Traditionally, the refining industry has been known for reverting back to the norm when it comes to oil and gas prices. The thing is, the boom in U.S. oil and gas production has thrown that equation all out of whack. It has gone so far that CVR Refining (NYSE:CVRR) CEO John Lipinski went on the record saying that refiners don't really know where the "norm" is in the American energy space is right now. Let's take a look at the factors that are making refiners scratch their heads and how this chaotic time will impact both producers and refiners.
What goes up, must come down
As massive amounts of oil started flowing out of places like the Bakken shale over the past couple years, it has become apparent that the U.S. pipeline infrastructure was wildly unprepared for such an event. Major oil hubs like Cushing, Okla., were almost overflowing with crude oil because they didn't have the infrastructure to move it to the coastal regions where the lion's share of refining capacity exists.
At the time, this was a party for refiners that had a majority of their refining capacity in the middle U.S, including CVR Refining, HollyFrontier (NYSE:HFC), and Western Refining (NYSE:WNR). Unfortunately, the party didn't last long. As new pipelines have been built to deliver more crude to the Gulf Coast, and rail shipments are sending crude to the East and West coasts, margins for these players have fallen back to what they were two years ago.
What has caused refiners to slump, though, has been a boom for producers where takeaway capacity has been an issue. The Bakken formation is probably the best example of this. Despite this region's production growing by 200,000 barrels per day since this time last year, Bakken-centric producer Kodiak Oil & Gas (NYSE: KOG) has seen its average sales price for a barrel of oil increase by 18%. Kodiak is able to achieve these high price realizations because increased pipeline and rail activity is shipping Bakken crude to other markets like the East and West coasts, where the premium for oil is much higher than in regions such as the Midwest.
However, statements from the managements of CVR Refining and HollyFrontier suggest this trend of falling margins could be short-lived as well. The reasoning behind this potential turnaround is that as pipelines push more crude toward the Gulf Coast, that region will meet its crude capacity and become overloaded, thus dumping loads of crude back in the laps of the mid-continent refiners at discounted prices. If everything goes their way, they could see prices drop to levels similar to 2012.
These rapid shifts will most likely continue for quite some time as America works out the kinks in the system, but for now many companies are not quite sure what that system will look like because the industry is moving so fast. As Lipinski put it: "We're still trying to find the norm. We don't know exactly where it's going to be."
What a Fool believes
This should be a small lesson to investors in the U.S. oil and gas boom. As long as there are some inefficiencies in how crude is moved about the country, refiners and producers will probably continue this tug of war on pricing. One of the big unknowns in this equation is how much America can export crude and petroleum products. If the limits that are imposed either through physical constraints on the system or government regulation were to change, then it is very possible that we could see even greater changes in the oil and gas value chain.
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