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CITGO'S Temporary Losses

By Oliver L Campbell

As a staunch defender of CITGO'S acquisition by the "Old PDVSA," I was puzzled why its profits have lately turned into losses and wanted to find out the causes. An analysis has been made possible from the prospectus recently issued by CITGO for the purpose of refinancing its present debt. The losses, shown on the first line, are followed by some relevant data in the table below.

Figures in US$ millions, US$ per barrel (bbl), and barrels per day (b/d)

Period

2007

2008

2009

2010

1st Qtr

Profits/(Losses)

1,586

801

(201)

(128)

Sales

38,015

41,280

24,932

7,291

Average price per gallon of gasoline

$2.14

$2.54

$1.73

$2.09

Gulf Coast 3/2/1 crack spread

$13.19

$9.37

$7.18

$6.68

Gulf Coast light/

heavy crude spread

$12.42

$15.69

$5.20

$8.93

Average price product sales bbl

$79.84

$103.95

$68.24

$84.34

Average price

crude purchases bbl

$64.34

$90.33

$58.52

$76.25

Difference in price sales/purchases bbl

$15.50

$13.62

$9.72

$8.09

Purchases of

heavy oil b/d

490,000

430,000

443,000

390,000

Purchases of

light oil b/d

195,000

203,000

193,000

258,000

Total crude oil purchases b/d

685,000

633,000

636,000

648,000

Oil purchases

from PDVSA b/d

269,000

258,000

285,000

248,000

As gasoline accounts for half of CITGO'S sales in value terms, the price per gallon is an important factor affecting total sales. The average price of $1.73 obtained in 2009 was the lowest for some time.

The Gulf Coast 3/2/1 crack spread takes the value of 2/3 a barrel of gasoline plus 1/3 barrel of No. 2 fuel oil and deducts the value of a barrel of West Texas Intermediate (WTI) crude oil. However, the more important statistic is the light/heavy crude spread which is measured as the difference in price between WTI and Maya Heavy. The larger this difference, the more CITGO'S refineries, which are designed to process heavy, sour crudes, benefit and the greater the profits. The $5.20 differential in 2009 was the lowest seen in the last decade and mainly explains the net loss in that year.

The differential picked up in the 1st Qtr 2010, so another reason must be found for the substantial loss of $128 million in just three months. I believe it is because CITGO bought considerably more light crudes than in the previous years. This means the difference per barrel between the average sales price and the average crude purchase price went down $8.09. Two questions need to be asked: a) why did PDVSA supply less of its heavy, sour crudes which have a lower price than light crudes? and b) why did CITGO not compensate for this by buying substitute, heavy crudes from third parties?

The production cut imposed by OPEC was in force throughout 2009, so that is not the reason for sending less heavy crude to CITGO in 2010. However, PDVSA'S production may have fallen and/or it may have sent more heavy crudes to China. Either way, CITGO has had to had to bear the extra cost through no fault of its own. CITGO believes that, as oil demand rises, OPEC countries will produce the heavy oil they had shut in, and the light/heavy crude spread will widen again. A spread of some $12 per barrel should push the company back into net profits. Meanwhile, PDVSA could help by providing the 50% of CITGO'S crude requirement it used to deliver rather than the current 40%.

CITGO paid dividends of $1.3 billion in 2007 and $1.3 billion in 2008 which will surprise those who have questioned CITGO'S contribution to the Group's cash flow. The company also loaned PDVSA $1.0 billion in December 2007 with interest of 3.82% payable on the one-year note. The note was renewed in December 2008 for a further year with a lower interest of 1.36%. The note was then renegotiated so that repayment would be made by offsetting the value of the delivery of two designated cargos per month, with any balance being repaid no later than 31 December 2010. It is significant CITGO is only earning interest of 1.36% per annum on the note when it has just renegotiated a financing package of $2.1 billion with annual interest of up to 11.5%. CITGO has served as a financing vehicle for PDVSA in the past, but this is not unusual where one Group company is seen as a better credit risk than another.

The question is how soon will CITGO return to making profits? PDVSA could assist by increasing the volume of crude it sells to CITGO to around the 285,000 b/d it sold in 2009. In that year, CITGO bought 40 different types of crude from 16 different countries. Whether this diversification is a strong point, or whether keener prices could be obtained from term contracts with just a few suppliers, is something worth looking at.

Under the CITGO-Venezuela Heating Oil Programme, the company aids poor people in 25 states--I had always thought it was only in Massachusetts--by providing cheap heating oil in the winter. This is a fine humanitarian gesture, but it is debatable whether Venezuela should subsidise the poor of the world's richest economy rather than leaving it to the USA authorities. This is especially so right now when CITGO is making losses. Would it not be possible to cut back this programme temporarily?

There may also be some scope to lower the crude oil transfer price which is based on a formula incorporating the average spot prices of several widely-traded crudes. Admittedly, this would reduce PDVSA'S income but, by returning to the black, CITGO would become a better credit risk and obtain financing on more favourable terms. With an average interest rate of 10% on the $2.1 billion financing, CITGO will be paying an annual interest of $210 million i.e. as much as the net loss in 2009.

My point is, that If nothing at all is done and the light/heavy crude spread remains at around $9 a barrel, then it looks as if CITGO will continue making losses this year.

PDVSA'S upstream production and CITGO'S downstream refining and product marketing must be seen as an integrated operation. The fact CITGO is temporarily making losses does not alter the fact the integrated operation still produces excellent profits for the PDVSA Group.

As an amusing titbit, help in reducing costs was unexpectedly obtained from an avian source. CITGO granted the New Jersey Natural Lands Trust an easement in Petty's Island, situated in the Delaware River, which the company owns and where it had an oil terminal which is now closed. It turns out the island is the habitat of the American bald eagle. In exchange, CITGO is released from carrying out expensive work to remedy hydrocarbon contamination. This contribution by the bald eagle, the national symbol of the USA, will doubtless be much appreciated by the company!

To conclude on an upbeat note, CITGO'S refineries have an excellent safety record, unlike those in Venezuela. In April 2010, The American Petroleum Institute presented the company with an Occupational Safety Award in respect of 2009.

Oliver L Campbell , MBA, DipM, FCCA, ACMA, MCIM was born in El Callao in 1931 where his father worked in the gold mining industry. He spent the WWII years in England, returning to Venezuela in 1953 to work with Shell de Venezuela (CSV), later as Finance Coordinator at Petroleos de Venezuela (PDVSA). In 1982 he returned to the UK with his family and retired early in 2002. Petroleumworld does not necessarily share these views.

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Petroleumworld News 07/03/10

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