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 (NYSE:FTO) -- but a recent Morningstar report makes it clear that the topic warrants more than occasional mention. To inject a high-octane kick into our Foolish analysis, I've summarized some of the report's key points below.
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 (NYSE:XOM) U.S. downstream operations located in PADD III, Morningstar says it's no surprise that the integrated giant's U.S. refining segment posted a third-quarter loss.
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 (NYSE:TSO) and the U.S. refining segments of Chevron (NYSE:CVX) and ConocoPhillips (NYSE:COP).
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.
Valero's (NYSE:VLO) Delaware City coking and gasifier operation has certainly felt the regional chill, and Northeast-focused refiner Sunoco (NYSE:SUN) saw third-quarter results swoon.
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.
