Masterpiece Refining – From PBF Energy

PBF Energy Inc is a private company that bought three US refineries with 0.5 MMb/d capacity in the past two years and now plans to go public. Two of the refineries are on the East Coast where many larger players have abandoned the refining business. The third is in the Midwest sweet spot. Today we look at how the company plans to keep these refineries profitable for investors.

Before we start – a quick disclaimer. RBN Energy does not advocate investment in IPOs, or any security, for that matter. We are not an investment advisor.  The purpose of this article is not investment advice or an endorsement.

Last Monday (December 3, 2012) PBF Energy Inc filed papers with the SEC pursuant to an IPO listing on the NYSE. The company owns three refineries in Delaware, New Jersey and Toledo, Ohio with combined capacity noted above of 0.5 MMb/d (about 3 percent of the US total). Two private equity companies - the Blackstone Group and First Reserve Corporation - currently own a majority interest in PBF and they will use the IPO to exit their investment. Under the IPO filing process, the SEC requires PBF to submit an S-1A registration statement and prospectus. These documents detail refinery commercial operations to identify risks that potential investors should be aware of. The good news for analysts is that the prospectus provides a peak into details of the refinery operation that would not normally see the light of day.

We felt the opportunity afforded by PBF’s prospectus was too good to miss and so we took advantage of the data to delve a little deeper into how these refineries expect to make money in today’s market and how they are reacting to the changes in US crude oil supplies that we have been documenting here over the past year. You can read a copy of the complete prospectus here.

PBF is currently owned by private equity and if the IPO is successful it will become a publicly traded company that just owns refineries. Running refineries as a standalone business has inherent risk because the profitability of their operation depends on the refinery margin or crack spread (read more about margins in Refinery Yields Forever). That boils down to the spread between crude prices and refined product prices. Trouble is the crude and refined product markets can often be at odds with one another. You can purchase crude at the going market price and then find the market price for the products your refinery produces has fallen below the cost of crude – meaning you lose money on every barrel. Larger multinational oil companies can offset some of these risks by owning oil in the ground and by selling refined products through their own distribution network. If you just own the refinery, you need to purchase every barrel of crude and sell every gallon of product at market prices.  So far PBF has succeeded in keeping its refineries profitable.

The two PBF East Coast refineries are located 30 miles apart on the Delaware River with marine access to the Atlantic seaboard (see map below). The Paulsboro NJ (160 Mb/d) and Delaware City DE (190 Mb/d) (** see personal note below) facilities are both complex refineries (see Complex Refining 101 Part 1 and Part 2 for details on how complex refineries work).  We have looked at East Coast PADD 1 refineries previously in our blog series about the fate of the Sunoco Philadelphia refinery (see Don’t Let the Sun Go Down and Beginning To See The Light). The East Coast refining market has been unprofitable for refiners in recent years because they rely on imported crudes that are priced higher than domestic grades. Valero closed the Delaware City refinery in December 2009 because it was losing money. PBF bought the Delaware refinery from Valero and restarted operations there in May 2011. PBF purchased the Paulsboro refinery from Valero in December 2010. 

PBF Refineries in Delaware City DE and Paulsboro NJ

Seventy to eighty percent of the crude slate processed by the Delaware City and Paulsboro refineries consists of medium, heavy and sour crudes – the remaining throughput is sweet crudes and other feedstocks such as fuel oil.  Both refineries have historically received the bulk of their crude via ships and barges on the Delaware River – meaning imported crude. The Paulsboro refinery has a longstanding agreement with Saudi Aramco under which they purchase 100 Mb/d of medium and heavy Saudi crude. These imported Saudi crudes are priced using the Argus Sour Crude Index (ASCI) – a benchmark that is based on three medium sour US Gulf of Mexico crudes (Mars, Poseiden and Southern Green Canon). These crudes are currently priced relative to international crudes meaning that they are more expensive than US domestic grades like the benchmark West Texas Intermediate (WTI). In November 2012, ASCI averaged $103/Bbl and WTI averaged $86.75/Bbl. The PBF and Delaware refineries are therefore disadvantaged because they have no pipeline access to cheaper US domestic crude grades. This reliance on more expensive imported crude was the reason so many East Coast refiners went out of business and PBF was able to snap up two refineries for a bargain price. PBF’s plan is to reduce reliance on these imported crudes – more about that in a minute. In the meantime they are doing their best to keep costs down on Saudi imports. Reuters reported last week how PBF is using large supertankers to ship oil from Saudi across the Atlantic to offshore ports in the Gulf of Mexico where they lighter it onto smaller foreign flag vessels for the trip up the East Coast (see the article here). That tactic keeps transportation costs down by using large tankers for the bulk of the trip and avoiding the use of more expensive and less readily available Jones Act vessels if the lightering was done in a US port.

The two PBF East Coast refineries are not obvious candidates to take advantage of burgeoning production of less expensive light sweet crude from North Dakota and the Eagle Ford. They can only consume a limited amount of light sweet crude because they are configured to handle heavier crudes (see Turner Mason and the Goblet of Light and Heavy). However, the Delaware City refinery is the only refinery on the East Coast that has coking capacity to process heavy sour Canadian bitumen crude. That crude is hard to transport because of its thick viscous nature and is normally diluted using condensate or natural gasoline to make a dilbit blend of light and heavy crude (see It’s a Bitumen, Oil Does It Go Too Far?). Not only is it hard to transport but it is produced in Western Canada – a long way from the East Coast. The pipelines transporting Canadian crude into the US all go through the Midwest, not the East Coast. In order to get access to as much domestic light sweet crude as they can consume as well as Western Canadian heavy crudes, PBF is investing $57 MM in 2012 to upgrade a rail unloading facility at the Delaware City refinery.

The rail facility is already receiving 40 Mb/d of Canadian and Bakken crude by rail tank car. The upgraded facility will be able to handle 110 Mb/d of crude by January 2013. PBF is also in the process of acquiring 2,400 crude rail tank cars. Owning the tank cars means that they can dedicate them to transporting crude for their refineries and reduce the cost of third party leasing. Two thirds of these rail cars will be coiled and insulated to transport Western Canadian bitumen crude. The bitumen is kept heated in transit so that it can be loaded in and out of the rail tank cars without using diluent. That means the Delaware City refinery can process the bitumen without having to handle diluent that would simply increase light fractions and reduce the refinery throughput capacity.  The remaining one-third (800) railcars will be used to transport lighter crude. Although the Paulsboro refinery does not have a rail loading facility, PBF plan to move crude by barge from the Delaware facility up the river to Paulsboro.

During November 2012 Saudi Arab Heavy crude was sold at a $3/Bbl discount to ASCI, which averaged $103/Bbl meaning that imported crude cost PBF around $100/Bbl. What would be the saving if they replaced that crude with Canadian Heavy?  Western Canadian Select (WCS) heavy crude with diluent was priced at $76/Bbl in November, delivered to Cushing. Not counting transportation costs the crude differential to Arab Heavy was $24/Bbl. The price of bitumen crude without the diluent would be lower than WCS so the differential would be higher – lets call it $25/Bbl. Even with a $20/Bbl rail cost (conservative estimate from Western Canada to the East Coast) the Canadian crude would have been $5/Bbl cheaper than Saudi imports. Replacing 100 Mb/d of Saudi crude at a $5/Bbl discount would have lowered costs $0.5 MM/day on paper (there would be differences in crude quality and processing costs to account for in practice that might narrow that spread).

Future Canadian crude supplies to East Coast refineries may not need to travel quite so far by rail either. Enbridge is expanding its U.S. mainline system between Superior, WI and Chicago, IL and boosting Canadian mainline terminal capacity. It's also scaling up projects to ship more crude to Ontario and Quebec, partly by reversing the flow of its Line 9 pipeline between southern Ontario and Montreal. These projects bring Western Canadian crude closer to PBF’s refineries and put downward pressure on East Coast imported crude prices. New supplies of domestic US crude could be even closer to home. The PBF prospectus points out that the East Coast refineries are very close to the Utica shale. Oil production in the western part of the Utica in Ohio is growing rapidly and expected to be significantly higher in the next several years. That will provide PBF with a “backyard” supply of all the light sweet crude that their refineries can consume.

Although it is easier said than done, the way for refiners like PBF to beat the odds is to secure crude supplies at low cost, to make sure that the refinery produces refined products that are in demand and to keep down operating costs. In this respect the PBF IPO prospectus argues that the company is well positioned to continue to make money at its East Coast refineries. We just saw how they plan to bring crude costs down by getting supplies from the US and Canada to replace more expensive imports. The East Coast is also a good market for locally based refiners to sell refined products. That is because refining capacity in the East Coast of 1.25 MMb/d is well below refined product demand of about 5 MMb/d (source Energy Information Administration). As we discussed in Don’t Let the Sun Go Down on Me supplies of gasoline, diesel and heating oil are vulnerable on the East Coast because they rely on imports and limited pipeline capacity out of the Gulf Coast. Hurricane Sandy recently underlined that lesson when East Coast supplies of gasoline ran short. Vulnerable product supplies should keep prices and margins higher for PBF.

Operating costs for US refiners are also coming down these days. A large part of those costs is for heating the various refinery units usually using crude feedstocks or natural gas as a fuel. Paulsboro and Delaware City both use natural gas. The price of natural gas is low in international terms – meaning that US refiners using natural gas for fuel pay less than their overseas competitors to refine their crude. The prospectus tells us that PBF annually consumes ~ 37 million MMBtu of natural gas in their refineries. The current price of natural gas in the US is about $4/MMBtu versus $10/MMBtu in Europe – a difference of $6/MMBtu that translates into ~ $200 MM a year in savings.

So far we have seen how PBF expect to make their East Coast refineries profitable despite their poor track record under previous owners. In the second installment of this blog series we will look at the Toledo refinery economics and then at the arrangements that PBF has set up for crude feedstock supply and product sales at all three of its refineries.

** A personal note from Rusty.  “Back in the early 80s, Delaware City was owned by Getty Oil Company, my employer at the time.  That’s where I learned the crude oil selection process, understudying Dr. John Bishop, one of the developers of the Delaware City crude selection linear program, senior planning executive in our Los Angeles office and a pioneer in refinery optimization.  Del City was originally designed to run Neutral Zone crude (an area that separated Saudi Arabia and Kuwait at one time) where Getty had heavy and very heavy crude production.  As the availability of that crude declined, it was replaced in the Del City crude slate with Maya and other heavy crudes that were attractively priced.  It was a tragedy with Del City was shut down and it is great to see the refinery doing so well now.”