This was the week when, for the first time in a long time, fuel shortages in California have made it to the headlines. Inevitably it has resulted in the usual calls from the local politicians for investigations as to the cause. Since we have been following this industry for quite a while it is worth a little thought exercise to try to figure out what happened, look to see if there are any opportunities to be had, and look to the future a bit to see if it could happen elsewhere.
1. California is a mediocre place to produce gasoline.
Very nearly a year ago, we did this article, in which it was pointed out that because of differences in the crude oil price between different regions of the country, it was greatly more profitable to produce fuel in the middle of the country using WTI or Syncrude than it was elsewhere.
This situation has been going on for a long time, because of "landlocked" crude oil supply that has come on line in North Dakota and also the Syncrude business coming on stream in Canada, coupled with the price differential between Brent Crude and WTI caused by supply threats in the middle east.
The situation got so bad last January that some of these companies were producing gasoline in California at negative margins, that is, at a loss, just so that they could keep the operations running to produce diesel fuel for export.
A lot is going to be made in the press in the upcoming weeks about the California air quality regulations and their effects on this economic calculation, and we pointed out a year ago that for Tesoro (TSO) it cost an additional $2 per barrel to produce gasoline in the Los Angeles area than it did to produce it using the same Alaskan crude oil in Anacortes Washington. This does not seem like much money, only 5 cents per gallon, actually, but it is enough so that if you are one of the refining companies, trying to make a decision about where to add capacity, you're going to do so in places where you can take advantage of the low cost Midwest crude oil.
2. Operable Capacity on the US West Coast has Declined
According to the most recent EIA data, nationwide operable crude oil refining capacity has declined from 17.632 mbpd for this week in 2009, to 17.230 mbpd in 2012. Part of this decline is driven by lower overall demand. In the last week in September of 2008, the US used 9.249 mbpd of finished motor gasoline. Last week, the US used 8.683 mbpd, a decline of 6.5%. Keep in mind that this is inclusive of the roughly 9% of our fuel supply that consists of ethanol. So for the refining industry, there has been a situation of overcapacity since the collapse in prices in 2008.
Here is the operable refining capacity for PADD V, the US West Coast, since 2010:
Moral: If you are in the refining business, and there is too much capacity, you're going to shut down capacity in the least profitable areas, and keep it running in the most profitable areas. Exactly the same logic is used to allocate maintenance capital. You are going to spend more money to keep your most profitable operations running.
So, it is not terribly difficult to figure out what happened.
The Current Situation
Here is the situation as it currently exists using the current gas prices from GasBuddy.com, minus local taxes, and converted to dollars per barrel:
|Retail Price||Local Tax||Fed Tax||Dist||Net Price||$/Bbl|
|Los Angeles||$4.53||$0.41||$0.18||$0.05||$ 3.89||$163.42|
|New York||$3.70||$0.32||$ 0.18||$0.05||$ 3.15||$132.17|
Here is the updated table of refinery economics by region, using the crude oil prices from Chevron, plus other sources: All values below are in Dollars per Barrel:
|West Texas Intermediate||87||77||48||46||44||36||54||35||46|
|Light Louisiana Sweet||107||56||28||26||24||15||34||15||25|
|Alaska North Slope||112||51||23||21||19||10||29||10||20|
|Arabian Extra Light||106||57||28||26||24||16||34||16||26|
You can see that right now, using North Slope oil, and producing products in Los Angeles, it's finally equally or more profitable at current prices than it is to produce gas in Denver using WTI. So, at least temporarily, there will be some motivation to shorten the turnarounds and keep a better eye on maintenance in California, since there is a chance to make money.
There are a couple of opportunities in this, for those who wish to see the bright side:
1. Tesoro (TSO).
We highlighted the problems that this company was having last January, and they were all related to the low margins for gasoline in California. Well, guess what? The margins in California are not low anymore. Furthermore, the company recently bought the Carson, California refinery from BP for about 30 cents on the dollar, at the exact moment of its lowest possible price, and the results of this have yet to show up on a single financial statement. The stock price was about $40 when I wrote that article, and with the margins at what they were at the time, we were thinking a price in the mid-50's. Today's price is still only about $43, so there is still plenty of upside.
2. Tesoro Logistics (TLLP)
Tesoro Logistics is in the business of shipping Bakken crude oil to Anacortes, Washington. You can see from the above table that a year ago, the value of doing this was about $7 per barrel, which is the difference between the Denver gas price and the Seattle gas price, using WTI-priced crude oil.
The value of doing that now is still in the same range, but the value of "exporting" unleaded from Washington to Los Angeles is $29 dollars per barrel, at current pricing. Therefore, that is exactly what is going to happen.
If you had gone long when I wrote this article a year ago, with the price at $31, you would be happy that you were just under $44 right now. This stock is vulnerable to the spread between Brent and WTI, so there is a little more risk in this, and possibly not as much upside.
3. Western Refining (NYSE:WNR)
This company is in the business of buying crude oil in West Texas, at a discount to WTI, and selling the finished products in places like Phoenix, which are influenced by West Coast fuel prices.
A year ago, the profit for doing this was $25 per barrel, today, what with the fuel price issues spilling over into the Phoenix region, the profit for doing this is $44.
The most recent quarterly report for this company confirms that the above model we did is about right: Their average gross refining margin for the second quarter was about $31 per barrel, which is comparable to what Calumet (NASDAQ:CLMT) was getting, refining specialty products, minus the conversion costs of about $5 would give a result of $26, so our model was pretty close.
So, on its face, if things keep going the way they are, there is certainly some upside potential for WNR as well. The stock is about $26 this morning, which is up near its 52 week high, but is only up about $2 since all of the excitement started. The headwind on WNR is that the company is still carrying debt from a refinery transaction that went bad back in 2008 just at the height of the market.
I should point out that looking at the above chart, there still an area of the country in which refining margins are still relatively low, reinvestment is minimal because of the feedstock imbalance, and refining capacity over the last few years has declined. We are talking about the US East Coast. With all of the issues happening in California and the investment going on in the middle of the country, you can imagine the ramifications if this situation continues. This is worthy of some more consideration later.
As we are so fond of saying, the world is chaotic, and there are no guarantees on anything, except that I am ready to guarantee that a hard-nosed manager of a refining company is going to put his or her maintenance capital into the part of the company that is making the most money.
Do with this information what you will.
Disclosure: I am long CLMT, TSO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.