In September, I said there was no chance of a new refinery in the U.S. Back then, with 20% of the U.S. refining capacity shut down from hurricanes, it seemed obvious that our nation's energy infrastructure was fragile at best. Now, with all of the refining capacity finally back online and gas prices below pre-Katrina levels, it seems that this important topic is no longer in the news. Have we made any progress?
Fortunately, there has been some good news. Arizona Clean Fuels Yuma has signed a deal with the Mexican government to build a pipeline to link the refinery with the Mexican coast. The company describes this event as crossing a major hurdle toward construction of the 150,000 bpd (barrels per day) refinery. Don't get too excited just yet, though. The company is still searching for funding for the $2.5 billion project, and not a single grain of sand has moved to begin construction.
The U.S. needs additional refining capacity. It doesn't matter whether it comes from building new refineries or expanding existing ones, though the latter appears to be the route of choice. Marathon Oil (NYSE:MRO) announced a project to expand its Garyville, La., refinery by 180,000 bpd. At a cost of $2.2 billion, the project is estimated for completion in the fourth quarter of 2009. Marathon has also recently completed a 26,000 bpd upgrade of their Detroit, Mich., refinery.
Looking at the math, it becomes clear why expansions are the route of choice. Which investment would you chose: 150,000 bpd for $2.5 billion, or 180,000 bpd for $2.2 billion? In other words, nearly $17,000 per bpd for new construction, compared to just over $12,000 per bpd for an expansion? To see a great use of capital, compare either of these numbers to the 8,000 bpd increase at Alon USA (NYSE:ALJ) at $800 per bpd.
Marathon is not alone in pursuing expansion. Motiva Enterprises, a joint venture between Royal DutchShell (NYSE:RD) and Saudi Aramco, has also announced that it is evaluating expansions for its three refineries on the Gulf Coast. The potential expansions range from 100,000 bpd to 325,000 bpd, but no final plans have been published. From 2006 through 2011, ConocoPhillips (NYSE:COP) is planning incremental upgrades and expansions for nine of its 12 domestic refineries, which will increase total system capacity the equivalent of a "single world-class refinery"--I assume this to mean about 400,000 bpd.
I expect to see more announcements along these lines. The U.S. currently imports 3 million bpd of refined products, and environmental regulations specifying numerous fuel blends make it difficult for foreign supplies to compete with domestically refined products. The above announcements equal roughly 1 million bpd of capacity over the next five years. Demand growth for that period is expected to be 1.6% annually, totaling an additional 1.6 million bpd of consumption. In other words, the announcements to date don't even keep up with demand growth over the period.
I often wonder whether refining companies, trading with P/E ratios near 10, still represent a decent value. My gut feeling is that the crack spread (the difference between crude oil and refined products) needs to remain near current record levels to drive continued profits in this sector. Given the supply/demand scenario presented above, it appears quite possible.
One final word: Before you celebrate lower gas prices with the purchase of a new SUV, you might just end up with a gasoline hangover. After the hurricanes, the refineries that were not impacted continued to operate through their scheduled maintenance period and are now overdue. Therefore, more refineries than normal will shut down in the spring, which will be followed by the summer driving season, and then hurricane season will be upon us again. In short, my guess is that current prices are probably about as low as you can expect for the coming year.
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Robert Aronen owns shares of none of the companies mentioned. Please feel free to share your comments with him at [email protected].
