Valero Energy Corp. (VLO) said on Monday it has agreed to buy rival Premcor Inc. (PCO) for $6.9 billion in cash and stock, vaulting it ahead of Exxon Mobil as the largest refiner of crude oil in North America.

The deal, which is expected to spark further consolidation in the sector, will expand Valero's geographic reach in the United States and boost its processing of heavy, high-sulphur sour crude oil, which costs less to buy than the lighter oil.

"With industry margins at an all-time high, this is the best and most strategic acquisition, which will be a cash-making machine for the foreseeable future," said Fadel Gheit, a senior analyst at Oppenheimer & Co.

Shares of Valero jumped 4 percent in early trade to $77.87. Shares of Premcor rose 23 percent to $72.45, slightly below the per share value of the deal.

The deal will put pressure on others to act and will increase the value of the remaining independent refiners such as Frontier Oil Corp. (search) and Tesoro Corp. (search) , Gheit said.

As a result of the acquisition, San Antonio, Texas-based Valero will add four refineries to its 15 operations and boost its refining capacity to 3.3 million barrels of oil a day from 2.5 million, generating $70 billion in annual revenue.

Valero Chairman and Chief Executive Bill Greehey said he sees no regulatory hurdles related to the acquisition.

The deal comes at a time when domestic supply in the United States has not kept pace with demand, according to the National Petroleum Refiners Association (search), and it is increasingly hard to build new facilities for economic, environmental and political reasons.

There are now 149 refineries with a combined capacity of 16.8 million barrels a day, down from 325 with a capacity of 18.6 million barrels a day in 1981, according to the group.

The deal is structured as a 50-50 mix of Valero stock and cash. Shareholders in Premcor, based in Old Greenwich, Conn., will receive a total of about $3.5 billion worth of stock and $3.4 billion in cash.

Premcor shareholders will have the choice to receive either 0.99 share of Valero common stock, worth $74.29 based on Valero's Friday closing price of $75.04, or $72.76 in cash for each Premcor share, or a combination of the two.

The cash deal represents a premium of about 23 percent to Premcor's closing price of $59 a share on Friday.

Valero will also take on about $1.8 billion of Premcor's long-term debt, offset by $800 million in cash.

Valero said the deal, which is set to close by year-end, with Premcor would boost earnings by 14 percent in the first year and save $350 million in the second year after the deal closes on interest expense, administration, and crude oil costs from purchasing leverage.

Valero also said it expected crude oil discounts would boost operating income by $1.6 billion in 2005.

Valero last week reporting its first quarter profit more than doubled, boosted by strong refining margins.

Following the deal, Valero will continue to be headed by Greehey, with no changes to its board.

Lehman Brothers advised Valero on the deal, while Morgan Stanley advised Premcor.