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Marathon Petroleum bets big on refining growth

The strategic rationale behind the refiner's deal to takeover Andeavor appears solid, but is the timing right?

Marathon Petroleum has agreed to take over rival Andeavor for $23.3bn, in a blockbuster deal that will create America's largest refiner, with a network of pipelines, terminals and refineries spanning the country.

The proposed acquisitionthe largest refinery deal in US historyvalues Andeavor at $152.27 a share, a 24.4% premium on its share price just prior to the announcement.

The purchase means Marathon will have access to 3.03m barrels a day of refining capacity, nearly twice that of ExxonMobil. It will replace Valero as the US's largest refiner. 

Geographically, the companies are a neat fit. Marathon's base is currently in the Midwest and Gulf Coast regions, while Andeavor has major facilities in California, Washington and the Southwest. Marathon would operate 16 refineries and says this will help it deliver around $1bn in synergies, mostly through expanded purchasing power.

As Tudor Pickering Holt & Co pointed out in a research note, the complimentary geographic footprints should minimise the risk of the deal being scuppered by anti-trust regulators, and the expanded refining base would mean Marathon will be operating around 16% of the nation's total refining capacity.

The expanded midstream network will also make Marathon a larger player in the fast-growing Permian region in West Texas, where millions more barrels a day in production will be looking for new markets in the coming years. Andeavor has deals in place already to move Permian light crude to the Gulf Coast, and Marathon sees further opportunities to expand.

Marathon also pointed out that the deal will help it take advantage of the coming International Maritime Organisation 2020 regulations, which will require ships to drastically reduce emissions. To meet the new rules, shippers can either install costly onboard scrubbers to clean up their emissions, or switch from high-sulphur fuel oil to cleaner-burning marine diesel oil.

Relatively few ships have opted to invest in the scrubbers, so demand for marine diesel oil is expected to spike in 2020 when the rules go into effect. It will be a huge opportunity for refiners that have the coking capacity to turn heavy fuel oil into lighter marine diesel oil. Marathon says this deal will give it America's largest coking capacity at around 800,000 b/d, surpassing Valero.

Timing concerns

While there are clear strategic reasons for the tie-up, Marathon shareholders are worried the company is overpaying for Andeavor. The latter's shares jumped as much as 15% on news of the deal, but Marathon's shares had dropped almost 8% at the day's close.

America's refining industry has been on a roll since the oil-price downturn in 2014-15, when cheaper feedstock boosted profits. New export opportunities and healthy demand in the US have further boosted their fortunes.

This strong run has given Marathon the financial firepower to pull off the deal, but there is a concern that the company is buying at the peak of the cycle for refiners. Andeavor's share price has doubled since late 2014, and $152/share price for Andeavor is well above the company's $144/share 52-week high.

For the deal to pay off, Marathon will have to follow through on the promised $1bn in synergies. It will also need the market to remain friendly for refiners. If oil prices come roaring back, eating away at refining margins and demand, the deal could leave a sour taste in investors' mouths.

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