Sunoco’s Buyout Could Boost Pump Prices

With our energy logistics infrastructure ever evolving, a recent move by one growing player could signal the end of an era — an end that could lead to higher gasoline prices for the average consumer.

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 country have been able to feast on cheaper West Texas Intermediate (WTI) crude and profit from the spread, refineries on the East Coast haven’t been so lucky.

Almost all East Coast refineries are built to “crack” only light, “sweet” oil (i.e. Brent crude) and can’t handle the more “sour” WTI crude. With Brent pricing the global standard, it’s more directly tied to those nasty geopolitical events and growing demand than Midwestern WTI. And with saber-rattling ongoing in the Mideast and demand from various emerging markets still growing rapidly, analysts predict a new price floor for oil.

This increasingly difficult environment has already prompted companies such as Valero (NYSE:VLO) and Hess (NYSE:HES) to begin exiting the refining business on the East Coast altogether. Ultimately, consumers on the east side of the country could pay 5 to 10 cents more per gallon because of the costs of transporting refined gasoline from the Gulf or the Midwest.

The latest mega-acquisition could accelerate that development.

End of a 120-Year Era?

After nearly 120 years in the refining business, industry stalwart Sunoco (NYSE:SUN) has agreed to be bought out by pipeline company Energy Transfer Partners (NYSE:ETP). The $5.35 billion deal will give ETP access to Sunoco’s 7,900 miles of pipeline and storage terminals that stretch from Texas to New Jersey, as well as 32.4% stake in Sunoco Logistics Partners (NYSE:SXL).

That MLP subsidiary controls around 5,400 miles of crude-oil pipelines and 2,500 miles of refined-product pipelines. When the deal is done, Energy Transfer will get about 30% of its revenue from oil, refined products and other “heavier hydrocarbons.”

The blockbuster deal is the latest in a flurry of activity in a normally sleepy sector. The shale-field development binge and growing adoption of hydraulic fracturing has highlighted the need for more energy infrastructure across the U.S. There are bottlenecks all across the line.

To that end, a variety of logistics players are on the hunt to expand their capacity. So the deal certainly makes sense for Energy Transfer Partners. The company will continue in its transformation from  midsize regional  into a national carrier of petroleum products with more than 45,000 miles of pipelines.

The deal also makes sense for Sunoco. The Philadelphia-based company has been shifting its focus away from refining of crude toward energy logistics. Its pipeline and storage assets are a good fit with ETP’s overall system — and the 23% buyout premium doesn’t hurt, either.

So as a pipeline play, this acquisition is top-drawer. But what will happen to the East Coast refining business — and gasoline prices?

ETP has already made it clear that it doesn’t want Sunoco’s retail business, which operates around 4,900 gas stations across the U.S. CEO Kelcy Warren has said that both the retail and the refining operations are “not core” and will be sold or spun off as another MLP to unit holders.

Before the ETP buyout was announced, Sunoco had been in talks with private-equity firm Carlyle Group to create a joint venture to run its 335,000-barrel-per-day Philadelphia refinery. The ETP buyout certainly could put a wrench in Sunoco’s plans.

Under the joint venture being considered, Sunoco would put up the refinery assets in exchange for a non-operating minority interest in the venture. However, Energy Transfer Partners may not even want a minority interest in assets that don’t fit within its pipeline-focused business model. While Sunoco has pledged to keep the refinery open until August, a full closure is still a real possibility. That closure would crimp gasoline supplies.

Sunoco is still looking into alternative uses for its idled plant in Marcus Hook, Del. One possibility includes using it to process or store natural gas. Either solution could make sense — especially the storage option — since ETP has plenty of experience in this area. But neither will help the pending gasoline price/supply crunch.

And the Sunoco-ETP merger isn’t the only refining deal that could boost gasoline prices on the East Coast.

In an effort to bring some jet-fuel production in house, Delta Air Lines (NYSE:DAL) has agreed to purchase a refinery in suburban Philadelphia from Conoco (NYSE:COP) spin-off Phillips 66 (NYSE:PSX). The plant had been idled for months, and without a buyer, it would have been closed by the end of May.

Delta is planning to spend around $100 million to convert the refinery to maximize production of jet fuel. While that will certainly help Delta’s fuel bill — assuming the airline can run it better than ConocoPhillips did — the rest of us are out of luck. A switch to more jet-fuel production means less gasoline for drivers.

Price Jump at the Pump Looming

Sunoco’s two refineries, along with the Trainer facility owned by ConocoPhillips, are responsible for about half of all the jet fuel, gasoline and diesel produced on the East Coast. Needless to say, any changes to this production or continued closure plans will put a crunch on gasoline supplies. Oppenheimer Funds analyst Fadel Gheit perhaps said it best: “The golden age of East Coast refineries is over.”

While gasoline demand has been dropping in the face of already rising prices, the market still hasn’t taken into account the potential of full closures of these plants on the price of a gallon of gas. Refiners on the Gulf Ccoast will need to pick up the slack, resulting in longer supply chains.

According to the U.S. Energy Information Administration, gasoline would have to be trucked and shipped via train to make up for the lost supply. That will tack on at least 5 to 10 cents a gallon. Additionally, many of the newer pipeline plans are about moving crude oil downward from the Cushing storage depot to the more state-of-the-art refineries in the Gulf. That leaves the Northeast high and dry.

Ultimately, most of us will be paying more at the pump over the next few years anyway, even with some of the new pipeline construction that’s under way. Sunoco’s sale, along with Delta’s jet-fuel play, highlight how difficult and desperate the refining industry is getting.

For investors, it’s best to stay away from refiners and continue to focus on opportunities in the midstream sector — new infrastructure and pipelines is where the action will be.

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