The oil glut in the Midwest should finally see some relief. Calgary-based TransCanada (NYS: TRP) is planning to build a 485-mile oil pipeline, extending from Cushing, Okla., all the way to the Gulf Coast refineries in Texas.
A similar attempt was made by Enbridge, which bought ConocoPhillips' (NYS: COP) 50% stake in the Seaway pipeline in November and announced that the pipeline would be reversed in order to carry crude oil from Cushing, which is the crude oil store house and delivery point of the West Texas Intermediate, or WTI, grade, to the refineries in the Gulf Coast in Texas. However, industry experts have been arguing that the reversed pipeline alone won't be able to ease the current glut in Cushing. A new pipeline has been long overdue.
What's all the fuss about?
The drama started in late 2010, when the WTI started trading at a discount to the Brent benchmark. The Libyan crisis and the continuing geopolitical unrest in the Middle East (with the Iran crisis being the latest) sparked fears of a global shortage of crude oil, which reflected on the Brent. Right now, the WTI grade trades at a 13% discount to that of the Brent, and at one it point was trading at a discount of more than 20%.
If both projects materialize, the excess supply in Cushing should ease and the WTI benchmark price will start inching toward its counterpart across the Atlantic. The WTI -- perhaps the most widely used crude oil price benchmark -- should now reflect prices that are more realistic rather than remain artificially deflated.
Net result: The Brent-WTI spread should narrow in the near future, depending on the timeline of the new project. Which also means that refiners in the Gulf Coast will no longer have the privilege of buying crude cheap and selling refined products at a premium.
So, where do we go from here?
That's probably the question plaguing most refiners. With input costs going up, refiners will either have to bear the brunt or pass the buck on to end users. It may even be a combination of both. In all probability, we can expect margins to contract. But the bigger question is: How bad does it really look?
I believe refiners will initially stand to gain as a more robust supply system will ensure greater capacity utilization. Keep in mind that higher capacity utilization is the best thing that can happen to a refinery, since operating costs are always at a maximum. Here's a breakdown of current capacity utilization for three refiners operating in the Gulf Coast. Let's see who stands to gain and who needs to think of alternatives (like capacity expansion).
Valero Energy (NYS: VLO) : The largest independent U.S. refiner has nine refineries in the Gulf Coast with a total throughput capacity of 1.78 million barrels per day. However, total throughput volumes for 2011 were only 1.45 million bpd, which translates to roughly 81% capacity utilization. In other words, there's more room left for crude oil inputs.
Marathon Petroleum (NYS: MPC) has refineries in Garyville, La., and Texas City, Texas. Unfortunately, overall capacity utilization was well over 100% for 2011, which is why I don't see much scope in further increase of crude input volumes. This could hurt the company, as there would be no room to maneuver when input costs become higher.
For ConocoPhillips, capacity utilization in the U.S. stood at 91%. Though a region-wise break up isn't available, the company's three refineries off the Gulf Coast represent almost 41% of total throughput capacity. In short, there's a good chance that refining volumes will be ramped up, thus optimizing capacity utilizations.
Foolish bottom line
It remains to be seen how much a price hike in the WTI blend could eat into the profit margins of these refiners. But none of these possible developments will be seeing the light of day until TransCanada's completion of the pipeline next year, which is "pending approval by federal, state and local governments." The dynamics of oil prices are much more complex, and Fools would be well advised to keep a close watch on these companies. Right now, it's a wait-and-watch situation.
However, if you're looking for more ideas, The Motley Fool has created a new special oil report titled "3 Stocks for $100 Oil," which you can download today, absolutely free.
At the time thisarticle was published Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of TransCanada. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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