Insight: Bakken plans first U.S. refinery in 35 years

HOUSTON/NEW YORK Mon Nov 21, 2011 1:17am EST

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HOUSTON/NEW YORK (Reuters) - The Bakken shale oil bonanza in North Dakota has already upended the U.S. oil market once by reversing a decades-long decline in production.

Now, as the boom fuels a surge in diesel consumption, the remote state may boast a second milestone: construction of the first U.S. greenfield refinery in 35 years.

Tiny by industry standards, the 20,000 barrel-per-day plant -- which received county zoning approval a week ago and now awaits a final state air permit -- illustrates how the tight-oil revolution is reshaping the U.S. energy industry in unexpected ways.

Frenzied drilling activity and a crush of truck and rail traffic across major shale energy fields from Texas to Pennsylvania have fueled a spike in diesel consumption nationwide of more than 10 percent in recent months.

In North Dakota, far from the rust belt refineries of the Midwest and now America's fastest-growing state economy, the $200 million refinery presents a perfect opportunity.

"We knew it was just a matter of time before everything opened up," says Mel Falcon, a former oilfield roughneck and head of operations for Dakota Oil Processing, the private development company behind the project. The refinery will produce almost exclusively diesel fuel, he says.

Drilling in the prolific play has exploded thanks to technological advances in tapping Bakken and Three Forks crude in hard shale, tripling output in just over three years to more than 464,000 barrels per day (bpd) as of September.

Hundreds of diesel-fueled trucks are needed to accommodate such growth in a largely remote state, hauling crude to the nearest pipeline or rail head, hauling refined products to the drilling site or trucking in sand and water. These are key ingredients to hydraulic fracturing, or fracking, which involves injecting a mix of water, sand and chemicals into shale formations at high pressures to extract oil and gas.

That is on top of diesel used in the fracking process as well as the trains that transport Bakken crude to other states in the absence of sufficient pipeline capacity.

Local diesel terminals were sucked dry this month -- some for hours, others for days -- as a major Indiana refinery underwent planned maintenance while fuel demand rose due to seasonal demand from farmers and shippers at the tail end of the autumn harvest and the Bakken shale oil plays. Some truckers had to drive hundreds of miles to fill up.

"Trucks arrive at the loading station and some wait three to four hours and others in excess of eight hours," said Bud Kerr, operations manager at J5, a hauling company in North Dakota. "The problem appears to be worse than what it was last year."

FRACKING DEMAND

The growth in diesel demand is small on a national scale, but dramatic for the region. Diesel consumption in North Dakota shot up 29.3 percent in September from a year earlier, nearly two-thirds higher than previous years, to 2.37 million gallons (56,000 barrels) per day, state tax data showed.

That is just 1.4 percent of total U.S. demand, ranking the state 30th -- but rising quickly. Nationwide, diesel demand in October rose 12.3 percent, or about 460,000 bpd, from a year ago, according to the American Petroleum Institute, which pointed to shale gas development as a key driver.

The average Bakken drilling rig uses about 1,500 gallons of diesel a day, according to industry figures. Mike Rud, spokesman for the North Dakota Petroleum Marketers Association, put the estimate higher, saying the state's 200 rigs are responsible for total demand of some 600,000 gallons per day.

"When you combine the energy sectors with the demand from a strong agricultural economy and bustling construction, you create the perfect storm in terms of demand for a state on the end of pipelines," he said.

Besides trucks, railroads have also accounted for the rise in diesel demand. Rail has emerged this year as a critical mode of transportation for the oil industry as existing pipeline networks are overwhelmed by the surge in Bakken output.

More than 100,000 bpd of crude is now moved out of the Bakken by rail. Last week BNSF, a leading shipper, loaded a 103-tank train at the newly completed Bakken Oil Express bound for St. James, Louisiana, some 1,700 miles south.

BNSF says a typical train in its fleet can move one ton of freight 495 miles on one gallon of diesel, based on average fuel consumption in normal conditions. Last week's train hauling 70,000 barrels of crude -- approximately 10,000 tonnes -- would then consume some 34,000 gallons.

This month's diesel demand surge reverberated as far away as Chicago. Differentials in the Midwest cash diesel market spiked to their highest level in three years until the restart of BP Plc's crude and coker units at its 405,000 bpd refinery in Whiting, Indiana, helped loosen the market.

Traders expect the Bakken demand to keep rising.

"We're going to need a supply side solution to this tightness, because development is not going to slow down up north in the Bakken oil field," a Midwest trader said.

NEW REFINERY

Now North Dakota has just one refinery, Tesoro Corp's 58,000 bpd refinery, about 223 miles southeast of the new refinery's site.

Tesoro aims to begin construction before year-end on a 10,000 bpd expansion of the Mandan plant geared mostly toward increasing diesel output. Still, the state will be far from supplying its own diesel needs. Much of what it consumes comes from refineries in Montana and Minnesota.

The Dakota Oil Processing project is expected to fill 252,000 gallons per day, or about 10 percent, of the state's current diesel needs, said CEO Chester Trabucco.

"The singular focus of this refinery is to be able to provide diesel to the local community and the oil industry," Trabucco said. "By definition, providing that diesel relieves suppliers to better cover their agricultural customers."

The project involves a refinery on 160 acres that was zoned for crops. Pending state approval of an air permit and secured financing, the company hopes to break ground at the first thaw in May 2012 and start it up a year later, Trabucco said.

It is not the only proposed new refinery in the country.

In 2007, Dallas-based Hyperion Resources Inc proposed building a 400,000 bpd refinery and electrical power plant project in the southeast corner of South Dakota, about 675 miles from the site.

At the time, U.S. gasoline demand was high, prices were rising and capacity was running short, prompting plans to expand. Most refiners opted to expand existing plants instead of building new ones, given the regulatory hurdles and costs.

A company called Garco Energy built a tiny 4,000 bpd plant in Wyoming on the remnants of a natural gas processing facility.

But times have changed.

The global recession and high oil prices have put domestic gasoline and fuel demand into a near terminal decline; refiners on the East Coast are shutting down and others are exporting.

Hyperion has not given up on the South Dakota proposal, but a lengthy permitting process and two construction extensions pushed the planned groundbreaking back to mid-March 2013.

Analysts say even the smaller North Dakota plant is not yet a done deal.

"They still have to go through the regulatory and environmental review process," said Mark Routt, an analyst and engineer at KBC in Houston.

Jim Semerad, manager of compliance and permitting for the North Dakota Department of Health's air quality division, said the state is reviewing the project's permit.

MUTED OPPOSITION

Unlike the local outrage that has stalled shale gas drilling efforts in New York or the not-in-my-backyard attitude that has often thwarted other industrial projects, there is limited opposition to the Dakota Oil Processing plant.

Susan Zimmerman, a part-time rancher and farmer who lives about 10 miles from the proposed refinery site, has gathered about 50 signatures from neighbors worried about emissions and increased truck traffic near their serene farmland.

"This area has not been very populated," she said. "We don't have the infrastructure for all of this, all the traffic. These roads are small."

She said her chief concern is trading fertile farmland for a refinery when oil prices could fall and snuff out the boom.

"What happens when oil goes down and you don't have the agriculture to fall back on? You can't put all your eggs in one basket. I just feel this can be put in a better place on less productive land."

(Additional reporting by Selam Gebrekidan in New York; Editing by Jonathan Leff and David Gregorio)

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