Profits for Refiners: More Than A Pipe Dream
February 17, 2011
Every so often, the gods smile on oil refiners. The breakdown in the relationship between West Texas Intermediate and Brent crudes represents an extra-toothy grin.
There has been a structural change in the North American oil market. In the past, oil flowed north from the Gulf Coast toward refiners in the Midwest and the Northeast.
The development of new fields such as Canada's oil sands has turned the flow's direction southward. Now oil heads into the crossroads at Cushing, Okla.—where the Nymex WTI contract price settles—but then struggles to get farther south because pipelines remain geared toward the old days. As energy economist Phil Verleger puts it, "Cushing has become the 'Roach Motel' for crude," which can get in, but can't get out.
With tanks nearly full at Cushing, WTI has slumped relative to other grades of crude. Historically, it traded at a small premium to Brent. Today, a barrel of WTI is cheaper by about $17, or 17%.
Brent prices have remained strong in part because the U.S. Northeast is dependent on fuel imports.
U.S. legislation requires that shipping between domestic ports be done on U.S.-built, -flagged and -owned ships with a U.S. crew. That makes it expensive to ship fuel by boat between the Gulf and, say, New York. East Coast demand is, therefore, met in part by imports from Europe, where Brent is the main benchmark.
The upshot is blowout margins for any Midwestern refiner with access to WTI or able to process heavier Canadian crudes that are backing up in the pipeline and therefore also discounted. Little wonder Midwest refining utilization is running at 93.4% against the national average of 84.7%. Deutsche Bank analyst Paul Sankey highlights companies like Frontier Oil as benefiting most. Against that, refiners concentrated in the Northeast, such as Sunoco, look relatively disadvantaged.
Unlike prior changes in the WTI-Brent relationship, this one looks set to last until new pipelines are built to alleviate the Cushing bottleneck. One project, however, TransCanada's Keystone XL pipeline, has just hit a fresh regulatory delay, which could push its opening to mid-2013 or later.
Another option would be to reverse the flow of existing pipelines between Cushing and the Gulf Coast. Attention has focused on the Seaway pipeline, jointly owned by Enterprise Product Partners and ConocoPhillips. The latter, however, also refines oil in the Midwest, where it processes more than three times the amount of WTI that it pumps out of the ground.
Presumably, someone could pay Conoco a high price to persuade it to forgo the big margins that result, as well as shoulder the costs of reversing the pipeline's flow. But with the company's refining division likely enjoying an unusually profitable quarter, the price would be high.
Source: The Wall Street Journal
Engineering News Archive