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Starks Energy Economics, LLC 1st quarter 2012



Focus:

US MidContinent Refineries



     The current large price differential between Brent crude oil and West Texas Intermediate (WTI) crude at Cushing ($15-$30 a barrel lower), both of similar quality, rebounds to the profitability of US MidContinent refiners who can use Canadian imported crude, locally-produced crude--particularly from North Dakota's Bakken/Three Forks, and crude from the Cushing, Oklahoma terminal. The refineries' value can be seen by the dramatic price differential that developed in January-February when two MidContinent refineries were offline: $76/barrel for the Minnesota regional price, a $41/barrel differential to then-$117/bbl Brent. (Both refineries are now back online.) Presently, the Brent price is $16/bbl higher than at WTI -Cushing, which in turn is $14/bbl higher than the Minnesota regional price. These crudes are all similar in quality—light and sweet, with Bakken actually slightly better than WTI—so differentials are due primarily to transport constraints.

     What is the MidContinent region, exactly? The easiest way to define it is by Energy Information Administration (EIA) regions known as Petroleum Administration for Defense Districts (PADDs). For our purposes, the MidContinent is PADD II and PADD IV: the twenty Midwestern and Rocky Mountain states of Colorado, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Missouri, Montana, Nebraska, North Dakota, Ohio, Oklahoma, South Dakota, Tennessee, Utah, Wisconsin, and Wyoming. The MidContinent has 4.3 million barrels per day (MMBPD) of operable refining capacity. The Gulf Coast has 8.6 MMBPD, twice as much.

     Increased oil production from North Dakota and Canadian imports intertwines with the Keystone XL pipeline saga. In the latest twist, TransCanada has announced it will seek, and the US government has signaled it will grant, approval to build the 435-mile, $2.3 billion, 700,000 barrel per day (BPD) Cushing-to-Gulf Coast segment, separately from the Canada-to-Cushing leg. If go-ahead is received, it could be built by mid- to late 2013. Of the total, 320,000 BPD is not yet subscribed for Canadian crude and may be available. Per Tudor Pickering & Holt, depending on delays in the Canada-to-Cushing segment, all 700,000 BPD may be available to domestic crude for a time. Plans have also been announced to reverse Seaway Pipeline, again so more crude can be pipelined from Cushing to Gulf Coast refineries. The Seaway plan is 150,000 BPD by mid-2012, with a total of 500,000 BPD by mid-2013. Once these pipelines are built, or even once construction is approved and capacity contracted, the current location differentials between Brent, WTI-Cushing, and Bakken-Minnesota crudes are likely to shrink.

     These Cushing-to-Gulf Coast pipeline capacity additions, an eventual total of 1.2 MMBPD, look large until they are compared with Canadian crude imports of two million BPD and recent increases in North Dakota production to nearly 500,000 BPD. Pipeline capacity within Texas is also valuable as the state's production has increased in the last few years by fifty percent, from one to 1.5 MMBPD. Oil production is also up in Oklahoma and Kansas.

     So with a) strong Canadian oil imports of two million barrels per day, b) North Dakota production alone increasing fivefold by 400,000 barrels per day in the last few years, c) upticks in oil produced from Rocky Mountain Niobrara, Kansas and Oklahoma's Mississippian Lime, and Ohio's Utica formations, d) capital refinery expenditures that five companies have made to increase their heavy, sour crude capacity by 300,000 barrels per day thus displacing light, sweet crude, e) the considerable capital required to build new refining capacity, and f) at present—only expensive, non-pipeline alternatives (rail and truck) to transport additional crude out of the region to the Gulf Coast, or even Cushing, it is easy to see why the value of MidContinent refining capacity has increased temporarily: MidContinent crude prices are under pressure relative to global light, sweet crude oil prices.

     The size of the Canadian/Bakken/Three Forks crude supply and the economics of transporting and refining are sufficiently compelling that in addition to the two proposed Cushing-to-Gulf Coast pipeline expansions, an 80,000 BPD increase of the Berthold, North Dakota rail terminal is expected to be completed in 2013, and two small (20,000 and 13,000 BPD) North Dakota refineries have been proposed.

     More detail on specific refining companies' financial data and a graphical presentation is available in the subscriber content.



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