Midland refiners settle for less volatility

OREANDA-NEWS. November 12, 2015. Midland crude-focused refiners expect to see smoother prices and fewer discounts as new pipeline capacity changes market dynamics and ends what had been a golden age for the companies.

Isolated refiners closest to production in the Permian basin in West Texas and New Mexico, as well as refining peers with direct access to that crude, have benefited from several years of crude supplies running at discounts to barrels at the US crude storage hub in Cushing, Oklahoma.

But late this summer line fill started up on newly opened pipelines connecting west Texas to larger coastal markets, helping to push Midland-priced West Texas Intermediate to its first quarterly premium to Cushing in at least five years, according to Argus assessments.

The reversal shrank third quarter profits for Midland-focused refiners. But while companies no longer expect the deep Midland discounts that have lifted fortunes over the past three years, refiners also do not expect a repeat of the third quarter.

"The premium that we saw in the third quarter already cleared itself, and it doesn't make sense to have a premium to Cushing or premium to other markets," said Delek US chief executive Uzi Yemin last week.

Nearby refiners have enjoyed a spot at the front of the line for a recovery of oil production in Texas's Permian basin in recent years. Shale fields in the Delaware Basin, a Permian sub basin, faced infrastructure constraints similar to the Bakken early in their development. Proximity allowed Western Refining, HollyFrontier and Alon USA to command quality and pricing advantages as infrastructure to the region caught up.

Since 2010, third quarter Midland-priced crude has averaged a \\$1.92/bl discount to Cushing, including the massive \\$10.56/bl discount seen in the third quarter of 2014.

Midland this year has averaged a \\$1.30/bl premium to Cushing, however. Prices flipped as Sunoco Logistics' 230,000 b/d Permian Express 2 crude pipeline began moving barrels into the company's Nederland, Texas, terminal. The pipeline began operating in July and by August was running "at high capacity." Sunoco's takeaway added to growing volumes on Plains All American Pipelines' 250,000 b/d Sunrise and 330,000 b/d Cactus lines out of the region — 860,00 b/d of new logistics access to larger markets.

Refiners expect Permian production to continue to grow in spite of a bruising domestic crude market that has forced rigs to lay down in other US fields. The downturn includes south Texas Eagle Ford production, which was expected to fall for a ninth consecutive month in December, according to the Energy Information Administration. The drop in south Texas output increased demand for Permian barrels along the Texas coast, helping Midland keep its premium to Cushing until October.

"I just don't see a scenario where Midland will trade over Cushing for any significant time or at a significant differential," Western Refining chief executive Jeff Stevens said during a recent call to discuss earnings. "We still believe that the last area of production to slow down will be the Midland market, just because of the quality of the crude and the quality of the balance sheets of a lot of the big players there."

Access to a steep Arizona gasoline market also helped far West Texas refiners offset some of the reversal. Western Refining reported a 14pc drop in third quarter operating income compared to last year at its 125,000 b/d refinery in El Paso, Texas. HollyFrontier boosted both crude throughputs and refining margins at its 100,000 b/d Navajo refinery in Artesia, New Mexico.

But Delek US had no such support. The US independent refiner, which moves Midland barrels to refineries in El Dorado, Arkansas, and Tyler, Texas, reported a \\$72.5mn profit during the third quarter last year. Profits sank to \\$18mn this year, in large part because of Midland's premium.

Delek expected Midland to return to a more modest discount to Cushing going forward. Midland has already averaged a roughly 95?/bl discount so far this quarter. But the refiner was also looking into alternative supplies.

"We are working on it, probably another solution to have the optionality to bring barrels from the Gulf coast," Delek's Yemin said last week.