(FORTUNE Magazine) –

You don't expect tears from a group of hard-bitten oil executives, but there they were. Jonathan Stuart, the plant manager for Valero's St. Charles oil refinery, near New Orleans, was briefing a delegation from the company's San Antonio headquarters--including CEO Bill Greehey--on how the plant and its 50-man "ride-out" crew had fared during Hurricane Katrina. And he began to cry. Explaining how one maintenance supervisor had used his personal credit card to buy supplies the day before the storm hit and then stayed up night and day cooking gumbo for the crew during its aftermath, Stuart lost it. "Excuse me a minute," he mumbled, wiping his eyes as he stepped out of the conference room.

For Greehey, who'd flown into New Orleans that day--getting special permission to use the closed airport--it was a moment both devastating and reassuring. That Stuart, an old refining pro from South Africa who had emigrated to the U.S. in 1983, would show so much emotion underscored just how heavy a toll Katrina had taken on Valero's employees. But Stuart's empathy for his co-workers also illustrated just how successful Greehey has been in infusing his company with a collegial, let's-get-it-done-together ethic. Just eight days after the storm, the St. Charles facility, located near a swamp between the Mississippi River and Lake Pontchartrain, was already up and running--even though a rival Shell refinery across the road was at least a week away from getting online. Stuart's crew had put in 20-hour days, replacing electric motors, erecting power poles, and restringing power lines. Greehey was wearing his oldest shoes, expecting to have to wade through debris and water, but the plant was clean and dry. It would crank out 3.6 million gallons of gasoline that day, plus 2.9 million gallons of diesel fuel, earning some $5 million for Valero. Stuart's miracle crew had also managed to take care of its own--locating the last of the plant's 570 employees that very morning.

Valero is at the center not just of Hurricane Katrina but of the roiling storm over oil that continues to whip through the economy. Not long ago refining was considered a humdrum business, sneered at by Wall Street for its overcapacity and lousy margins, taken for granted by energy consumers drunk on low gas prices. Greehey saw things differently and gradually built Valero into the country's largest player. At the same time, he instilled an old-school corporate culture that, remarkably, has given the company a distinctive edge in an era of crushing global competition. This marriage of corporate strategy and on-the-ground execution has helped Valero's shares skyrocket--since 2000 the stock is up sevenfold, outpacing more heavily watched oil stalwarts such as Exxon (Valero just announced a stock split and dividend increase). Unquestionably, the company has been helped by soaring energy demand and prices. For the first time in decades, refineries are working at nearly 100% capacity and raking in record profits. Yet Greehey's success is in good part man-made as well. He didn't just see the opportunity, he put together a team and a system that could take advantage of it. "Bill proved all the analysts wrong, including myself," says Fadel Gheit, Oppenheimer's top oil expert. If naysayers ever needed proof of Valero's first-among-equals status in refining, the tale of Katrina and the St. Charles refinery is Exhibit A.

WHEN TURNING SOUR IS GOOD

"What is happening today is what we thought was going to happen when we decided to become exclusively a refining company in 1997," says Greehey, who keeps a grizzly bear he shot in 1982 in his office to remind him of the tough times. "We saw demand continuing to increase, we saw the U.S. going to cleaner fuels, which would shrink supply. Everything has worked."

Greehey's gamble, as they still call it in Texas, didn't start out so smoothly. Back in 1981, when he made his first foray into refining, Valero was predominantly a natural-gas-pipeline company--and thank goodness. That year the company bought a small refinery in Corpus Christi and proceeded to spend $1 billion upgrading it. Greehey's theory was that so-called sour crude--the cheap, sulfur-heavy cousin of more desirable sweet crude--offered a gold mine of opportunity. Few refiners were equipped to handle sour crude, and Greehey figured he could make a bundle by customizing his plant to specialize in the stuff. It didn't work out that way, at least not at first. Gasoline prices began dropping, the cost of feedstocks--crude and other raw materials--soared, and Greehey's grand idea quickly turned south. "The headlines all said we were going bankrupt," the CEO recalls. The natural-gas-pipeline business provided Valero just enough cash to get by. "Things got very, very tight," says Palmer Moe, a former executive who ran the pipeline business while Greehey focused on refining.

For more than a decade, Valero remained a one-refinery firm. But Greehey never abandoned his grand vision. And in 1997 he decided to go back to the well--this time with everything he had. By then, gas pipelines were hot properties, so he spun off that business and began buying refineries. No one else wanted them, and he plucked up one after another at 10 cents to 20 cents on the dollar of replacement cost. When Exxon bought Mobil in 2000, it had to divest its Benicia refinery outside San Francisco to meet antitrust guidelines. Greehey swooped in. The profits from that plant, which supplies 10% of California's gasoline, gave Valero money to acquire Ultramar Diamond Shamrock for $6 billion the next year. With the $8 billion purchase of Premcor, which closed Aug. 31, Valero is now the biggest refiner in the U.S., with 18 plants capable of processing 3.3 million barrels of crude a day, most of it the low-cost, sour variety.

Throughout much of this buying binge, Wall Street laughed. No one believed a dirty, old-economy industry like refining could make outsized profits--especially a firm focused on the bottom end of the market like Valero. Until recently, most refiners didn't make more than a 5% return on capital. But Greehey's brainchild was a juggernaut in waiting.

ATTITUDE IS EVERYTHING

Along the way, Greehey established a corporate culture that's as much of a throwback as the industry he champions. Referred to internally as "Mr. Greehey," he maintains a no-layoff policy, a dress code for managers--in the office, men must wear suits and ties and women wear dresses--and a no-tolerance drug policy. "Clothes reflect an attitude," says Greehey. Employees are regularly tested for marijuana or cocaine use through hair samples taken by the human resources department. Executives have been fired for being condescending or using profanity when addressing underlings. And anyone who willfully violates a safety rule is immediately thrown out.

Wall Street failed to appreciate how Greehey's old-fashioned personnel policies could pay off in the modern era. Many of the refineries Valero acquired were in sorry shape. The company brought in new safety equipment and an enthusiasm for the business that sparked results. Greehey told employees that they would come first, before shareholders and customers, that plant conditions would improve, and if they worked hard with Valero, they'd get the best benefits in the industry. "What we have found," says Greehey, "is that the more you do for your employees, the more they do for the shareholders and the more they do for the community."

"I see this cycle with companies where they fire and they hire and they fire and they hire," he says. "I think it's just poor management. Fear does not motivate people."

Greehey traces his philosophy to his upbringing in Fort Dodge, Iowa, where he went to work at age 12 to help support his family. "I was born poor, real poor," he says. "We had outhouses, we didn't have bathrooms. My dad worked at a mill for minimum wage at a time when unions weren't strong enough to have a livable wage. And my mother always had to work. The point is, I have been around a lot of poor people in my life. It makes me think differently about our employees."

The St. Charles refinery is a quintessential example of Greehey's values in action. Purchased just two years ago for $400 million, the plant was operating in bankruptcy, had only recently recovered from a nasty fire, and faced environmental lawsuits for polluting the atmosphere. Baby alligators scuttled over the grounds. "It was the absolute dog of the refining industry," says plant manager Stuart. But within this junkyard cur Greehey saw great potential. He promised employees that their jobs were secure, spent $466 million making the plant safer and more efficient, and brought in Stuart to revive operations. Greehey also re-established relations with the community of St. Charles Parish, raising more than $600,000 through Valero's annual United Way drive--ten times the amount the plant had raised the previous year. Since Valero bought it, the St. Charles refinery has churned out $1 billion in profits, more than paying for the cost of its purchase and capital upgrade. But the plant would show its truest colors in the face of Katrina.

PRIDE AND WET WORK

Some pundits are asking why so much U.S. energy infrastructure resides along the Gulf Coast, where it's vulnerable to hurricanes. But that's simply where the oil and gas is. And today, it is also where the talent is--a local workforce that is expert in moving crude from offshore rigs, through pipelines, onto tankers, and then into refineries for distribution throughout the country.

Like any refinery in a hurricane zone, Valero's St. Charles facility had a disaster plan. The scope of that plan and, even more, the way it was carried out offer memorable insights into how Greehey's management formula is working. As the hurricane gathered force on Friday, Aug. 26, plant manager Stuart started by ordering ten big generators and 24 diesel-run pumps from a standby equipment-rental company. Once Katrina hit, a power outage was almost certain, and the plant and its ride-out crew would need electricity for the administration building and the control rooms where computers monitor processes throughout the refinery. Meanwhile, workers bought up supplies--Stuart wanted at least four days of food and water on hand.

The storm surge was predicted to be 13 feet, which would cause the lake to breach the levee five miles from the plant. Big pumps needed to be in place to get rid of excess water as quickly as possible. Smaller pumps were put on top of storage tanks with floating roofs to prevent rainwater from accumulating. Too much water can tilt a roof, exposing flammable liquids and creating a fire hazard.

After an early-morning conference call with San Antonio on Sunday, orders were given to shut the plant down. That's a tricky process. Temperatures of up to 1,000 degrees Fahrenheit and pressures as high as 1,000 pounds per square inch have to be reduced smoothly to avoid leaks and equipment damage, and to keep hot hydrocarbons from hardening to a molasses-like consistency and plugging pipes. Too fast a shutdown will create problems in the subsequent startup. "It's like a car," says Richard Marcogliese, Valero's senior vice president of refining. "You don't stop all of a sudden at 90 miles an hour."

With the plant closed down by 3 P.M. Sunday, Stuart and his crew retreated to the second floor of the administration building, where cots and sleeping bags were set up. As darkness fell, the wind howled, rain pelted the windows, and the building began to rock. Fear rolled through the group. One worker's pet Mexican Chihuahua, Paco, which had no other place to spend the storm, went skittering by John Hill, the maintenance director. "Hey, there goes Taco," said Hill. "John, his name isn't Taco, it's Paco," corrected the dog's owner, maintenance superintendent Steve Dufrene. "Well," said Hill, "if we run out of food, his name is gonna be Taco." Laughter lifted the somber mood.

As the wind rose, crews ran outside to check tanks and instrumentation and to refuel pumps and generators. But by 3 A.M., squalls were at such dangerous levels that Stuart ordered everyone back inside. As Katrina hit with full force, the refinery lost power. Not until 2 P.M. Monday had enough of the storm passed for the crew to emerge and assess the damage. There was flooding on the east side of the plant, insulation had blown off cooling towers and storage tanks, electric poles were down and, the generators having run out of fuel, the computer screens in the control rooms were dead. There was no way to check the plant's vital signs.

Meanwhile, in San Antonio, Greehey, Marcogliese, and Valero chief operating officer Bill Klesse were also keeping tabs on other operations. They figured that St. Charles was likely to remain down for two weeks. Valero refineries in Krotz Springs, La., Lima, Ohio, and Memphis were running at less than full capacity, because crude couldn't be delivered from pipelines that had lost power during the storm. Should they request oil from the Strategic Petroleum Reserve? Yes. Nine ships on their way to other refineries needed to be rerouted. Through Valero's Washington office, the team asked for waivers of the Jones Act, to allow foreign-flag vessels to carry crude and product while pipelines were down, and of environmental restrictions, to allow more gasoline imports. FEMA might have blown its job, but the Department of Energy got it--the waivers went into effect before gasoline demand soared over the Labor Day weekend.

As Stuart struggled with electrical outages and communication lapses, the San Antonio headquarters began dispatching supplies to aid employees whose homes were destroyed. Trucks arrived carrying food, water, chain saws, shovels, Nextel phones (the only cell system that worked), and--crucially--small generators to power lights and refrigerators. Valero ordered 60 mobile homes for employees whose own houses were uninhabitable. The Valero SAFE fund, which grants employees up to $10,000 each in aid, dispatched adjusters to evaluate damage. Stuart opened the refinery's gas and diesel pumps, providing free fuel to any Valero worker as well as to local law enforcement.

Stuart also had to worry about employees like Melvin Edgar, a security supervisor with a home in the flooded Gentilly section of New Orleans. Edgar spent two days and nights sitting on the roof of his house until the Louisiana Wildlife and Fisheries folks picked him up in a boat and deposited him at the Superdome with thousands of other refugees. "Then the nightmare started," he says. "I watched babies die, people commit suicide. Thugs were raping and mugging people. I was too terrified to sleep."

When buses arrived to evacuate people to Texas, Edgar jumped on one going to San Antonio, borrowing the cellphone of a policeman to call Valero headquarters. Robert Pena, an office services manager, picked him up at Kelly Air Force Base, took him shopping for clothes at Wal-Mart, out for a hot meal, then home for a shower and some sleep. A day later, Pena drove Edgar to St. Charles. "I wanted to get back to find my family and get back to work," says Edgar, who refused a FEMA check. "If it wasn't for Valero, Lord knows where I'd be."

By Wednesday, water at the east side of the plant had been pumped out. A team from Corpus Christi showed up to set poles, repair lines and install new motors. Folks in San Antonio began calling any numbers they had for St. Charles's employees, urging them to report in. Drawn by food, fuel, and a place to stay, enough workers returned to the plant to man operations. With power restored Thursday, the startup process proceeded smoothly. Stuart grew optimistic that by the time Greehey arrived the following Wednesday, he'd be back in business.

And he was. Katrina didn't stop one tradition: the barbecue lunch served whenever Greehey visits a plant. Greehey was stunned when more than 1,400 Valero employees, contractors, and other local workers showed up at a giant tent and greeted him with a standing ovation. Stuart's tears at the briefing were followed by plenty more, from other executives and from workers, overcome by what they had gone through and what they had achieved. "The loyalty and the dedication is unbelievable," the CEO told Stuart and his managers at that first meeting, after another executive broke down. "We got this refinery running, [and] it will be weeks before the refinery across the street is running. These are unbelievable stories, and I can understand why you are as emotional as you are. How you jump-started and got this thing done--I guarantee it, no one else could do what you did. No one."

The cynical might say that Greehey's mantra of putting employees first is no more than a slogan with little bearing on profits, market share, and shareholder value. But it's hard to argue with results. ("It's a win-win," Greehey said that day at St. Charles.) Valero's stock jumped 25% in the ten days after Katrina hit. "Right now morale is so high in this refinery, you can't get at it with a space shuttle," Floyd Tarver, an electrical superintendent whose half-brother drowned during Katrina, told Greehey when he arrived. "Valero has been giving away gas, chain saws, putting up trailers for the employees. They've kept every employee paid. Other refineries shut down and stopped paying. What else can you ask?"

That spirit--plus favorable market conditions--should help Valero churn out big profits for the next several years. Valero's ability to handle cheap sour crude will be especially advantageous as more of the stuff is pumped to satisfy growing demand for energy. The Premcor acquisition will give Valero new economies of scale and save the combined company $300 million. With St. Charles out of commission for only eight days, Valero is projected to earn record profits again this year--earnings were up 34%, to $847 million, in the quarter ended June 30. Greehey built a money machine, but didn't forget to give it a soul.

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