Location, location, location: In the coming years, it could be the single most important factor in determining the fate of refineries.
In past articles, I've briefly noted regional market imbalances -- particularly when describing the pricing strength enjoyed by Frontier Oil
Better know a PADD district
Originally defined during World War II in order to allocate oil resources, the Petroleum Administration for Defense Districts (PADD) divides the 50 U.S. states into five districts:
- PADD I -- East Coast
- PADD II -- Midwest
- PADD III -- Gulf Coast
- PADD IV -- Rocky Mountain
- PADD V -- West Coast
Although end-market dynamics have long varied between districts, the global economic slump has made clear comparative winners out of refinery operations located in districts IV and V. Meanwhile, companies that cook up their crude on the East and Gulf coasts have suffered.
Why so? Fools, let's play a little geography.
First, nearly half the country's refining capacity is concentrated on the Gulf Coast (PADD III). That leads to high regional inventories, depressing the price of refined products and crimping refiners' margins. With the majority of ExxonMobil's
Denizens of the Rocky Mountains and West Coast (PADDs IV and V), on the other hand, have largely kept refineries in the black. Not only are these regions insulated from foreign imports, but there's also relatively little pipeline connectivity to the highly productive Gulf Coast. The upshot has been lower inventories, higher prices, and better margins. These beneficial dynamics, notes Morningstar, helped yield third-quarter profits for West Coast independent Tesoro
On the opposite end of the spectrum, we have the East Coast (PADD I), where refineries have been shuttered faster than New Englanders can winterize their summer homes. The trouble here is twofold:
- The region is saturated by more imports than any other U.S. district.
- A veritable spiderweb of pipelines connect the area to the Gulf, further intensifying the competitive scene.
Running on fumes?
Morningstar wagers that refining margins will remain weak even in the face of growing gasoline demand, owing to narrow distillate (diesel, jet fuel, etc.) margins and unfavorable crude oil differentials. And because of demand from China, coastal U.S. refiners could suffer a surfeit of cheaper sour-grade crude, even when OPEC reopens the spigot.
Summarizing regional disparities, Morningstar concludes, "Given the substantial headwinds of the industry, however, these factors are better used in determining which refineries will stay open as opposed to which are good investments."
Unless you're looking to fill out an ultra-aggressive part of your portfolio, that sounds like high-performance advice.