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Delta deal raises ghosts that haunt refinery profits

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05/04/2012 | 12:51am CET

Delta Air Lines' (>> Delta Air Lines, Inc.) extraordinary deal to rescue a Philadelphia-area refinery just weeks from being shuttered may give the unusual coterie of suitors eyeing Atlantic Basin plants a harsh lesson in the cyclical nature of the business.

Delta Air Lines' (>> Delta Air Lines, Inc.) extraordinary deal to rescue a Philadelphia-area refinery just weeks from being shuttered may give the unusual coterie of suitors eyeing Atlantic Basin plants a harsh lesson in the cyclical nature of the business.

The revival of the 185,000-barrels-per-day Trainer, Pennsylvania plant may be premature, sinking East Coast refining margins just as they are showing signs of recovery.

The refinery -- idled by ConocoPhillips (>> ConocoPhillips) -- is one of a dozen facilities on both sides of the Atlantic that had been mothballed as surging international oil prices conspired with limp demand to crush profit margins and launch the biggest purge in U.S. refining capacity since the early 1990s.

By pulling it back from the brink, Delta, the first airline to purchase a refinery, has demonstrated that some of the other plants may yet be reprieved by the most unlikely of buyers -- a revival that some experts say could be premature and feed into another cycle of weak margins.

Those plants are now likely to haunt the industry for years to come. Idled but not dismantled, they stand ready to resume cracking crude into gasoline at the first sign that margins are on the up.

"I do think down the road there is going to be some buyer's remorse," said John Corrigan, partner at Booz and Company consultants in Dallas. "I don't think the margins are going to stay where they need to be to justify operating those refineries."

More than 2.1 million bpd of refining capacity in the Atlantic Basin has been shut or threatened with closure over the past three years due to poor economics.

The U.S. East Coast -- hit hard by crude costs due to its reliance on expensive North Sea and West African oil -- faced 700,000 bpd in potential shutdowns from three refineries, which would have cut the region's capacity in half.

The closures have boosted East Coast margins, which tipped $13 a barrel in April for the first time since September 2008, after languishing below $10 a barrel for most of the interim period, Credit Suisse data shows. Gulf Coast and Midwest refining margins averaged over $14 a barrel for that period.

East Coast margins could be threatened further if Sunoco (>> Sunoco, Inc.) seals a joint venture with Carlyle Group LP <CG.O> to save the oil company's 335,000-bpd Philadelphia refinery, further adding to the region's capacity.

Additional pressure could come from a planned 125,000-bpd increase in throughput on the Colonial Pipeline, which, according to the company, can currently deliver about 800,000 bpd of fuel from the Gulf Coast into the New York Harbor market.

"Bringing this refinery back online at this time can only worsen already-weak margins in the Atlantic Basin," said Rob Smith, manager of downstream and petrochemicals for PFC Energy in Washington.

"Without Trainer, the market was already oversupplied on refined products."

Despite the sweeping loss of capacity across the Atlantic Basin, East Coast gasoline inventories stand at 53.5 million barrels, only 1 million barrels below the five-year average, data from the U.S. Energy Information Administration shows, and demand has come off steeply in recent years.

Total U.S. refining capacity has seesawed. After rising every year between 2004 and 2009, it declined in 2010, rose in 2011, and fell heavily, by 380,000 bpd, in the first two months of 2012 after the shut-in of East Coast plants, EIA data shows.


GRAPHIC on closures:

GRAPHIC on margins:



While maximizing profits is always the goal, refining margins may not be the only thing at play for buyers in the Atlantic Basin fire sale. Strategic interests for the niche players coming to the table may outweigh the margin losses that would make traditional refiners turn away.

Over the past week, oil-trading companies in Europe snatched up two of Petroplus's (>> Petroplus Holdings AG) five refineries, on the block after the Swiss refiner crumbled under a mountain of debt caused by slumping margins.

Vitol, the world's largest oil trader, teamed up with AtlasInvest to buy Petroplus's 68,000-bpd Cressier plant in Switzerland on Thursday while Gunvor, co-owned by a Russian tycoon, picked up the refiner's 100,000-bpd Antwerp plant in Belgium.

While trading companies are traditionally middle men, buying and selling oil cargoes on global markets, they have shown a growing interest in production, storage and refining assets as trading profits shrink and stricter derivatives regulations loom. Owning such facilities would help firms avoid limits on derivatives trading as they would need to make deals to hedge risks created by holding physical assets.

For Delta, which consumed roughly 250,000 bpd of jet fuel last year at a cost of $12 billion, analysts said the benefit of having a cheap supply of the fuel from Trainer could give it an advantage over rivals in the New York area, where it is expanding services.

Sunoco's Philadelphia plant may benefit from plans to run cheap crude from the Bakken area in North Dakota, easing the pain of importing higher-priced oil from across the Atlantic.

"These are niche plays. I think this does not reverse the trend of the industry divesting themselves of refining on the East Coast because of bad margins and aging plants," said Booz and Company's Corrigan.

"It's interesting that these are non-industry players trying to play in a complex industry."


In addition to the high cost of importing crude, East Coast refinery margins have been hit by heavy competition from new plants in India. U.S. Midwest rivals have benefited from a surge in cheap Canadian and North Dakota oil supplies, allowing them to produce at a much lower cost.

Meanwhile, gasoline demand on the urban East Coast has been hard hit by high prices in recent years, pushing motorists toward public transport. Consumers faced a series of fuel price spikes after the announcement in the third quarter of 2011 that three plants -- Trainer and Sunoco's Marcus Hook and Philadelphia refineries -- would shut if no buyers were found.

From October to April, East Coast gasoline has averaged nearly $3.64 a gallon, according to EIA data, the highest on record for the period and above the national average of $3.60. Overall East Coast gasoline demand is down nearly 14 percent from the peak hit in the summer of 2007, EIA data shows.

"These price shocks are particularly bad for demand for those areas where you have the urban population because they can park their cars and hop on the subway," said Andrew Reed, principal at Energy Security Analysis Inc in Chicago.

"Between demand and their reliance on gasoline profits, these refiners are at a permanent disadvantage."

Reed and other analysts said investment in plants to increase yields of distillate fuel relative to gasoline could help pull up margins, although apart from Delta's plans to hike output of jet fuel at Trainer, none is on the books. The refinery has the capacity to produce some 23,000 bpd of jet kerosene, more than 20 percent of the region's total.

The threatened loss of the three refineries helped push retail gasoline prices to seasonal records earlier this year, sparking a debate over fuel costs that spilled into the U.S. presidential race. Prices have since come off, partly due to talk Sunoco's Philadelphia refinery and Trainer would stay online.

But analysts say the additional feedstock demand from the plants could drive up prices for international benchmark Brent crude, adding further margin pressure to Atlantic Basin refineries.

Plants in the region have been paying a hefty premium for crude tied to Brent prices relative to Midwest refineries, which are fed on crude priced off U.S. oil futures, or West Texas Intermediate, over the past year. WTI's discount to Brent has hit $28 a barrel during that period, bolstering margins for plants able to process oil linked to it.

"There are two impacts on the balance, you will have a less tight gasoline situation this summer," said Jan Stuart, Credit Suisse's head of energy research in New York.

"The flip side is that you are tightening up Brent and most Atlantic sweet that much more."

Still, some analysts insist that even with Trainer and the Philadelphia plant running, enough capacity has been lost by the closure of some Petroplus plants in Europe, Valero's (>> Valero Energy Corporation) 235,000-bpd Aruba refinery in the Caribbean and the 350,000-bpd Hovensa plant in the U.S. Virgin Islands to help prevent a deluge of products from swamping U.S. markets this summer.

"You still have Hovensa shut, we are still net down (in terms of refining capacity) and the jury is still out on some of Petroplus's plants," said Katherine Spector, analyst for CIBC in New York.

"We don't know (how big) it will be exactly, but there will still be a net contraction of capacity."

(Additional reporting by Jonathan Leff and Selam Gebrekidan; Editing by Marguerita Choy and Dale Hudson)

By Matthew Robinson and Jeffrey Kerr

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Financials ($)
Sales 2017 82 012 M
EBIT 2017 3 891 M
Net income 2017 2 263 M
Debt 2017 3 508 M
Yield 2017 4,18%
P/E ratio 2017 13,15
P/E ratio 2018 11,08
EV / Sales 2017 0,41x
EV / Sales 2018 0,36x
Capitalization 30 265 M
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Average target price 73,0 $
Spread / Average Target 8,7%
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Joseph W. Gorder Chairman, President & Chief Executive Officer
R. Lane Riggs EVP-Refining Operations & Engineering
Michael S. Ciskowski Chief Financial Officer & Executive Vice President
Cheryl Thomas Chief Information Officer & Vice President
Susan Kaufman Purcell Independent Non-Employee Director
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