Noted oil economist Phil Verleger has read the Philadelphia Energy Solutions (PES) bankruptcy filing and makes no bones about his verdict. The company is scapegoating the Renewable Fuel Standard for its financial woes, Verleger says, instead of properly attributing the demise of the 330,000-b/d refinery to the end of the long-time crude oil export ban, antiquated equipment and a lack of investment that kept the plant competitive with other northeastern refineries.
But most importantly, Verleger sees a possibility that the bankruptcy judge just might render a decision that could wreak havoc with the RFS and throw the RINs market into utter chaos. Bankruptcy papers clearly indicate that PES would like to get its RIN obligation discharged in the reorganization. If not, the company would have to purchase and retire RINs with an aggregate market value of approximately $350 million at current market prices before a compliance deadline this spring. It would also need to buy about 550 million 2018 vintage RINs. A buyer of that quantity under current circumstances might lead to a quick doubling of the renewable credit asking prices.
But if a bankruptcy judge allows cancellation of the RINs' obligation, any credibility associated with the RFS program might be thrown out the window.
There is a legal obligation to blend ethanol and other biocomponents into transportation fuels and the EPA might have great difficulty administering the program, even though the agency has been an advocate. A court decision granting PES' request for relief might lead to a "Lehman-like moment" that could completely halt RINs' trading, plunge the value of accumulated RINs to near zero and bring about pure chaos.
PES' owners blame the U.S. renewable fuels' standard for their woes, but Verleger disagrees. Failure came about because the refinery complex is out of date and it is a merchant refinery with no downstream outlets. It also operates in a region where flat demand is a victory and decelerating demand a probability. Financially solvent and technologically advanced companies can operate under these circumstances, but the noted oil economist finds no evidence that critical investments were made PES in the refinery.
The PES bankruptcy filing took place on Jan. 22, and the RINs' cost of $217 million was the largest expense other than crude oil costs. When the Trump administration reaffirmed the government's commitment to the RFS in the autumn, it dealt a blow to merchant refiners and other processors who hoped to shift the compliance burden to others. PES CEO Gregory Gatta told the Philadelphia
Inquirer: "It is unfortunate that the company was driven to this result by the failed RFS policy and excessive RIN costs." He added that the company "can only hope that our filing ... will provide the necessary catalyst for meaningful long- term reform of the RFS program."
In contrast, Verleger notes that megarefiner Valero reported net income of $4.1 billion for the year and saw a quarterly profit of $509 million excluding the Trump tax cut benefits. Expense for RINs was $311 million in the fourth quarter, but the company invested $2.4 billion, with half of it going to "growth projects."
Some of those past investments have included logistical additions and refinery tweaks so that properties could run heavily discounted Canadian crude.
"Valero invested. Canadian producers have not. And clearly, PES has not," notes Verleger.
He backdates the lack of investment for several decades. Some 35 years ago, the Washington Post acknowledged that the refinery owner at the time (Sun Oil, and then Sunoco) bucked the trend toward expensive refinery upgrades in favor of keeping a light sweet more expensive feedstock dependence.
That luck ran out for Sunoco, but PES had a run of several years during which it could bring inexpensive landlocked U.S. crude to Philadelphia, thanks to the U.S. export ban. An investment was made in a $186 million rail-unloading facility, but refineries were not upgraded. Nowadays, Bakken crude trades within a few dollars of WTI, so shipping the North Dakota crude to the East Coast doesn't make economic sense.
In contrast, Delta Air Lines bought the closed ConocoPhillips refinery in Trainer, Pa., in 2012, renamed it Monroe Energy and upgraded the refinery to meet tougher U.S. specifications. In 2016, some $70 million was invested so that the plant could produce the lower-sulfur gasoline required by EPA.
PES hoped to make investments in the refinery from funds from a proposed IPO, but investors balked at terms. There was no IPO and no investment.
The end of the export ban on U.S. crude combined with the completion of the Dakota Access Pipeline eliminated PES' access to favorably priced crudes. PES had a favorable position only so long as the export ban was in effect, notes Verleger.
The refinery isn't just dependent on expensive light sweet crude. It also produces about 12% of low valued industrial products that ultimately fetch prices beneath crude costs. It is much less competitive than nearby PBF, which boasts about double the PES margins.
"The owners (of PES) gambled that the large discount of US crude to world prices would continue enabling the refinery to continue earning profits."
Verleger concludes that PES lost the gamble and the growth of U.S. crude exports has made it impractical and unprofitable to move Midcontinent crude to East Coast sweet refineries.
Verleger acknowledges that the RIN market isn't a particularly efficient market, with inequities incurred by small marketers who don't get RIN discounts passed along. Distortions can create an unequal playing field. But finding the source of the problems is a difficult task, with possible flaws including hoarding by large traders in the credits.
But he suggests that rather than declaring amnesty on RIN obligations, a more appropriate decision might be to scrap the refinery, which was once headed for closure earlier in the decade. Part-owner Carlyle Group gambled with its own money (and some government funds) that it could profitably rail crude to Philadelphia and make money. Instead, the export ban was lifted, dooming that flawed strategy.
--Tom Kloza, email@example.com
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