By Robert Campbell
NEW YORK, Sept 17 The proliferation of railway facilities to move Bakken crude oil to coastal markets was supposed to save less competitive plants on the East Coast, but new rail links are also eroding the price benefit from transporting the crude from North Dakota.
Two saviors of U.S. East Coast refineries this summer promised to expand their access to cheap inland North American crude to make the money-losing plants profitable again.
Both the 185,000 barrels per day Trainer, Pennsylvania refinery bought by a unit of Delta Air Lines and Sunoco's 330,000 bpd Philadelphia refinery, contributed to a new joint venture with private equity firm the Carlyle Group, want to boost their intake of crude from Bakken shale fields in order to displace imported oil priced against the costly international benchmark Brent.
But this investment thesis relies heavily on the idea that transportation bottlenecks will continue to repress wellhead prices of inland North American crude oil.
That is a dangerous assumption. In crude oil markets, when sufficient transportation links become available, wellhead prices rise rapidly. The shipper, not the end-user, tends to capture most of the spread between the price paid at the wellhead and the destination point.
Bakken crude has collapsed to near its lowest discount to Light Louisiana Sweet in recent days even as North Dakota crude oil production has continued to march ahead.
At a spread of around $12 a barrel, the price gap is nearing the estimated cost of moving crude by rail from the Upper Midwest to market on the Gulf Coast.
In other words, once the cost of shipping is included, Bakken crude is now as costly at LLS, the domestic light sweet crude marker at the Gulf Coast.
Here is where East Coast refineries find themselves in real difficulty.
Once sufficient transport capacity is available and the price of Bakken crude oil plus transportation costs is below that of a Gulf Coast alternative like LLS, Gulf Coast users will be willing to bid up the wellhead price of Bakken until the price plus shipping is equal to that of LLS.
Given the logistical challenges that some coastal refiners face, particularly on the East Coast, some plants that may have been counting on cheap Bakken crude to provide a competitive edge, may now be returning to international crude markets.
Although some East Coast refineries are constructing rail facilities near their plants, much of the trade still relies on transshipping crude from trains to barges on the Hudson and Delaware rivers.
This adds further shipping and handling costs. Without being able to extract more value from a barrel of Bakken oil than a competitor with cheaper transport links, East Coast refiners face being priced out of the Bakken market.
Moreover even if these refineries succeed in building new rail links that eliminate the need for barging, they may still be priced out of the market.
When two refineries compete for the same barrel of oil, the plant that is able to extract the most value from the crude can afford to pay a higher price for the crude.
Thus, if transportation costs to the East Coast were to come down to around the same price as it costs to move Bakken oil to the Gulf Coast, Gulf Coast refiners may still be able to pay more for Bakken crude.
Since Gulf refiners can make more high value fuels from Bakken than the old East Coast plants they can afford to pay more for the raw materials.
Short-term salvation may come from yet more production from the Bakken play that overwhelms transport infrastructure again and returns market power to buyers.
Yet this is always doomed to be a short-term hope. The huge gains to be reaped by cutting transport costs and gaining access to coastal markets means spreads between Bakken and Light Louisiana Sweet will always tend to narrow to the point that transport costs will gobble up the bulk of the difference.
And should sufficient pipeline capacity ever be built to allow the Bakken market to clear without recourse to rail, then those refineries that are pinning their hopes on rail to save otherwise unprofitable operations will again be at a big disadvantage.