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Refining Industry Helps Drive Gasoline Gains

A confluence of factors is fueling the quick rise in gasoline prices, not the least of which is the state of the U.S. refining industry.

Gas Pump
Mark Lennihan
Gas Pump

The recent shutdown of some North American refineries, and an increase in gasoline exports, has tipped the gasoline supply picture, just as speculation about Iran’s potential impact on global oil supply has driven crude prices sharply higher.

Four refineries serving the east coast, processing a total of about one million barrels a day, are going or have gone off line since 2010.

At the same time, the U.S. has become a net exporter of refined product in the past year, for the first time since the World War II era.

“It’s survival of the fittest, and to survive you have to be a world class refinery. To be geographically advantaged really helps. You have to be nimble,” said Tom Kloza, senior oil analyst with OPIS.

The east coast also relies on imported gasoline from Canada and Europe, among other places.

Kloza said that between the U.S. and Europe, 2.6 million barrels of refining capacity has been shut down since 2009.

U.S. gasoline consumption has been declining for the past four years, in part due to the weak economy but also a 20 percent increase in automobile fuel efficiency in the past decade, according to Fadel Gheit, senior energy analyst with Oppenheimer.

Falling demand and rising prices combined to crush refining margins, forcing the closure of refineries.

“They’re doing a lot better,” now, said Gheit of refiners.

“Obviously, because you see gasoline prices are moving much faster than crude oil prices.” The national average was nearly $3.70 per gallon Monday, up from $3.56, a week earlier, according to AAA.

Gheit said if the tensions with Iran do not result in military action, crude could lose as much as $20 per barrel, and gasoline prices would come down.

Kloza expects gasoline prices to continue rising and peak at $4.25 or lower in late April or early May.

He does not foresee the average $5 or more that some are forecasting, unless oil prices shoot sharply higher.

The runup in crude prices also comes as refineries are beginning to shift to a spring/summer gasoline blend.

One of the refineries that made that blend for east coast drivers was the Hovensa refinery in St. Croix, which announced it was shutting down last month. Hessand Petroleos de Venezuela jointly own the refinery.

“The refineries are not coming back. They are not coming back. The St. Croix refinery had $1.2 billion in losses in the last four years. The Sunoco situation is similar,” Gheit said.

Sunoco recently shut its Marcus Hook, Pa., refinery and may shut its Philadelphia refinery if a buyer is not found.

“We have basically dropped in gasoline supply, dropped more than the decline in consumption. They have created a tighter market,” said Gheit. “The gasoline supply is decreased further by increased exports... Any refinery in the U.S. with access to midcontinent crude, which sells as at a steep discount is able to process the cheaper crude and sell it on the market. And that encourages exports.”

Flash Point

The loss of Libyan crude from the world market last year was a turning point for the industry and became a death blow to the weakest refineries, like those in the Atlantic basin that were dependent on high-priced African crude to make gasoline.

The international benchmark, Brent crude , rose sharply as Libyan crude left the market and was much higher than U.S. West Texas Intermediate and other U.S. crude, like that found in the Bakken formation in North Dakota.

That helped Midwest refiners and stung companies with east coast refineries, like Sunoco and Conoco Phillips , both of which shut refineries in Pennsylvania.

As the supply picture improved, the gap closed and WTI ultimately reached $75 in October, but tensions surrounding Iran have sent the prices of both sharply higher again.

Brent now is more than $120 per barrel, and WTI is about $108.

“The gas ‘crack’ (the profit from turning crude oil into refined products) really collapsed in last September, October,” said John Kilduff of Again Capital.

“With the closures that are coming, certainly the industry has been responding to this environment for the past year. The refinery run rate has been mostly in the low to mid 80s [percent of capacity],” said Kilduff.

That number is now about 85 percent, well below a more traditional level of about 90 percent or higher, he said.

Scrambling to Replace Refined Product

Boiling Gasoline Prices

The east coast market is now in flux as wholesalers look to replace refined product.

The latest government data from November, shows the east coast imported 665,000 barrels a day of gasoline, while U.S. refiners in the Gulf Coast exported 626,000 barrels, mainly to Mexico, but also to other points in Latin America.

Gheit said the amount exported has tripled in the last year.

“Is this helping keep our prices here higher? Absolutely,” said Kilduff.

But since the industry is not running at capacity, the exports are also helping the refining industry maintain active capacity.

Even as east coast refineries shut down, there has been expansion in other places such as the Wood River refinery at Roxxana, Ill., which raised capacity to 350,000 barrels a day.

“There’s some offsetting. The new refineries tend to be more sophisticated, complex and tend to be built for exports. The common ground [for the ones being closed] is they tend to be simple and dependent on imported sweet crude. They were not built in particular for exports. They’re more like the local refinery,” said Kloza.5

The Gulf coast benefits from newer, more efficient refineries, and in fact, the jointly owned Royal Dutch Shell and Saudi Aramco Motiva refinery in Port Arthur, Texas is expanding capacity dramatically.

It soon will be the largest U.S. refinery, processing 600,000 barrels a day, up from 200,000, Gheit said. “That might quench some of the bubbling gasoline prices. That’s going to come to the market with a vengeance. It’s going to come in the summer.”

But gasoline distributors on the east coast had found it cheaper to bring supply from Europe and Canada than out of the Gulf on U.S.-flagged ships.

Gheit said, with Brent at lofty prices, that is changing. “Valero, or any refinery on the Gulf coast can get gasoline to Philadelphia cheaper than Sun can refine it."

The Midwest, meanwhile, has had the benefit of cheaper American and Canadian crude, which can be as much as $50 a barrel cheaper than Brent crude.

But its own recent batch of refinery outages and the switchover to spring time blends there is affecting gasoline prices, Kloza said.

On the west coast, he noted that the fire at BP’sCherry Point refinery last week and the seasonal changeover is affecting gasoline supply and prices there.

The west coast receives oil from Alaska but is also dependent on internationally priced crude and has some of the highest gasoline prices traditionally.

Gheit also said the Gulf coast refiners benefit from access to cheap natural gas, something the Hess and PDVSA-owned Hovesna did not have.

On Monday, TransCanada said it was going ahead with the southern leg of its $7 billion Keystone oil pipeline, connecting Texas refineries with the Cushing, Okla. storage hub.

TransCanada’s application to run the rest of its Keystone pipeline from Nebraska to the Canadian border has been a political football, opposed by environmentalists and derailed when Congress forced a short deadline on the Obama administration to approve the pipeline.

“Our logistical system hasn’t caught up with where we refine and use oil. We need a pipeline system that adjusts to the new supply dynamic,” Daniel Yergin, chairman of IHS CERA, said in a recent interview.

“Refining is a tough business,” said Yergin. The decline in demand? “It’s a combination of recession, greater efficiency, biofuels – all of those things and people just driving less.

You can see why refining capacity has to readjust to the changes in the market.” Kloza said Bakken crude is making its way to the Bayway refinery in New Jersey, and the sweet crude is the type that could be refined at Sun’s Philadelphia refinery, something a potential buyer might want to exploit.

The cheap price for Bakken may offset the cost of shipping it by train to the east coast.

“I can imagine more capacity coming on line in North America or the Caribbean but it’s going to have to run heavy sour crude.

Most of the new crude coming on in the U.S. is sweet, and there’s no pipeline to take it where it’s needed,” he said.

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