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U.S. oil refining companies haven't seen times as good as these since at least the middle of the previous decade. Over the past couple of years, refiners with access to cheap domestic oil have enjoyed solid profit margins and strong earnings, which sent share prices skyrocketing last year.
And with new pipelines providing increased access to those refiners located along the U.S. Gulf Coast, the good times should keep rolling, as more and more cheap crude keeps rolling in. But that's not all. In their quest to boost margins further, several U.S. refiners have their sights set on oil being produced by our neighbors up north.
Canadian crude, which is of a different quality from oil produced in American shale plays, is one of the cheapest types of oil you can find anywhere. And refiners are doing anything and everything they can to get a piece of the action.
Why Canadian crude is so cheap
It's worth emphasizing just how cheap Canadian heavy crude has become, even in comparison with domestic crudes like those produced in the Bakken. In the first week of January, the price of Western Canada Select, the benchmark for heavy crude extracted from Canadian oil-sands bitumen, dipped to nearly $40 per barrel below NYMEX West Texas Intermediate (WTI).
Even WTI's discount to Brent, the global crude oil benchmark, which topped $20 a barrel in early February, pales in comparison. So why exactly is Canadian oil so cheap? There are a couple of important reasons.
One of the biggest reasons is that Canadian oil has to compete with American oil for what limited pipeline capacity that currently exists. Growing crude volumes from Alberta's oil sands and the Saskatchewan Bakken often end up losing priority to growing volumes from North Dakota's Bakken shale and supply sources in the Rockies, for instance.
Another reason is that Canada relies heavily on one major export market -- the American Midwest. Instead of seeking foreign export markets, a whopping 98% of Canadian crudes are destined for the United States. With the aforementioned lack of pipeline infrastructure, compounded by the delay of the Keystone XL pipeline, Canadian oil producers find themselves uncomfortably levered to a market already inundated with oil extracted in its own backyard.
Refiners seeking Canadian crude
As with any profit-seeking company, U.S. refiners are cognizant of the massive disparity between Canadian crude and other grades of crude commonly used as feedstock. Many are actively seeking ways of capitalizing on this unprecedented price arbitrage opportunity.
Marathon Petroleum (NYSE: MPC ) is one of them. The Ohio-based refiner recently finished up an expansion of its Detroit refinery, where it increased capacity by 13% to 120,000 barrels per day. The primary objective of the expansion is to capitalize on rising production from Canadian oil sands.
Tesoro (NYSE: TSO ) is another refiner actively scouring for ways to transport more Canadian crude to its refineries along the American West Coast, where the vast majority of its operations are located. CEO Greg Goff recently said the company is contemplating shipping Canadian crude to the U.S. Pacific Northwest via barges, and then moving it via rail to its refineries in California.
In the fourth quarter, the company consumed about 5,000 barrels per day of Canadian crude at its refinery in Anacortes, Washington, displacing Alaska North Slope (ANS) and foreign crude oils.
Valero (NYSE: VLO ) is also thinking about accelerating the use of alternative methods, like barges and rail transport, to transport Canadian crude to its refineries along the Gulf Coast, as the company waits for authorization by the U.S. State Department on TransCanada's (NYSE: TRP ) Keystone XL pipeline.
In the meantime, Valero has the option of increasing the quantity of Canadian oil it ships via barge to its St. Charles refinery in Louisiana from Hartford, Ill., which receives Canadian crudes via an existing pipeline operated by TransCanada.
While it is already receiving modest amounts of heavy Canadian crudes at its refinery in Port Arthur, Texas, the company also has the option of using rail cars to transport Canadian oil to its other refineries along the U.S. Gulf Coast.
Finally, Phillips 66 (NYSE: PSX ) has also jumped on the opportunity to use Canadian crude at its refineries. At a recent Credit Suisse energy conference in Colorado, a company executive said the recently spun-off refiner is now transporting Canadian crude via rail to its refineries in California.
The company has already invested in 2,000 general-purpose railcars to transport cheap inland oil to its refineries. However, because of Canadian bitumenous crude's unique physical properties, such as its high viscosity that requires it to be heated in order to flow, Phillips is considering coiled tube cars that would be a better match for that type of oil.
Soaring U.S. crude oil production and improvements in pipeline infrastructure are now providing Gulf Coast refineries with hundreds of thousands of barrels per day of light oil produced in plays like the Eagle Ford and the Bakken. As a result, the Gulf region has drastically reduced its dependence on light oil imports from OPEC member nations, which has promising implications for America's balance of payments.
Yet many Gulf Coast refineries are better equipped to process heavier grades of crude, after having invested heavily over the years in catalytic crackers, hydrocrackers, and coking units, which are designed to convert heavy crudes into lighter refined products. While these facilities can run lighter crudes, it's not exactly the most economical way of doing things.
That's why companies like the aforementioned refiners are increasingly using rail and barge to ship heavily discounted Canadian crudes, as well as Bakken crudes, to their refining facilities in the United States. Even after factoring in the transport costs, Canadian crude still ends up much, much cheaper than Brent, allowing aptly positioned refiners to realize robust margins.
Going forward, major pipeline projects are planned to complement rail transport for delivering Canadian crude to U.S. refiners. One major project -- expected to be in service by the end of this year -- is TransCanada's Keystone XL Gulf Coast expansion project, which should allow for much greater quantities of Canadian crude to be shipped to the U.S. via pipeline.
With North American crude oil production showing no signs of abating, midstream companies are in high demand. As oil and gas producers clamor to secure contracts for limited pipeline capacity, companies such as Enterprise Products Partners profit from a simple yet lucrative business model that's very similar to a tollbooth. To help investors decide whether Enterprise Products Partners is a buy or a sell today, click here now to check out The Motley Fool's brand new premium research report on the company.