker unit would improve its yield of higher-margin transportation fuels, as it would convert low-value, high-polluting products such as bitumen and high-sulfur marine fuel oil into cleaner products such as diesel and lower-sulfur marine fuel. Thereby, it would also strengthen the competitive position of Exxon’s other refineries in Europe by taking heavy residue from these refineries as input and converting it into usable transportation fuel.

Secondly, the refinery upgrade will allow Exxon to tap into the growing demand for diesel fuel in Europe. Over the past few years, the demand for diesel fuel has grown at the expense of gasoline in Europe because of the shift in European automobile fleet towards diesel-fueled vehicles. From almost even just a decade ago, the use of diesel fuel in transportation has grown to more than 2.5 times that of gasoline in the European Union. Exxon expects the trend to continue as the popularity of diesel cars in Europe continues to increase. Last year, more than half of the new cars registered in Western Europe were diesel powered, compared to just 10% in 1990. ^[4]

Thirdly, increased diesel production would also impact Exxon’s sales volume-mix positively since margins on producing diesel from crude oil are thicker than gasoline. According to data compiled by Bloomberg, gasoline crack averaged at around $8 per barrel last year, compared to $14.3 per barrel for gasoil, a price benchmark for diesel. This could be partly attributed to excess gasoline supply in Europe, while diesel imports by the continent continue to rise. Last year, Europe imported 13% of its diesel, jet fuel and gasoil. ^[5]

We therefore believe that the planned Antwerp refinery upgrade would improve Exxon’s downstream margins in the long run. We currently forecast Exxon’s adjusted downstream EBITDA margins to improve from around 1.6% last year to almost 2% by 2020. However, if its downstream margins improve to around 3% in the long run, there could be a 10% upside to our current price estimate for Exxon Mobil.

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1. ExxonMobil Announces Antwerp Refinery Investment of More Than $1 Billion, exxonmobil.com [↩]
2. Exxon 2013 10-K Filing, sec.gov [↩]
3. European Oil Refiners See Bleak Year, wsj.com [↩] [↩]
4. Betting On Diesel Cars, Exxon Is Set To Expand Belgium Refinery, nytimes.com [↩]
5. Euro Oil Refiner To Keep Shutting Amid Wrong-Fuel Supply, bloomberg.com [↩]