Is the U.S. Gulf Coast the New Cushing?

As the Financial Times wrote last year, the crude oil trade is "in throes of an historic shift." U.S. Gulf Coast refiners, which had relied on imports of light sweet crude oil from OPEC nations for years, have drastically reduced such imports, courtesy of rising domestic oil production.

A number of pipeline projects – some already in service and others expected to come on line this year – will provide Gulf Coast refiners with more oil than they ever dreamed of, flowing from major production centers like the Eagle Ford Shale and the Permian Basin.

According to some experts, this sharp increase in pipeline capacity to the Gulf could overwhelm local refineries, many of which are ill-equipped to process the lighter grades of crude oil flowing from the Eagle Ford and the Permian.

They argue that this coming deluge of crude to the Gulf will turn the region into the new Cushing, with major consequences for domestic crude oil prices. Let's take a closer look.

Gulf Coast light oil imports fall
As the production of light oil has increased drastically over the past five years, led by increases in production from the Eagle Ford, the Bakken, and the Permian Basin, Gulf Coast refineries have become less reliant on foreign light crudes from places like Nigeria.

In fact, light crude imports processed in the U.S. Gulf Coast, or PADD 3, fell to less than 0.8 million barrels per day in the first half of 2012 from an average 1.2 million barrels per day in 2010. Tellingly, Phillips 66 (NYSE: PSX  ) recently announced that it expects to process 80% more domestic crude this year than it did in 2012.

And Marathon Petroleum (NYSE: MPC  ) also plans on using much greater quantities of North American crude, having recently boosted capacity at its Detroit refinery by 13%, to 120,000 barrels per day, in order to process Canadian heavy crude, which is even cheaper than Bakken and other grades of domestic crude. Both companies reported fourth-quarter earnings that blew Wall Street estimates out of the water, due largely to their increased access to heavily discounted inland crudes.

New pipeline capacity
Going forward, this trend is expected to continue as increasing pipeline capacity delivers vast quantities of light, sweet crude to Gulf Coast refiners. For instance, the expansion of the West Texas Gulf Pipeline, the Longhorn reversal project, and the first and second phases of the Sunoco Logistics Permian Express Pipeline – all slated for completion this year or the next – are expected to provide a substantial boost to takeaway capacity from the Permian Basin.

Similarly, new projects serving the Eagle Ford region are also expected to go on line this year, though several major ones have already been completed. For instance, one of the biggest pipelines serving this play, the Eagle Ford Enterprise pipeline, went into service last year.

The 147-mile pipeline runs from Lyssy, Texas, to Sealy, Texas, with a targeted capacity of 350,000 barrels per day. At Sealy, the pipeline connects to Enterprise Products Partners' (NYSE: EPD  ) Rancho pipeline, which connects directly to the Gulf Coast refining complex and the Enterprise Crude Houston (ECHO) oil terminal.

In addition to the Eagle Ford Enterprise line, numerous other pipelines, including Kinder Morgan's (NYSE: KMI  ) Crude Condensate pipeline, Koch Industries' Pettus to Corpus Christi Line, Magellan Midstream Partners' (NYSE: MMP  ) Double Eagle Pipeline, are expected to provide a combined 650,000 barrels per day of capacity from the Eagle Ford to Houston and more than 1.3 million barrels per day from the Eagle Ford to Corpus Christi, according to a special report by Platts.

This raises an important question. Are the Gulf Coast refiners ready for the deluge of crude oil coming their way?

Gulf Coast crude oil mismatch
It's tough to say. Over the past several years, many Gulf Coast refiners invested heavily in equipment designed to process heavier crudes. After all, how were they to know that advances in drilling technologies were about to fuel a domestic energy renaissance that would bring hundreds of thousands of barrels of light oil their way?

While many of the heavy oil refineries do have the capability to handle lighter crudes, it's not exactly the most efficient way to run their facilities. Running light oils at refineries geared for heavier grades can underload or overload different cracking units, which can lead to suboptimal utilization rates.

According to the EIA, in order for Gulf Coast refiners to process greater quantities of light sweet crude, they would need to rebalance their crude slates, upgrade their equipment, or reduce their usage of equipment designed to process heavier crudes.

All of these options are likely to result in the uneconomical use of Gulf Coast refining facilities. Moreover, due to the costs involved with these options, refiners may be reluctant to pay a premium for new supplies of light crude, which is likely to exert further downward pressure on price.

Final thoughts
Only time will tell whether Gulf Coast refining capacity will be overwhelmed by the flood of light sweet crude coming their way over the next couple of years. Keith Schaefer of the Oil & Gas Investments Bulletin recently told The Energy Report that he thinks Gulf Coast refiners will find themselves ill-equipped to handle growing volumes of light sweet crude. He suggests that there simply isn't enough refining capacity.

Other commentators argue that Gulf Coast refiners may actually be a lot more flexible than Schaefer suggests. Geoffrey Styles, managing director of GSW Strategy Group, an energy and environmental strategy consulting firm, noted in a recent article: "It's worth recalling that no significant new oil refinery has been built in the U.S. since the 1970s, although many have been upgraded substantially since then. That means that most of today's Gulf Coast refineries have cores that were built at a time when domestic light sweet crude was still abundant."

Both arguments have merit so it's hard to pick sides. I guess we'll just have to wait a little while to see who's right.

While Gulf Coast refiners are the most obvious beneficiaries of the boom in American oil production, don't forget about the midstream companies that transport the stuff and help alleviate regional bottlenecks like the one at Cushing. Enterprise Products Partners, with its superior integrated asset base, can profit from the massive bottlenecks in takeaway capacity by taking on large-scale projects. 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.


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