Chevron (NYSE:CVX) recently started production from the new base oil plant at its Pascagoula refinery. As the plant ramps up to its full capacity, Chevron will become the world’s largest premium base oil producer. We expect the $1.4 billion plant to improve Chevron’s downstream profitability in the long run. 
California-based Chevron is the second largest energy company in the U.S. after Exxon Mobil (NYSE:XOM). The company manages its investments in subsidiaries and affiliates, for which it provides administrative, financial, management and technological support. This extends both to its U.S. subsidiaries and to its international subsidiaries, engaged in fully integrated petroleum, chemicals and mining operations, as well as power generation and energy services. It generates annual sales revenue of around $230 billion with a consolidated adjusted EBITDA margin of ~21.8%.
We currently have a $128/share price estimate for Chevron, which is almost 12x our 2014 full-year GAAP diluted EPS estimate for the company.
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Base oils are used in the manufacture of lubricants that are primarily used to reduce friction between moving parts in engine applications such as turbines, passenger cars, heavy-duty diesel trucks, buses, ships, locomotives and motorcycles. Growing industrialization and the need to meet higher-quality motor oil specifications is driving the demand for premium base oils globally. By 2025, Chevron expects global base oil demand to grow by 97% from 2010 levels. 
The American Petroleum Institute (API) classifies base oils into 5 groups according to characteristics such as sulfur content, saturated paraffin content, viscosity and pour point. Group I base oils have lower saturated paraffin and higher sulfur content than other base oil groups. On the other hand, Group II and III base oils have higher saturated paraffin and lower sulfur content.
The demand for Group II and III base oils has been growing rapidly over the past few years due to more stringent environmental requirements that have lead to stricter performance standards for lubricants. A recent study suggests that the use of Group II base oils has grown significantly from around 20% of the plant capacity under study a decade ago to 47% now, while the use of Group I base oils has declined by 50% to just 28% of the plant capacity over the same period. 
Chevron produced 25,000 barrels of Group II base oil per day last year from its refineries in South Korea and Richmond, California. The recently started base oil plant at its Pascagoula refinery will double the company’s Group II base oil production capacity by the end of the second quarter. This will make it the world’s largest premium base oil producer. 
We believe that the new plant would improve Chevron’s downstream profitability by positively impacting its product mix towards more premium end products that are expected to have a higher demand growth trajectory, primarily driven by more stringent environmental requirements. Last year, Chevron’s downstream earnings declined almost 50% y-o-y due to thinner refining margins. This was primarily because of global overcapacity in more commonly available refinery end products such as gasoline and diesel. The scope of improvement in crack spreads of these end products is limited as 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. Therefore, companies like Chevron and Exxon Mobil are expanding their capacity to produce more premium end products that have higher margins.  Last year, Exxon Mobil too announced plans to expand its Group II base oil production capacity at its Baytown, Texas refinery. Notes:
- Chevron’s new $1.4B base oil plant up and running, wlox.com [↩]
- Chevron Corporation’s 2014 Security Analyst Meeting, chevron.com [↩]
- Understanding The Differences In Base Oil Groups, machinerylubrication.com [↩]
- Chevron 2013 10-K SEC Filing, sec.gov [↩]
- BP Drops Plans to Invest in China Refinery Project, IEA Says, bloomberg.com [↩]
- Base Oils 2014: Move To Lighter Base Stocks Accelerates, icis.com [↩]