ConocoPhillips's (COP) control of a key pipeline to the Gulf Coast is keeping cheap oil--and hefty profits--at its landlocked U.S. refineries.
Due to a supply glut in Cushing, Okla., a major U.S. storage hub, oil is roughly $13 a barrel cheaper in the middle of the U.S. than in other parts of the country. The situation is a boon for companies with more refineries in the region, including Conoco, who have access to cheaper crude than competitors along the coasts.
Unlike smaller, independent refiners, Conoco holds the trump card for keeping heady profits at these refineries: The company has a controlling interest in the Seaway pipeline, which runs from Freeport, Texas, on the Gulf Coast to Cushing, with a capacity of 350,000 barrels a day.
Seaway is currently transporting fuel products such as gasoline and diesel. But Conoco could reverse the pipeline to send West Texas Intermediate crude toward the Gulf, relieving the multimillion-barrel glut in the middle of the country.
A reversal would rebalance the oil market and could be a profitable arrangement for Conoco, as mid-continent oil producers would likely pay high premiums to get oil to the Gulf. But so far, Conoco executives have no intention of making the switch, content to see profits rise in its refining, or downstream, business.
"The performance of our downstream, I think, is going to surprise everyone as we go through 2011," said Conoco Chief Executive James Mulva at a recent conference. "In terms of reversal of the Seaway line, we don't really think that's necessarily really in our interest."
Shares of Conoco and other oil companies have posted strong gains in recent months as oil prices surged toward triple digits. Refining is only a tiny sliver of Conoco's overall profits, but as the company pursues a plan to shed lower-margin refinery assets to focus on exploration and production--and with new divestitures possible at its annual analyst meeting on Wednesday--increasing profits from the remaining refineries could help convince investors the strategy is working.
Conoco shares were recently down 0.06% to $77.50 on Tuesday morning. The stock is up 13.8% this year.
"For Conoco, it's not as big of a deal as for the independent refiners. But at the same time, keeping the price depressed is advantageous to them," said Stacey Hudson, an oil analyst with Raymond James. "Is it going to be a big deal for their overall business? It's probably marginal. Could it help the downstream business? Yes."
Conoco declined to comment for this article, but the profits implied by prices in the futures market for fuel products--a widely used measure to estimate refinery margins--suggest Conoco has little incentive to reverse the flow.
Gasoline futures are trading at nearly a $20 premium to WTI, while heating oil futures are trading at more than a $25 premium. The premiums for both products have held between $5 and $15 for most of the past two years. Meanwhile, the implied refining profits are significantly lower for Brent crude, the oil benchmark for Europe and many east coast refiners.
Among integrated oil companies, Conoco has one of the largest positions in the mid-continent, said analysts, offering it a leg up on competitors with more refineries along the coasts.
Meanwhile, companies that transport oil are trying to find ways to profit by relieving the glut.
Magellan Midstream Partners LP (MMP) said last week it is planning to reverse a pipeline to bring crude towards refineries near the coast. Barge operator Kirby Corp. (KEX) said shippers are trying to arrange barges to ship oil from Cushing on inland waterways.
Still, analysts say the glut will last as more production comes from the region, particularly if Seaway isn't reversed. The Magellan pipeline reversal would take up to two years to complete once started.
Capacity expansion by other refineries suggest there is confidence that profits will keep flowing. Valero Energy Corp. (VLO) said last week that it is expanding the capacity of its McKee refinery in the Texas panhandle.
"More production has come on line from small, local producers," Valero spokesman Bill Day said. "McKee is well positioned to take advantage of that."
(Ben Lefebvre contributed to this article.)
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