Insight: Lost in translation: U.S. refining model floors Petroplus

CORRINGHAM, Britain Wed Apr 4, 2012 9:30am EDT

1 of 3. The Petroplus refinery is pictured in Cressier near Neuchatel, in this file picture taken May 12, 2011.

Credit: Reuters/Denis Balibouse/Files

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CORRINGHAM, Britain (Reuters) - Flush with success in building up his oil refining business in the United States, New Yorker Thomas O'Malley was confident he could repeat the trick in Europe at the helm of Petroplus.

Now the man nicknamed the "godfather of refining" has gone, Swiss-based Petroplus is in administration and only one of its five refineries has avoided at least temporary closure.

The future of all five remains in doubt, threatening thousands of jobs in central and northern Europe.

O'Malley arrived in 2006 at Petroplus, a company founded by two Dutchmen steeped in the European oil industry, just as the big oil majors were selling refineries across the continent even though refinery profit margins were enjoying a rare upturn.

Under his leadership Petroplus became Europe's largest independent refiner by capacity, but over time the oil majors' decision to step back from refining proved wise.

By contrast, O'Malley pursued what turned out to be a disastrous strategy, displaying bad timing and a poor understanding of how the economics of the refining industry varies between regions.

Like so many businessmen, the self-confessed "short, bald Irishman" from a working class New York City background, failed to foresee the global financial crisis which struck in 2008, and the consequences for fuel demand.

"The future can never be certain, but it is my belief that we will continue to see strong refining margins well into the next decade," O'Malley said in the company's 2006 annual report.

Within a couple of years, the economic boom had turned to bust. Refining margins - the value of oil products over the cost of the crude from which they are extracted - collapsed and Swiss-listed Petroplus began its long decline.

Struggling with thin margins and slack demand, Petroplus ultimately went down when the cost of credit rose and its creditors pulled the plug.

FROM PETROPLUS TO PETROMINUS

In January this year the company declared itself insolvent and went into administration. O'Malley is back in the United States, pursuing another project in the same industry.

"He was trying to replicate the business model of independent refining in Europe based on his prior success in the U.S.," said Gergely Varkonyi, analyst at Deutsche Bank. "O'Malley underestimated the challenges in European refining restructuring."

Shockwaves from the collapse of Petroplus spread beyond the oil industry as the closure of its Petit-Couronne refinery on the Seine became an issue in the French election campaign.

President Nicolas Sarkozy, struggling to hold onto power as unemployment climbs, brokered a deal for Shell to supply the plant and allow it to reopen at least temporarily.

In Britain, panic buying of gasoline broke out in January as motorists feared disruption to supplies when the Coryton plant came under threat - although it uniquely among the five Petroplus sites has kept refining without a break.

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ROSY 2005 OUTLOOK

Back in 2005, prospects looked good. The industry was in robust health. Refineries labored at full capacity to produce the fuels China needed to support an economic boom both at home and abroad. The U.S. trucking fleet was using record amounts of transport fuel to distribute Chinese goods delivered by record numbers of container ships into its West Coast ports to American consumers across the country.

That forced up refined product prices faster even than rising crude costs, delivering higher profit margins. Refiners responded by investing in more capacity to make gasoline and diesel.

At the same time, credit was cheap.

This seemed an ideal time for private equity firms Carlyle Group and Riverstone to move in with a fashionable debt-funded buyout. Petroplus, a medium-sized European player, seemed ripe for expansion and the perfect target.

They bought the business in July 2005 for around 280 million euros ($339 million), aiming to expand it rapidly and sell it at a profit. Petroplus hired O'Malley, a big name in the United States where he had already successfully built up and sold on refineries.

Shortly after he joined, the firm's founders Marcel van Poecke and Willem Willemstein departed. This left O'Malley as chief executive and chairman of a complex European company, but short of senior staff with experience of the markets for its refineries in Belgium, Germany, France, Switzerland and the UK.

In the United States, O'Malley built up refining business Premcor by buying plants he believed to be undervalued and he followed the same strategy at Petroplus.

With O'Malley in the driving seat, Petroplus bought a Belgian refinery in Antwerp in 2006 for an estimated $511 million to add to the Swiss Cressier plant which it had already purchased in 2000 and one on Britain's Teesside acquired in 2005.

In November 2006 Petroplus floated for $2.4 billion in Switzerland's biggest public share offering for five years. This marked the exit for Carlyle and Riverstone which achieved their target of selling the business for a big profit.

Some proceeds went towards repaying debt and the company declared itself debt-free by the end of the year. However, Petroplus kept a credit facility of up to $2 billion, allowing it to borrow from banks whenever it required funds.

With this cushion, the company felt confident enough to eliminate what was standard practice for most in the industry: hedging its refining margins. Hedging would have provided protection against the sharp decline in refining profits that was to hit the company from 2008.

Fluctuations in refining margins affected its fortunes significantly. A rise or fall of $1 per barrel would produce a gain or loss in pre-tax profit of $73 million in 2006 and $141 million in 2007, the company said.

GOLDEN AGE

In what appeared to be a golden age for refining, the company kept paying high prices for ageing assets.

In 2007 it made perhaps its least wise purchases, buying the Petit-Couronne and Reichstett refineries in France from Shell for an estimated $875 million.

It also bought the Ingolstadt plant in Germany for around $623 million and Coryton from BP for $1.4 billion, backed by some $1.2 billion worth of bonds.

The strategy was paying off. Petroplus shares in July 2007 reached just under 116 Swiss francs, a stunning climb from its listing price around 59 francs the previous year.

That was the high water mark for Petroplus. Cracks had begun to show.

A fire broke out at Coryton in 2007. The British Health and Safety Executive has investigated 20 incidents reported there over the past four years.

Some refinery workers said cost cutting had caused a decline in safety. "Management stayed the same but guys at the refinery saw everything deteriorate without any work being carried out," said one worker at the Petit-Couronne refinery, who did not want to be identified.

"Some workers were scared of coming to work sometimes because safety conditions were not fulfilled any longer."

Petroplus said in an emailed response to Reuters questions that there had been no fatalities at any of its sites since it bought them, though it noted that there were 14 fatalities reported in the European downstream oil industry overall in 2010.

CRISIS STRIKES

In 2008 the golden age for refiners, like many other businesses, came to an abrupt end. The end of easy credit, the collapse of Lehman Brothers and financial crisis caused recession across Western economies.

European demand for oil products collapsed. Some experts believe the continent's consumption will never recover to its 2007 levels even when economic growth resumes.

With crude oil prices now surging again, much of European industry has switched to other fuels such as natural gas or invested heavily in energy saving. Motor manufacturers are turning out ever more fuel efficient models.

The creaking Petroplus refineries also faced increasing competition from more modern and efficient plants in Asia while U.S. refiners, which had always been more profitable, also rode the storm better.

According to data from energy consultancy Wood Mackenzie, U.S. refining margins averaged $10.70 a barrel in 2008, compared with $4.35 in Europe.

Margins tumbled to $4.10 in 2009 in the United States but had recovered to $5.90 by 2011. By contrast, European margins continued sliding to just $1 last year.

CRUMBLING EDIFICE

The Petroplus edifice began crumbling well before the end of last year when a consortium of 13 banks froze a $1 billion credit facility that company had used to buy crude oil.

Alarm bells began ringing last August when it posted a larger-than-expected second quarter loss, putting it in breach of a loan covenant and sending its shares to an all time low.

More signs of strain emerged in October when it said it might have to shut down the lubricants unit at Petit-Couronne.

In November it reported a bigger-than-expected loss for the third quarter requiring it to secure a covenant waiver from its lenders.

The company's last loan deal was the $1 billion revolving credit which was renegotiated in October 2009. That loan, priced at a hefty 300 basis points over Libor, was led by ABN Amro, BNP Paribas, Commerzbank, Credit Suisse, ING, Natixis and Societe Generale, according to Thomson Reuters LPC data.

One trigger that sent the banks scrambling for the exit was the sale, announced in the UK on November 30, of $200 million of receivables, where the company was obliged to promise the proceeds of future sales revenues, said Martin Schreiber, analyst at ZKB in Zurich.

"With its highly leveraged balance sheet if it sells part of its receivables, the debt holders worry about their assets if it does have to go into bankruptcy," he said, adding that the fact it had to do so added to anxiety about the company's future.

Petroplus filed for insolvency in January after it defaulted on $1.75 billion of debt and all five of its refineries were put up for sale.

Coryton kept refining under administration, having effectively leased its refinery to co-founder van Poecke, together with Morgan Stanley and private equity outfit KKR.

Petit-Couronne is due to reopen under the six-month processing deal with Shell which Sarkozy brokered.

Trading firm Gunvor said it was buying the Antwerp refinery, although the plant has yet to start up, and the remaining facilities are still seeking firm buyers.

O'Malley is now at PBF Energy, a joint venture of private equity firms Blackstone and First Reserve. In November, PBF announced plans to raise funds through an initial public offering.

O'Malley declined to respond to Reuters questions on Petroplus.

FAILED MODEL

Analysts said O'Malley's model where refineries operated independently of upstream exploration and production or downstream distribution outlets meant the company lacked less control over prices than integrated oil majors.

"In the United States it's a normal thing to do, but it isn't so much in Europe," said Schreiber at ZKB in Zurich.

Deutsche Bank's Varkonyi said that while U.S. refiners suffered overcapacity from time to time, the problem was much less entrenched than in Europe.

U.S. companies were more nimble in cutting excess capacity than their European counterparts, some of which were subject to political pressures to protect jobs as illustrated by Sarkozy's intervention at Petit-Couronne.

"When margins were weak, the (U.S.) market has undergone a relatively healthy restructuring. This hasn't been the case in Europe (where) owners are state-owned, or state-influenced companies," Varkonyi said. Regulatory reasons meant that shutting down or converting a refinery to a terminal has always been much more difficult, expensive and complicated than in the United States, he added.

O'Malley left behind some angry people. Speaking at the bar of Pegasus Social Club on the grounds of the Coryton refinery in Essex, Mark Stevens said: "Petroplus is a company based on greed and financial mismanagement on an epic scale." "Its owners bought the company on an ill-conceived plan and disappeared back to America when it failed. They changed its structure, and left it in the hands of Europeans. Now they are trying the same tricks in America," added Stevens, who retired as a process controller at Coryton at the end of January.

(Additional reporting by Martin de Sa'pinto in Zurich, Marion Douet in Paris and Marc Parrad in Rouen and Ikuko Kurahone in London; editing by David Stamp and Richard Mably)

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