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PES learned a hard lesson about crude-by-rail

05 Feb 2018 20:52 GMT
PES learned a hard lesson about crude-by-rail

Houston, 5 February (Argus) — US independent refiner Philadelphia Energy Solutions (PES) saw a long future for railed crude deliveries months before the US ended its decades-long ban on exports of domestic crude in late 2015.

The operator of a 330,000 b/d refinery blamed an estimated $350mn in costs in 2016 and 2017 associated with blending mandates called the Renewable Fuel Standard for its financial struggles in bankruptcy filings earlier this month. Those costs joined a familiar Atlantic coast mix of expensive feedstocks and a crowded market dragging down refinery returns.

Renaissance by rail

PES did not detail any efforts to invest in blending or other strategies to limit its exposure to the fuel standard. But the company four years ago saw rail driving future competitiveness on the east coast with investments across the US.

The Carlyle Group invested in the Philadelphia refining complex as Sunoco prepared to shut the facility down. Years of steep and climbing dependency on expensive light, sweet crude imports had slashed refining margins already under pressure from European fuel exports to the New York Harbor and millions of gallons a day of cheaper US Gulf coast products delivered by pipeline. West African crudes filled most of the facility's three crude units. Carlyle took a two-thirds ownership stake in a joint venture with Sunoco.

The Carlyle Group expected shale to help save the refinery. Philadelphia was not far from growing Marcellus fields flush with natural gas and natural gas liquids. Petrochemicals could give the refinery a second life.

Shale quickly underpinned PES' strategy, but not in the way the company had expected. Hydraulic fracturing began producing booming volumes of high-quality light crude from isolated North Dakota oil fields. Stranded from sufficient pipeline capacity, the crude began traveling by rail to the coasts.

PES completed a $130mn, 280,000 b/d railed crude offloading facility in 2014 able to unload four unit trains a day. The North Yard Terminal boasted unrivaled capacity in the region, befitting the Atlantic coast's single largest refining complex, and the region overtook the west and Gulf coasts as the primary destination for railed Bakken crude.

The facility gave the refinery access to large volumes of discounted crude and the company an anchor asset to go public with a logistics master limited partnership (MLP).

Rail had freed PES from Brent-priced West African and other light crude imports flowing through the refinery's contracted 300,000 b/d of terminal space at Sunoco's Fort Mifflin and Darby Creek terminals.

The North Yard Terminal was the envy of nearby Monroe Energy, a 185,000 b/d refining subsidiary of Delta Air Lines that lacked the space for its own rail terminal. Representatives at the time joked about searching for a good corn field nearby. PBF Energy built a 210,000 b/d offloading facility across the Delaware river at its 190,000 b/d refinery in Delaware City. Phillips 66, which operates the 250,000 b/d Bayway refinery in Linden, New Jersey, contracted up to 75,000 b/d of railed deliveries at a Global Partners transloading terminal upstate and built a 70,000 b/d unloading site at the refinery.

Locked and loaded

PES signed a 10-year agreement in January 2015 committed to at least 170,000 b/d of crude throughput at a rate of $1.95/bl. Any crude beyond that rate would carry a fee of 51¢/bl. PES paid its terminal $131,800 in shortfall payments in 2015 and transferred $298mn to the terminal operation between 1 January 2015 and 31 August 2017. In June 2015, the company reported it was seeking a controlling share of a 210,000 b/d crude-by-rail loading terminal in North Dakota with BOE Midstream. The refiner and MLP set out on a road show to woo investors in August ahead of a planned initial public offering.

New competitive pressures joined the refinery's old, nagging hurdles. The company six years ago faced pressure from US Gulf coast refineries feasting on cheap natural gas, heavy crudes and pipeline access into the New York Harbor market. Midcontinent refiners have joined these rivals, nibbling in from the west into the Pittsburgh and central Pennsylvania markets through new pipelines and potential reversals. PES warned last year that a proposed partial reversal of the Laurel pipeline connecting the refinery to those markets would cut off an outlet for 20pc of the refinery's production. The refinery says 45,000 b/d of its gasoline and 35,000 b/d of its diesel flow that direction. Batched refined products shipments on a planned expansion of Energy Transfer Partners' (ETP) 275,000 b/d Mariner East 2 pipeline could also move cheap competition to Philadelphia's doorstep.

ETP is a minority owner of PES following its purchase of Sunoco.

Global competition

And now PES competes with the world for its Bakken crude windfall. The 2015 road show faltered with oil prices that August, according to bankruptcy filings. By the end of that month, margin for New York Harbor products produced from Bakken crude including rail tariffs fell by a third, to $9.90/bl, according to Argus assessments. The crack spread for waterborne Brent the same day was $20.69/bl.

Investors lost their appetite for energy exposure. Bakken production began to drop, and pipeline connections providing cheaper transportation to larger markets further eroded rail volumes. Then, in December 2015, the US administration lifted a decades-long ban on US crude exports.

"Perversely, it became cheaper to transport crude oil from North Dakota to points in western Europe than it was to transport the same crude oil to Philadelphia and, therefore, these foreign refiners could afford to outbid (PES) and other [east coast] refiners," the refiner said in January bankruptcy filings.

PES began talks to refinance its debt the next year.

All east coast refiners face similar constraints on blending in the region's pipeline-dominated marketplace.

Pennsylvania governor Tom Wolf sought in November an Environmental Protection Agency (EPA) waiver for economic harm associated with compliance requirements for the state.

Delta Air Lines has consistently supported its 185,000 b/d downstream subsidiary in Trainer, Pennsylvania, and denied it was at risk of closure. The firm took control of the unit in 2012, around the same time that Carlyle purchased its 50pc interest in the Philadelphia complex.

Phillips 66 was investing in gasoline unit upgrades at its 250,000 b/d Bayway refinery in Linden. PBF Energy — a vocal critic of the mandates — has sought to expand its blending business, diversifying into most other US regions. Delaware governor John Carney last week requested a similar economic harm waiver from EPA. PBF declined to comment on whether the Delaware refinery faced closure.

Ironically, in the month that PES filed for bankruptcy, for one fleeting day the Bakken-by-rail crack spread matched the Brent spread for the first time since March 2015. But since that 4 January convergence at $10.33/bl, the Brent spread grew past $15/bl this week and the Bakken spread slunk back down to around $8/bl.

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