by Aaron Levitt | July 2, 2012 3:31 pm
Over the last few months here at InvestorPlace, we’ve highlighted some of issues facing drivers on the East Coast. As Brent crude prices have skyrocketed over the last year, refiners on the East Coast have had one heck of time turning a profit. While refiners in the middle of the U.S. have been feasting on cheaper West Texas Intermediate (WTI) crude and profiting from the spread, refineries on the East Coast haven’t been so lucky.
Built to handle only the lighter, sweeter Brent crude from overseas, the money-losing refining business has prompted a variety of firms — including Valero (NYSE:VLO) and Hess (NYSE:HES) — to begin shuttering their refineries along the Eastern Seaboard. Overall, these moves helped spur gasoline prices for consumers higher than they would have been otherwise.
Perhaps the most critical blow to the East Coast refining industry came last May, when after nearly 120 years in the business, industry stalwart Sunoco (NYSE:SUN) agreed to be bought out by pipeline company Energy Transfer Partners (NYSE:ETP) for $5.35 billion. At the heart of that deal was Sunoco’s 7,900 miles worth of pipeline and storage terminals as well as its 33% stake in Sunoco Logistics Partners (NYSE:SXL).
Deemed “not core” by Energy Transfer Partners or Sunoco, the company’s retail and refining operations were scheduled to spun off or closed, prompting fears of additional retail gasoline price increases in the North Atlantic region. Already, Sunoco has idled/closed its Marcus Hook facility near Philadelphia.
Nonetheless, despite East Coast’s refining woes, drivers may have just found their knight in shining armor because the largest refinery in the region may just be kept open.
Before Sunoco’s buyout was announced, the firm had been in talks with private equity group Carlyle (NYSE:CG) to potentially save another Sunoco facility — capable of pumping out 335,000 barrels per day facility — in Philadelphia. The SUN-ETP deal threw a wrench into that potential, given that the merger’s focus was strictly on the pipeline and storage assets.
However, it seems that all parties involved have come up with a solution to keep the oldest continually operating refinery on the U.S. East Coast up and running. According to the new joint venture agreement, Sunoco will contribute the Philadelphia refinery to the partnership and get a minority stake in the venture. At the same time, Carlyle will oversee the daily operations as well as pay for necessary capital improvement projects and upgrades.
Those capital projects will include a vital upgrade of the main catalytic cracker, which will allow the plant to begin refining heavier sour WTI crude from the Bakken shale region. Activity in the Bakken has surged since the fracking revolution has taken hold. The abundance of shale oil in the region is one of the main catalysts for WTI crude oil’s current low price.
The Philly plant will receive those supplies from a new high-speed rail train line that will be newly constructed. Additionally, Carlyle will help fund the construction of a mild hydrocracker and a hydrogen plant on the site. To help keep costs low, the joint venture, which will be called Philadelphia Energy Solutions, also plans on piping in natural gas from the Marcellus Shale to power the massive facility.
According to Carlyle, the refinery’s key location as well as its existing infrastructure will enable the joint venture to create new business opportunities related to production in the Marcellus and surrounding natural gas fields. Carlyle Managing Director Rodney Cohen said in a release that “Together we’ve re-imagined the Philadelphia refinery and its role as a critical energy hub in the Northeast.”
Carlyle isn’t alone when it comes to private equity adding refinery assets. The group’s deal with Sunoco follows both Blackstone (NYSE:BX) and TPG Capital, which made similar refinery deals over the last two years to expand their natural resources investments. Last month, airline Delta (NYSE:DAL) made history when it purchased Phillips 66’s (NYSE:PSX) 185,000 barrels-per-day Trainer refinery, located several miles from Sunoco’s plant. The airline plans to spend $100 million on improvements to make the facility capable of supplying its U.S. jet fuel needs.
Overall, the deal seems to be a win-win for the all the parties involved. Sunoco/ETP gets to keep a stake in the facility as well as its potential future cash flows. The alternative of turning out the lights would not have a great outcome for shareholders.
At the same time, Carlyle gets a relatively stable and critical piece of energy infrastructure for roughly free. The costs to upgrade the facility, while in the hundreds of millions of dollars, are still far less than if it wanted to buy the plant outright or build one from scratch. (Assuming it could even get a permit to do so: The last complex refinery in the U.S. was built/approved in 1977.)
On the whole, shareholders of the two firms should be pleased with the outcome and the potential long-term positive effects.
Perhaps, the biggest winners are drivers on the East Coast and North Atlantic. According to the Energy Information Administration (EIA), the Philadelphia facility accounted for nearly a quarter of the region’s refinery capacity in 2011. If it were shut down, petroleum product markets in the Northeast could be significantly squeezed. The EIA predicted last February that gasoline would have to be trucked and shipped via train to make up for the lost supply. Those shipping costs alone would tack on at least 5 cents to 10 cents a gallon. Not to mention the potential price increases due to shortage of supplies.
But now, the key piece to Carlyle’s plan is shipping in WTI crude from the U.S. interior. The price difference between WTI and Brent currently stands at around $13 a barrel. That’s a huge savings that will ultimately be passed onto consumers. Already, drivers in Bakken-fed states pay significantly less for gasoline than those in the Northeast.
If the Carlyle-Sunoco deal proves successful, it could maintain the trend of falling gasoline prices, which started back before Memorial Day. That certainly is welcome news for consumers as concerns about global economic growth have taken some of the wind out of the U.S. recovery’s sails as of late.
As of this writing, Aaron Levitt doesn’t own any securities mentioned here.
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