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Leading / Thinking / Performing

Appraising an Oil Refinery

in the 21st Century
This article was authored by Michael J. Remsha, Managing Director and Vice President

In the later years of the 20th century and now in the 21st, oil refineries have become
more and more complex in order to process higher sulfur and heavier crude oils
into boutique types of gasoline and diesel fuel. These reformulated gasolines and
diesels are required by governments to clean the air and protect the environment.

Refinery Description
An oil refinery is simply an intermediary between crude oil and a refined product. It takes
dirty, low-value oil from the ground and distills it under atmospheric pressure into its primary
components: gases (light ends), gasolines, kerosene and diesels (middle distillates), heavy
distillates, and heavy bottoms. The heavy bottoms go on to a vacuum distillation unit to
be distilled again, this time under a vacuum, to salvage any light ends or middle distillates
that did not get separated under atmospheric pressure; the heaviest bottoms continue on
to a coker or an asphalt plant. Other product components are processed by downstream
units to be cleaned (hydrotreating), cracked (catalytic or hydro cracking), reformed (catalytic
reforming), or alkylated (alkylation) to form gasolines and high-octane blending components,
or to have sulfur or other impurities removed to make low-sulfur diesel. Depending on the
process units in a refinery and the crude oil input, an oil refinery can produce a wide range
of salable products: many different grades of gasoline and gasoline blend stocks, several
grades of diesel, kerosene, jet and aviation fuel, fuel oil, bunker fuels, waxes, solvents, sulfur,
coke, asphalt, or chemical plant feedstocks.
Every refinery basically does the same thing. The first primary process unit is the
atmospheric distillation unit, and for some refineries, that is the only unit. Called topping
plants, these very simple refineries top off one or a few
product streams that are easily marketable, and then
sell the intermediate streams to other refineries for
further processing. Typically, topping plants are very
small, processing 5,000 to 10,000 barrels per stream
day (BPSD). A refinerys BPSD is the maximum
amount the refinery would be expected to process in
a day under perfect conditions. Barrels per calendar
day (BPCD) is the amount a refinery would be
expected to process, on average, in a day, deducting
for maintenance and other anticipated downtime.
Typically, BPCD is around 90% of BPSD.

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As refineries include more process units,

they become more complex; they then
can process heavier (lower API rating) and
more sour (higher sulfur content) types of
crude and produce more types of products
and feedstocks for other chemical plants.
Simple refineries have low complexity
factors. Complexity is simply an indication
of the magnitude of a refinerys processing
capability. The complexity factor for a
topping plant would be in the low single
digits, say 1 to 3, and a larger, more
complex refinery would have a complexity
factor around 10 or 12. Some refineries
have complexity factors as high as 18; this
type of refinery has many process units
and has the capability to process some of
the heaviest, dirtiest, and most difficult-toseparate crude oils into a wide range of
valuable products.
Another indicator of the refinerys
processing capabilities, equivalent
distillation capactity (EDC), is calculated
by multiplying the refinery complexity by the
size of the atmospheric distillation unit. The
concept of EDC allows for refineries to be
compared in a meaningful manner based
on their processing capabilities.
Additional process units are used to
maximize the value of the barrel of crude
oil or are required to meet state or federal
environmental requirements. Because
environmental requirements are constantly
changing, refineries must constantly
change the way they do business. Every
change costs a refiner millions of dollars.
One of the ongoing changes is the way
they make and blend gasoline and diesel.
A seemingly simple requirement to remove
more sulfur from gasoline or diesel may
require the addition of another hydrotreater
(which could be considered a giant filter).
However, if the hydrotreater removes more
sulfur than the refinerys current sulfur

plant can process, another sulfur plant will

need to be built. Then, because the new
hydrotreater needs more hydrogen than the
reformer produces or the current hydrogen
plant can provide, another hydrogen plant
would be needed. Off-sites (support
units) also may have to be modified and
expanded. So, we can see how easily
what began as a $50 million hydrotreater
addition could become a $200 million
project. Nothing is simple or inexpensive at
an oil refinery.

Refinery Economics
The basic economic principles that
determine the value of oil refinery products
and raw materials are supply and demand,
and competition. As demand increases
and supply of products remains constant,
the price of the product rises. Because of
higher profits, competition grows, which
results in an increase in supply. When
supply meets demand or possibly creates
an oversupply situation, prices fall. Profits
decrease and competition declines. This
scenario basically represents the roller
coaster of prices and values of the products
produced at an oil refinery. As a result,
refinery management must constantly
monitor the prices of the products
produced and also the types and prices of
the crude oil they process. If the price of
jet fuel increases, the refinery may make
more jet fuel but less diesel. When the
price of jet fuel decreases, diesel may be
more desirable again. As a result of such
factors, the slate of products produced at
a refinery is not constant. These products
are always being tweaked on the basis of
pressures and performance of the market,
the requirements of reformulated gasoline
(RFG) legislation, and summer/winter fuel
oil/diesel fuel demands.
In the 1990s, many refineries in the United
States had to invest hundreds of millions
of dollars to meet the requirements of

the Clean Air Act Amendment of 1990

(CAAA) and, in California, the California
Air Resources Board (CARB). Refineries
made the investments, expecting an
increase in the prices of their products and
a commensurate return on their investment.
However, it did not happen. Too many
refineries were modified, resulting in an
overcapacity in the industry. In 2001, the
overcapacity situation was normalized,
but with the increase in crude oil prices,
the refineries are still in a very competitive

ones) to shut down, which will drive up

the price of gasoline. The United States
government supports the need for more
refinery capacity and currently is reviewing
future environmental mandates to remove
more sulfur from gasolines and diesels.
Even with the improvement in 2007 in the
profitability of the refinery industry due to
increasing demand and a limited supply,
additional increases in cash flows are still
required to support the building of a new

Environmental expenditures are still

required today. Over the next few years,
refiners will have to make investments to
reduce emissions; reduce sulfur in gasoline
and diesel; replace methyl tertiary butyl
ether (MTBE) with another high-octane
blending component (primarily ethanol); and
reduce benzene, aromatics, and cetane
concentrations in certain products.

The basic economic principles discussed

above interact with the three valuation
methods appraisers use to estimate value:
the sales comparison approach, the income
approach, and the cost approach.

The future restrictions placed on refineries

will force more refineries (primarily small

Approaches to Value

Sales Comparison Approach

The sales comparison approach uses
the analysis of actual transactions in the
marketplace to derive a value for a refinery
based on the actions of buyers and

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sellers. This approach is a very powerful

tool to use in a refinery appraisal because
every refinery starts with the distillation
of a barrel of crude oil, every refinery is
operated to maximize the production of
gasolines, and most refineries are relatively
complex. To account for differences
between comparable refineries and the
subject refinery being appraised, the sales
can be adjusted using the basic appraisal
tools discussed in any valuation text.
Adjustments are made for the following
Size - The capacity of the atmospheric
distillation unit
Complexity - The magnitude of refining
or processing which the refinery can

had been relatively predictable until 2006

and 2007. During the mid- to late 1970s,
refinery values were higher because of the
high level of profits in the industry and the
continuously increasing demand for refined
products in the United States. Then, in
the early 1980s, refinery values began to
decline because of a change in the federal
small refiner bias, an overcapacity in the
industry, and major industry restructuring.
Refinery values peaked in 1988 and 1989,
when capacity and demand equalized
and profits increased. In 1990, the United
States government passed the Clean Air
Act Amendment, which required most
refiners to decrease plant emissions and to
modify the way diesel and gasoline were
made. This led to the advent of low-sulfur
diesel and reformulated gasoline.

Time - Differences in refinery economics
between the appraisal date and the
time of the sale
Age - Determining if the sale is
physically of a similar age and level of
technology as the subject
Location - Accounting for the subject
being in a better or worse location
concerning its ability to receive raw
materials and to ship products to a
Several other adjustments may be made
depending on the circumstances. In
addition, any inventories, intangible assets,
marketing assets, or other assets must be
removed from the transaction price to result
in only the price of the tangible plant assets
under review.
The market in refinery sales has seen a
roller-coaster pattern over the last two
decades caused by changes in profitability
and environmental requirements mandated
by governmental agencies. The market

Through the early to mid-1990s, few

refineries were sold in the market; those
that did sell sold for very low prices. As
the industry implemented the requirements
of the CAAA (which required investments
of hundreds of millions of dollars with little
or no increase in profits), more and more
sales took place. By the late 1990s and
through 2001, the sale prices of refineries,
on a per-unit per-complexity-point basis,
continued to increase (although they still

were not as high as in the late 1980s). By

2007, sales prices of oil refineries had
reached an all-time high, supporting what
some call the Golden Age of refining. The
consideration of these changes is critical
to an analysis of a refinerys value using the
sales comparison approach.

Income Approach
The next indicator to value on our list is
based on future income realizations. To
develop these future income realizations,
the income approach is the tool most
frequently used by buyers and sellers in
the marketplace. However, the primary
difficulty of this method is the necessity
to forecast the future. To accomplish this
step, buyers and sellers use a matrix of
income approaches to test their forecasts in
as many different ways as possible. Thus,
for negotiating sessions, buyers and sellers
will know the high and low ends of their
negotiation range.
Items to be forecast in the income
approach include throughput and
production, prices of the products
produced, refinery gain, raw material
costs, operating expenses, future capital
expenditures and sustaining capital
requirements, and the capitalization or
discount rate.
Often, forecasts for prices of products
and raw materials are available from
various published sources. Throughput,
production, and refinery gain can be
forecast by reviewing past performance,
the future budget for the plant, and the
plants material balance. Operating
expenses can be projected by reviewing
operations over the past three to five years.
Future capital expenditures are commonly
budgeted by plant management for three, five-, or ten-year periods. Beyond the
budget, 2% to 3% of the replacement cost
will be necessary for sustaining capital,

just to keep the plant in safe operating

condition. It is especially important to
review environmental requirements in the
future and make sure they are included in
the budget.
The forecast is typically projected over
a period of at least 10 to 12 years,
sometimes 20 to 30 years, or even into
perpetuity if the market is strong and the
subject plant has a long economic life. It
is most common to develop a discounted
cash flow (DCF) rather than just
capitalizing one year. The industry typically
is not stable enough to forecast a one-year
normalized income stream. Participants in
the market develop after-tax, debt-free cash
flow (or free cash flow) streams that reflect
the income level received by equity and
debt holders. Depreciation is calculated
using tax schedules, often accelerated
schedules, to reflect the buyers new tax
The discount rate that is to be applied to
an after-tax, debt-free cash flow stream
is developed using a weighted average
cost of capital (WACC). This requires an
investigation of publicly traded common
stocks to develop a typical capital structure
(equity and debt weightings) and beta (a
measure of the volatility or risk inherent
in the industry). The capital asset pricing
model or the build-up method is used to
derive an equity investors required return
on an investment in the subject refinery.
Adjustments must be made for risks
inherent in the single plant being valued and
the additional risks of equity ownership.
Debt cost is high because of the risk of
the single-plant nature of the investment;
thus, BAA or BBB industrial bonds (higher
risk but not junk) are utilized. The WACC
is then calculated on an after-tax basis and
applied to the forecasted cash flow stream.

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The result of the income analysis is the

business enterprise value associated with
the operating plant. To determine only the
value of the tangible assets, deductions
must be made for working capital and
intangible assets. A normal level of
networking capital is estimated based
on a comparable company analysis. The
intangible assets, which may include the
trained and assembled workforce and
management team, operating manuals and
procedures, software, emission credits,
and many others, also must be valued.
The resulting income indicator of value
for the tangible assets includes the real
estate comprising land, buildings, and land
improvements; and the personal property,
both battery-limit process units and off-sites
or support assets.

Cost Approach
The last method to be investigated here
is the cost approach. This approach
in particular requires a certain level of
knowledge about the economics of, and
the technology utilized in, the industry. In
applying the cost approach, the appraiser
must calculate the current cost of the plant,
using the reproduction cost new of an
exact replica and/or a modern replacement.
The difference in the two costs is a form of
functional obsolescence or a loss in value
from within the property due to excess
capital costs.
A deduction must be made for physical
depreciation. This deduction is based on
wear and tear experienced by the property.
At this point in the cost approach,
economic obsolescence, or a loss
in value from an external economic
factor, is investigated. Knowledge of
industry economics is necessary for this
investigation. This may include a study
of industry margins, supply/demand

relationships, competition, return on capital,

or a comparison of refining industry returns
with a benchmark such as the S&P 500.
The next deduction is for another form
of functional obsolescence - operating
obsolescence caused by changes in
technology. New or different technologies
frequently result in better control systems
that increase yield, and reduced labor
and energy requirements make the new
modern plant more valuable. Major forms
of operating obsolescence are typically
found in the catalytic reformers and in the
catalytic cracking units. The subject plants
performance must be compared to that of
the modern replacement plant to derive a
penalty the subject must endure over its
remaining life. After developing the present
value of the penalty, a deduction is made
for operating obsolescence.
The last deduction is a form of both
functional and economic obsolescence
that is sometimes called a necessary
capital expenditure. This capital expense is
required by a government agency primarily
for environmental reasons. Again, based
on the plant budget forecast, the present
value of these capital costs is developed,
then deducted.
After all these deductions are made, the
value of the land is added after deducting
any known and budgeted clean-up costs
from the land value as if clean. The result is
the cost indicator of value.

Correlation Concluding a
At this point in the appraisers process,
three indicators of value have been
developed for the subject assets. The
sales comparison indicator can be a
strong indicator of value because it reflects
the actions of buyers and sellers in the
market. A buyer put money on the table

and actually purchased a plant, and a seller

actually sold it. Even in a market that has
few sales, the appraiser cannot ignore
the market. Of course, the sales must be
investigated to ensure the sale data used
reflect a refinery similar to the subject. The
sales do not have to be exactly the same,
since they will be adjusted to the subject,
but they should be as similar as possible.
By using even one, two, or three sales, the
appraiser will have at least a range of value
in which the subject property should fall.
The income approach, as mentioned
above, is the method on which buyers and
sellers rely to make a decision. They make
the market. But it should be remembered
that appraisers reflect the market; they do
not make it. Participants in the market
generate many income approaches
because they cannot forecast the future
with any degree of certainty - no one can!
They are preparing to negotiate a price.
Appraisers use the results from buyers and
sellers in the sales comparison approach
and try to copy them by developing
an income indicator of value based on
projections into the future and an industrybased discount rate. The income approach
can be very volatile because of even very
minor changes in the forecast. While it is a
useful valuation tool, the income approach
must be supported by either the cost or
sales comparison approach to increase its
The cost approach is especially useful for
unique or special-purpose property where

comparable sales are not available and

an income approach is not possible. It is,
simply, the development of the current cost
of the property being valued, less all forms
of depreciation and obsolescence, plus
land value. To develop the cost approach,
the appraiser must be knowledgeable
of the economics and technology in the
industry. A complete and detailed cost
approach analysis is very time consuming,
but of the three indicators of value, it is
the one that produces the most subjectspecific detail.
The most supportable appraisal, a
complete appraisal, utilizes all three
indicators of value. All three indicators
reflect the market: the market as defined
by refinery buyers and sellers; as defined by
the buyers and sellers of refinery products,
raw materials, operating expenses, the
current cost of equity and debt; and as
defined by current construction costs, new
technology, and industry economics. In a
perfect world, all three provide the same
value conclusion, or at least define a narrow
range. In reality, correlation of the values
indicated is often required.
When deriving a conclusion from the
investigation and analysis of the market, the
appraiser must use judgment, experience,
and common sense to correlate the final
conclusion of value for the subject refinery.
The correlation and conclusion must be
based on the market, not some pie in the
sky forecast. When the market speaks,
appraisers listen.

Previously published in Appraising an Oil Refinery in the 21st Century, Machinery & Technical
Specialties Journal, Volume 17, Number 4 (2000-2001 Fiscal Year)

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About the author:

Michael J. Remsha is a Managing Director and Vice President with American Appraisal
Associates, Inc., in Milwaukee, Wisconsin. In this capacity, he provides direction and
technical support on the valuation of special-purpose and personal property. He has
been a full-time appraiser since 1977. Mr. Remsha has valued over half of the operating
refineries in the United States and many in Europe and Asia.

About American Appraisal:

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