The model portfolio is composed of international investments and is priced in US dollars. All foreign currency holdings are converted to US dollars, based upon closing currency valuations as of the date of publication. Views are solely that of the author, and will differ materially from conventional analysts as well as the investing public at large. The purpose of the model portfolio is to monitor performance of investments written about in this blog, and is not to be construed as research. The blog is written for entertainment purposes only, and does not represent investment advice in any way, shape or form. Always consult an advisor prior to engaging in any investment activity.





Tesoro is a refiner of crude oil. A publicly traded subsidiary, Tesoro Logistics LP (TLLP-NYSE,$33.90) was listed earlier last year to handle the gathering and distribution of some of the Bakken crude to three of the Tesoro refineries throughout the United States. TSO holds more than 15 million shares of TLLP which have a market value of more than $500 million US.


Tesoro Corp is the single greatest beneficiary of the Bakken crude oil boom in the Dakota-Montana region of the United States.

Bakken crude produced by oil companies in the north central Williston basin region of the United States is a high quality oil that contains few impurities and is relatively simple to refine into end use products.  What is NOT well understood by oil investors is that much of this output is essentially "stranded".  

In the key region where Bakken crude is produced, only 1 oil refinery exists.  That refinery is a 68,000 bpd operation in Mandan, ND, owned and operated by Tesoro Corp.   As the Bakken shale formation in the Williston basin presently produces more than 600,000 bpd and is forecast to exceed 700,000 bpd by year end, all other output needs to either be shipped by rail terminal some distance for refining, shipped by pipeline to oil refineries or is transported by truck.  The transportation costs to move this oil are expensive.   From the wellhead, trucking, pipeline and/or rail terminal plus rail transport charges to get this crude to any refiner, other than the Mandan, ND. refinery, can gobble up as much as $10 US per barrel of the gross price received.   

Any oil refiner that can accept Bakken crude for processing is very much in the driver's seat insofar as pricing is concerned.  Oil producers currently  accept a discount of about $6 US per barrel against WTI for their output, before further deducting any shipping charges against their gross price.    



The Mandan refinery might be the MOST PROFITABLE REFINERY of its size in the world today.

This Bakken crude glut looks to be, more or less, a permanent structural issue that specifically benefits midwestern US refineries.  The region of the Dakotas and Montana are lightly populated and have few large industrial users of crude oil; most Bakken crude will ALWAYS have to be shipped somewhere else. The Mandan North Dakota refinery will therefore always be in a position whereby they are able to purchase the local crude for a steep discount against WTI. This discount goes right into the pockets of the refiner.

In 2011, the Tesoro North Dakota and the Salt Lake City Utah refineries generated gross margins of $25.59 US per barrel.   In an industry that considers $10-$12  per barrel gross margins to be nicely profitable during periods of strong utlization, such results confirm a structural monopoly.


Tesoro's Mandan refinery has just completed a 10,000 bpd expansion at a capital cost of about $40 million US. 

Previously, Tesoro was processing about 58,000 bpd of Bakken crude; now output will rise to 68,000 bpd.  Crack spreads for Bakken at the Mandan refiner typically range from $20-$30 per barrel.  At $20 per barrel and assuming a 300 day operating year, Mandan could produce operating profits of $400 million per annum.  At $30 per barrel, the Mandan operation could throw off as much as $600 million per annum of operating profits.    Incremental EBITDA on the 10,000 bpd expansion at Mandan is forecast to produce an estimated annual increase in EBITDA of $40 million, a 100% EBITDA return on investment.

Permit me to try and place the importance of this low cost expansion into perspective.  Tesoro invested about $40 million US to add about 10,000 bpd of refining capacity at Mandan, specifically to process Bakken crude.  Should the 2011 margins persist, that 10,000 bpd will generate an additional $75.3 million of operating margin, which requires limited capital investment to maintain.   

By way of comparison, Kodiak Oil and Gas (KOG-NYSE, $8.12) presently produces about 10,000 bpd of oil per day, has a market cap of $2.16 billion and  an enterprise value of over $3 billion.  KOG intends to add about 10,000 bpd of Bakken production in the coming year; to do so will require planned capital expenditures of more than $585 million US as per their estimates.    Once Kodiak has grown the production by that forecast 10,000 bpd, the fight becomes one whereby a significant amount of capital will need to be invested annually simply to maintain that production; present production does not currently generate that "all-in" return being thrown off by Tesoro's Mandan refinery.  In that light, is one better served by investing in a capital intensive oil and gas explorer, which holds significant oil price risk, or is one better served by owning a monopoly refiner that has limited sustaining capex and generates much higher margins from that same 10,000 bpd.   

Investors have effectively priced 10,000 bpd of Bakken output at $3 billion of EV for a junior.  Teroso, for $40 millon, has just added an equivalent amount of revenue generating capacity, one that will be earning far higher returns in the current oil market than an oil producer. 

More to the point, TSO presently enjoys a superior financial benefit on 68,000 bpd of Bakken crude output than does ANY existing Bakken E&P at current oil prices.  Resultantly, why would one even consider buying ANY Bakken explorer/developer over TSO, if one intends to earn the optimum financial return with their capital?   


Tesoro will be using the MONOPOLY PROFITS  spun out from Mandan to pay for expansions of their Salt Lake City refinery, and for a terminal expansion of the Anacortes, Washington refinery to allow the acceptance of steeply discounted Bakken crude

In each case, the profit margins of the expansions should allow for very quick payback.   It is estimated by Tesoro that total capital costs of their Salt Lake City and Anacortes expansions/conversions could total $260 million over the next 2 years.  Incremental EBITDA that is forecast when those projects are completed could exceed $135 million per annum, for a 52% EBITDA return on capital.


Refiners depend upon a complex combination of high utilization of their facilities, rising demand for their products and an ability to source easy to process crude at inexpensive rates in order to earn a return for their investors. 

Tesoro, more so than any other refiner I have evaluated in the North American markets, appears to meet my standard for investment.  Most refiners have few distinguishing characteristics that would suggest a monopoly, or even an oligopoly business model.  In the case of the Bakken crude market, TSO is very much a monopoly buyer for 68,000 bpd of crude at Mandan.  The company's gathering and distribution partnership will be sourcing a significant amount of the discounted Bakken crude for the Anacortes refinery in the years to come.  This will directly add to Anacortes profits and will indirectly generate profits for TSO through their equity stake in TLLP.  

With 144 million shares outstanding (fully diluted) and total liabilities of $5.1 billion at the end of Q1, 2012, TSO has an enterprise value of $8.7 billion.

EBITDA for 2011  was $1.497 billion,  which indicates a trailing EV/EBITDA ratio of 5.8 times.   Shareholders equity presently exceeds $4 billion, or $27.62 per share. 

It should be noted that Tesoro employs LIFO inventory accounting, which is a far more conservative system than blended average cost or FIFO.   Refiners that use FIFO inventory accounting get hurt when oil prices drop sharply.

Tesoro does not pay a dividend at the present.  Their capital can be internally invested to produce a far higher yield for the business.  Nevertheless, I anticipate a token payment to start at some point in 2012. 


A GROWING glut of Bakken crude, improved US demand based upon consumer trends that I have noted previously in the blog quarterly report, and completed expansions in Utah and Washington could eventually propel TSO annualized EBITDA beyond $2 billion in the next 36 months.


Such an amount would suggest plenty of upside for a company with a current market cap of about $3.5 billion US.    Should global interest rates remain stable, the Tesoro LP shares could also grow in value over time, which would indirectly benefit shareholders of TSO through their proportionate equity stake.

If oil E&P companies are hell bent on overproducing from the Bakken formation, to the point that they are tripping over themselves to discount their output at the refinery, I'll gladly take their money.  The Mandan refinery looks to be about the only facility in the world today that actually generates a higher return on their refined products than North American oil producers will earn from production at current prices, on an "all in" basis.   The Salt Lake City, Utah refinery will shortly join the Mandan ND refinery in terms of profit potential, once that expansion/conversion is completed. 

Some suggest that TSO has an opportunity to produce a fairly signficant positive earning surprise in the month of July.  I consider that to be possible.


The blog model portfolio will be purchasing an additional 1667 shares of Tesoro Corp at market opening on the NYSE on Monday, July 2nd, 2012.*  I own shares of Tesoro personally.



*On July 2nd, the blog model portfolio completed a purchase of 1667 shares of Tesoro Corp at a gross price of $25.05 US per share.  After paying a $110 US commission, the net investment totalled $41,868.35 US.  At the same time, I purchased additional shares of Tesoro personally.