Valero Energy Corporation - Company Profile, Information, Business Description, History, Background Information on Valero Energy Corporation



530 McCullough Avenue
San Antonio, Texas 78215
U.S.A.

History of Valero Energy Corporation

Valero Energy Corporation operates a specialized petroleum refinery in Corpus Christi, Texas. The company markets the products of this facility--primarily high-grade gasoline--and, through a half-owned subsidiary, sells, stores, and transports natural gas throughout the state of Texas.

Valero was founded as a natural gas pipeline on the last day of the year in 1979. In an effort to diversify itself into a broad-based energy firm, the company purchased a petroleum refinery shortly after its inception. Renovation and start-up of this facility in a difficult world petroleum market nearly put Valero out of business. The company subsequently sold off its gas properties to a limited partnership to retain financial stability and concentrate on its refining activities. Conditions in the petroleum industry repaid this gamble, and Valero thrived in the late 1980s and early 1990s.

The company was created by the Texas Railroad Commission, which regulates energy in Texas, to rectify the misdeeds of the Lo-Vaca Gathering Company, one subsidiary of the Coastal States Gas Corporation, Valero's corporate precursor. In the 1960s Coastal's chairman, Oscar S. Wyatt, Jr., had signed contracts to deliver gas to many customers, including several large Texas cities, at low prices, with the expectation that costs for gas would not rise. By 1972 and 1973, however, gas prices had gone up dramatically, and the company was not able to fulfill its contracts. The Texas regulatory board allowed Coastal to pass on its higher prices to customers and to make a small profit, rather than see the company go out of business. The question of the penalty for Coastal's broken contracts became a matter of litigation that stretched through the mid-1970s.

Finally, in December of 1977, the Commission ruled that Coastal would have to refund $1.6 billion--more than the company was worth--to its customers. To satisfy this ruling, Coastal's intrastate Texas gas-gathering pipeline was spun off into a new company, Valero. Former Coastal customers were awarded 55 percent of the new company's equity, while the other half went to Coastal's shareholders, with the exception of Wyatt. In addition, Coastal was ordered to spend $230 million exploring for new gas over the next decade and a half. Any new gas found would be sold to Valero at a rate 15 percent below the current market price. Valero also got a $110 million chunk of Coastal stock.

Thus, at its birth, Valero became the largest intrastate pipeline in Texas, with 8,000 miles of transmission lines, assets worth $700 million, and start-up revenues exceeding $1 billion. In addition, Valero had the right to charge customers ten cents per million cubic feet (mcf) over its cost of gas in its first year, and 15 cents over mcf in its second, guaranteeing the company a profit of at least $23 million. Valero's stock was slated to be listed on the New York Stock Exchange shortly after its formal inaugural.

To separate itself from its corporate parent, Valero chose to locate its headquarters in San Antonio. The city was both the company's largest customer and an outpost 200 miles from Coastal's Houston home. The company's name was taken from the Mission of San Antonio de Valero, the original name of the Alamo. As its president, the company chose Bill Greehey, formerly the court-appointed head of Lo-Vaca. Greehey had been instrumental in negotiating the out-of-court settlement that resulted in Valero's formation.

Beyond Valero's basic gas business, Greehey planned to expand into gas storage and oil and gas exploration, as well as coal and oil refining. He planned to make Valero a "fully integrated energy company," as he told a Fortune correspondent in January of 1980.

In its first year of existence, Valero moved quickly to solidify its position and expand into the nonregulated areas of its industry. The company tapped into new supplies of gas, signing contracts in Mexico and Texas, and also added new storage facilities. Announcing that it would spend $14 million expanding its production of natural gas liquids--which at the time were selling at high prices--the company planned to build a $10.2 million processing facility and construct a 25-mile pipeline. Valero also spent $4 million on tentative moves into the gas exploration and drilling business.

Valero made its most significant investment late in 1980 when it bought a one-half interest in Saber Energy, Inc., a small marketer of gasoline, for $51 million. With its new partner, Valero planned to turn Saber's tiny gasoline-producing operation in Corpus Christi, Texas, into a state-of-the-art specialized refinery. The facility was designed to use the product at the bottom of a barrel of crude oil--a high-sulfur, tar-like substance known as atmospheric residual oil (abbreviated "resid")--as its raw material, or "feedstock." Resid was obtained as a by-product of the processing of raw crude oil and generally cost significantly less than a barrel of crude, which was the feedstock of a conventional refinery. By cracking resid in a complicated and expensive process, Saber's refinery would create high-quality gasoline. In the Saber partnership, the company made its bid to become a broad-based energy concern.

In 1981 Valero embarked on the construction of the new refining facility, which was slated to cost $100 million. In addition, the company revamped its somewhat ineffective exploration and production operation, moving aggressively to get under way and opening regional offices in Midland and Houston, Texas; Denver, Colorado; and New Orleans, Louisiana. By the end of the fiscal year, Valero's net income had risen to $97.3 million, an increase of more than 50 percent from the previous year.

By 1983 Texas was in the grip of a severe recession, and Valero's outlook was growing less rosy. The company's earnings from its core businesses--gas sales and transportation of other people's gas through Valero's pipelines--went into decline. In an effort to counteract losses, Valero joined in industry efforts to encourage the shipment of gas directly to large commercial customers, which helped somewhat to prop up its earnings.

In its new endeavors, Valero had mixed success. Although the company had spent $100 million on exploration, it had yet to benefit from these efforts. Valero's natural gas liquids business, however, proved prosperous. The company had increased its gas liquids capabilities by 50 percent, building eight plants at a cost of $150 million to stockpile ethane, butane, and propane, and these facilities contributed significantly to Valero's profits. "If not for gas liquids," Greehey told Business Week in 1983, "we would have been in trouble."



The biggest problem proved to be Valero's large investment in the Saber gasoline refinery. Two years into the project, estimated costs had reached $617 million, the most ever spent per barrel of oil on a refinery. Valero had taken on $550 million in debt to finance construction, and by 1983 the project was behind schedule. Experiencing difficulties meeting federal air pollution standards, the company was forced repeatedly to postpone full start-up of the facility. In addition, the economics of the refinery had shifted significantly since the project's inception. When Valero had started out, resid had been very cheap, while gasoline, the refined product, had been selling at a relatively high price. This justified large expenditures to convert one into the other. By 1983, however, the cost of Valero's raw materials had risen, and an oversupply of gasoline had driven prices for its end product down, dramatically reducing the potential profitability of the refinery.

The cost of raw materials for Valero's refinery was driven up further in 1984 when Great Britain suffered a coal strike. Unable to use coal as a fuel, British industry turned to resid instead, driving the demand and the cost of Valero's feedstock to unexpected heights, which at times exceeded the cost of straight crude oil. As a result of this stroke of bad luck, Valero's Saber refinery had still not become profitable by the middle of 1984.

Valero had certified to its lenders that the refinery was up and running two months after it had originally planned, but even after this step was taken, low gasoline prices meant that the plant was operating at a loss. In August of 1984 heavy trading of Valero's stock prompted speculation that the company would be the target of a take-over.

Saber posted losses of $53 million in the first half of 1984, and by that fall, its rapidly weakening financial condition had obligated Valero to buy out its partner. In doing so, Valero added Saber's substantial debts to its own large tally of borrowed funds, doubling its overall level of long-term indebtedness. As a result, the company was forced to omit a dividend to its shareholders in the quarter in which the consolidation was made. To placate its worried bankers, Valero agreed to limit its spending on other areas of its business while it postponed payments to the bank on its loans. With this news, the price of the company's stock sunk to its lowest point, as investors anticipated the company's possible bankruptcy.

In an effort to shore up its financial condition, in February of 1985, Valero entered into an agreement with Techniques d'Avant Garde Group SA, known as TAG, a holding company controlled by Saudi Arabian Akkram Ojjeh. TAG invested $15 million in Valero as part of an agreement that the Saudi investor would raise its interest in the company to one third if Valero could locate a cheap source of raw materials for its refinery. In a second bid to raise funds, Valero sold off a 50 percent interest in its West Texas pipeline system to InterNorth, an energy company based in Omaha, Nebraska. The sale brought the financially beleaguered company $68 million.

By late spring of 1985, more favorable conditions in the energy industry as a whole had begun to lift Valero's prospects. As costs for crude oil by-products fell and the price of gasoline rose, the Saber refinery was able to increase its earnings, posting a small operating profit for March. Despite this good news, the company temporarily suspended its production of gasoline at the Saber facility, resuming operations in June. The following month, Valero's agreement with TAG, the Saudi investor, was called off. At the end of 1985 Valero reported losses of $16.1 million.

By early 1986 Valero was also suffering from a glut in its original field, natural gas. Unable to sell the gas it had contracted at its founding in 1979 to buy from its corporate parent, Coastal, Valero refused to fulfill its contracts and in January, was sued by Coastal for $243 million in the first of a number of "take-or-pay" suits over gas purchase agreements that would not be resolved until the end of the decade.

In an effort to strengthen its financial position, Valero restructured $700 million of its debt in April of 1986 and got out of the coal business by selling off the mine it owned in Indiana. Unable to make its expensive Saber refinery profitable given conditions in the world oil market, Valero began to informally hunt for a buyer for the facility. Despite the drain on funds by the unprofitable refinery, however, improved performance in Valero's pipeline operations enabled the company to finish the year in the black, posting profits of $34.7 million.

Faced with the problem of a profitable gas business that was carrying a money-losing refinery, Valero significantly restructured itself in early 1987. The company spun off its natural gas pipeline and natural gas liquids businesses into a limited partnership, in which it would hold a 49 percent share. For this portion, Valero turned over $184 million of its own money, as well as $191 million contributed by public equity investors. The remainder of the gas partnership's funding was raised through the issuance of $550 million in notes. In addition to these moves, Valero abandoned its attempts to find oil and gas reserves, shutting down its exploration activities.

With the money from the divestiture of its gas assets, Valero was able to reduce its dangerously crippling debt load by more than $700 million, restoring its balance sheet to relative health. This meant, however, that the core of the company was its money-losing refinery. Valero lost $13.3 million in the first six months of 1987 on its refining and gasoline marketing activities.

By 1988, however, the climate for petroleum refining had improved, and Valero began to see a turn-around in its fortunes. Lower prices for its raw materials, coupled with reduced gasoline inventories and growing customer demand, enabled the company to turn a profit of $13.2 million in the first half of the year. Noting that the recent turmoil in the oil and gas industry had put many refineries out of business, Valero's leaders were confident that domestic demand for gasoline would continue to exceed refining capacity, keeping prices high. In addition, the company counted on the fact that the product it refined was high-quality, high-octane, clean-burning unleaded gas, for which it anticipated a growing demand.

On the supply side, Valero noted that prices for resid had fallen as stockpiles had grown, and the company moved to upgrade its refinery, increasing capacity. To assure future steady supplies of raw materials, the company sought to take on a foreign petroleum producer as a joint owner in the refinery. Valero ended 1988 with $30.6 million in posted profits.

The company's fortunes continued to improve in the following year. Valero's half-owned natural gas operations had profited from the deregulation of the gas industry; it increased its sales by adding customers outside Texas. The company was able to transport, through interstate gas pipeline link-ups, and sell gas to clients in other states and in Mexico. Its number of gas processing plants had grown to 11.

Valero also continued to upgrade its oil-refining facilities. The company added a device that enhanced the octane level of the gas it produced and also constructed a natural gas processing plant that split the gas into products to be used in petrochemicals or oil refining activities. In 1989 Valero announced that it would own a 20 percent stake in a planned $104 million plant for processing gases given off in the refining process in Corpus Christi, Texas. These measures, along with the reduction in Valero's debt load, allowed the company to reduce its break-even point for a barrel of refined oil from $6.00 when the plant had started up, to $3.60 in 1989. As a result of refinery upgrades and the strengthened market, Valero was able to restore its dividend payment in a sign of fiscal health in the second quarter of that year. The company finished 1989 with profits of $41.5 million.

Valero's recovery from the severe difficulties it had experienced in the mid-1980s continued as the company moved into the 1990s. The world oil industry was thrown into turmoil in August of 1990 when Iraq invaded major oil producer Kuwait, driving up the prices of both crude oil and refined petroleum products. With this increased activity, Valero contracted for an additional $200 million investment in its refinery facilities. The company ended the year with earnings of $94.7 million, nearly double those of the year before. In a reversal of earlier conditions, petroleum refining accounted for a vast portion of the profits, while the company's interest in its natural gas partnership contributed only 20 percent of the company's returns.

The outbreak of the Allied offensive in the Persian Gulf in early 1991 immediately drove petroleum prices down. In anticipation of this effect, however, Valero had sold much of its first quarter production in advance at inflated prices and added $30 million to its balance sheet. Although Valero lost money when it was forced to shut down part of its production to make improvements to its plant, the company completed 1991 with record profits of $98.7 million.

Looking to profit from the general move toward more environmentally conscious, cleaner-burning fuels, such as natural gas and the high-octane products refined at its Corpus Christi facility, Valero continued to upgrade its plants in 1992. In addition, the company expected that by 1994 their entire gasoline output would be made up of reformulated gasoline. With an eye to further expansion, the company solidified its balance sheet by repurchasing the outstanding shares of an old stock offering and sought permission to raise money for expansion by issuing new stocks. Valero also opened an office in Mexico City, in an effort to enhance its relationship with the Mexican government and assist it in its search for clean energy.

As it moved into the mid-1990s, Valero had solidified its position in the petroleum industry. With its high-tech refinery, the company appeared well positioned to prosper in the coming years.

Principal Subsidiaries: Valero Natural Gas Partners, L.P. (49%); Valero Refining and Marketing Company.

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