Marathon Oil Races to Divest Refining Business

The Company: Marathon Oil, the fourth-largest U.S. integrated oil company
The Filing: Form 8-K filing with the SEC on July 31
The Finding: Even though revenue rose almost 32 percent in the second-quarter ended June 30 to $22.2 billion, Marathon Oil said its net income declined 50 percent to $774 million, or $1.08 a share, hurt by lower refining and marketing margins. Management is considering a plan to split the company into two independent companies, one focused on upstream activities, such as exploration and production, and the other dedicated to refining and marketing.

The Upshot: Pressured by the twin demons of peak oil prices and lower gasoline demand, Marathon said refinery profits plummeted 87 percent to $158 million. Further exacerbating downstream profitability, the company needed to tap the domestic spot oil market for contracted capacity obligations. Unable to fully pass along its costs to customers, refining and wholesale marketing gross margin per gallon fell to 8.35 cents in the second quarter of 2008, compared to 39.25 cents last year.

CEO Clarence Cazalot told analysts on the earnings call that he did not believe the market fully appreciated the context and visibility of Marathon's upstream operating environment. In other words, the cycle-prone refining operations are depressing the company's intrinsic value. The board will make its decision known in the fourth-quarter on the potential separation of the company into two separate publicly traded entities, said Cazalot.

Cazalot is sending mixed signals. In late June, construction commenced on its $1.9 billion heavy oil-upgrading project at Marathon's Detroit refinery. When completed in late 2010, the facility would give the company a competitive edge, refining access to an additional 80,000 barrels a day of heavy oil capacity from its Canadian oil sands production activities.

The Question: If the company sells its Midwest downstream business, where will it process the bitumen from its Western Oil Sands mining operations?

David Phillips

David Phillips has more than 25 years' experience on Wall Street, first as a financial consultant and then as an equity analyst for several investment banking firms. He sifts through SEC filings for his blog The 10Q Detective, looking for financial statement soft spots, such as depreciation policies, warranty reserves and restructuring charges. He has been widely quoted in outlets such as BusinessWeek, The International Herald Tribune, Investor's Business Daily, Kiplinger's Personal Finance, and The Wall Street Journal.

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