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Midwest Refiners Benefit From Weak WTI Prices

Midwest refiners may be in the sweet spot for profits.

With high stockpiles causing prices of oil in the mid-continent of the U.S. to remain at a steep discount to other grades of crude, independent refiners are expected to deliver stronger refining margins than their larger Gulf Coast peers.

“The refiners in the Midwest are benefiting from the cheapest raw material cost out there because the oil is landlocked until we move it by some other means,” says Andy Lipow, president of Lipow Oil Associates.

Higher domestic oil production from the Bakken Shale formation in North Dakota and new imports from Canadian tar sand oil production have created a glut of shipments to Cushing, Oklahoma — the main delivery point for West Texas Intermediate crude, or WTI, the U.S. oil benchmark.

With virtually no pipeline infrastructure to move that oil to the major refiners in Texas and Louisiana, landlocked WTI crude is now priced at nearly a $24 discount to oil in the Gulf Coast.

Those depressed WTI prices have been good news for refiners like Marathon Petroleum Corp. .

With four of the company’s six refineries located in the Midwest, the firm reported $1.26 billion in refining profits for the second quarter, up from $590 million a year ago. While its refining output was flat, the firm’s margins nearly doubled year over year to $10.78 a barrel.

This was Marathon Petroleum’s first earnings report as independent entity. Its shares were just spun off from Marathon Oil Corp June 30.

Shares of independent Midwest refiners have outperformed those of larger Gulf Coast refining giants as the WTI spread has widened, attracting the interest of investors looking for a pure play on the WTI discount.

Midwest Refiner Shares in Focus

Shares of Texas-based CVR Energy,which operates a 115,000 per day refinery in Kansas, have surged nearly 70 percent in 2011. Fueled in part by stronger margins, of nearly $20 a barrel in the first quarter, analysts now estimate the refiner will earn $3.20 per share in 2011, six times last year 's profits.

With a market capitalization of just over $2 billion, CVR Energy’s biggest institutional shareholders are hedge funds Third Point and Appaloosa, each of which holds an 8 percent stake in the company, according to recent SEC filings. Citadel investment Group held just over 2.5 percent of CVR shares on March 31.

Western Refining, an independent refiner and gasoline retailer, operates three refineries with a capacity of about 220,000 barrels per day. Its shares have risen more than 85 percent year-to-date. As of March 31, its institutional holders included hedge fund Passport Capital and BlackRock Institutional Trust.

Morgan Stanley analysts expected Western Refining, Tennessee-based Delek and Texas-based Holly Frontier to report second-quarter results above Wall Street estimates. In a note to clients in early July, the analysts also predicted the WTI discount to Brent and Gulf coast crude could push out to $50 in 2013, providing continued momentum for the mid-continent refiners.

“We continue to see material upside and generally less risk of a narrowing spread,” the analysts said.

How Long will it Last?

Oil industry analysts say it will be at least 18 months before any major pipeline comes online, connecting the large oil supply in Cushing, Okla. to the Gulf Coast, home to nearly half of the nation’s refining capacity.

“As we build more pipeline capacity, we'll see that spread narrow probably down to about $4 a barrel, “says Lipow. “The spread will narrow to just represent the transportation cost of getting it from Cushing to the Gulf Coast.”

Until then, Midwest refiners will continue to have a cost advantage.