Crude Reality: Why Consumers in the Northeast Will Pay More At the Pump

by David Fessler, Investment U Senior Analyst
Thursday, January 05, 2011

I suspect most folks who drive to their nearest Wawa to gas up don’t pay a whole lot of attention to the price they pay. Unless the leftmost digit changes. That usually gets their attention.

But if you live in the Northeastern United States, as I do, you might just see that leftmost digit change from a “3″ to a “4″ in the next six months. $4.00 a gallon gas? Again?

It all has to do with two problems the major oil companies are facing right now. One is new emission regulation regarding ultra low-sulfur diesel (ULSD) fuel standards. Right now, it’s in high demand for trucks. Soon most states in the Northeast will require it for home heating use, as well.

Many refineries aren’t equipped to make ULSD in the quantities required, or their refineries aren’t designed to produce it at all.

The second problem is the crack spread. “Crack spread” is a term used by the oil industry. It’s essentially the difference between the price of crude and the price of the products refined from it.

In other words, it’s the profit that oil refineries can expect to make by “cracking” the crude oil down into its many refined products, the majority of which are gasoline and diesel.

That all works fine if crude prices remain relatively stable. Add volatility into the mix, ULSD requirements and crude price spikes (like the one we’re experiencing now), and it’s a whole different ball game.

The Wheels Are in Motion Towards Higher Prices

Here’s the scenario: If refineries have to pay too much for crude, and it’s heavier oil of lower quality, it costs more to refine it into gasoline and ULSD. If profit margins erode too far for too long, oil companies simply shut down their refineries, especially the aging, inefficient ones.

That will lead to higher prices, as more gasoline and diesel will have to be imported via rail and truck from other parts of the country, primarily Gulf Coast refineries. The added cost of transporting the fuel will be tacked on immediately. We’ll also very likely experience supply glitches. That will lead to price spikes on top of the transport costs.

Well that’s exactly what’s happening all over the Northeast. The EIA, in a report released just before Christmas, predicted that 50% of the refining capacity in the Northeast would be shut down by next winter.

Here’s what the EIA said in the report:

“Reduced short-term product supply flexibility due to longer delivery times and potential transportation bottlenecks for sources outside the region could increase price volatility.

“An increase in demand for ULSD due to changing state regulations could exacerbate the issue.”

The reasons, as we’ve stated above, are higher crude prices and ULSD requirements that some of the refineries simply can’t meet with the equipment they have.

In September, Sunoco, Inc. (NYSE: SUN) said it would shut down its two remaining refineries on the East Coast by the middle of 2012. Both have had several money-losing quarters in a row.

Then this past December, it decided to shut its Marcus Hook, New Jersey plant six months early. It temporarily shifted some of the production lost to its giant Philadelphia refinery, but it too is scheduled to be closed by this coming July.

Right on the heels of Sunoco’s announced closings, ConocoPhillips (NYSE: COP) shut down its Trainer refinery in Philadelphia immediately.

Both companies have other facilities that will remain open, along with Hess Corporation’s (NYSE: HES) Port Reading, New Jersey facility.

Northeast customers will be competing for gas and diesel with customers in other parts of the country, and in other countries. Higher prices here will be the result.

From the EIA:

“Higher price differentials for wholesale products compared with the Gulf Coast and market abroad would have to occur to incentivize producers to send more products to the Northeast.”

I’ve been saying for over a year prices for gasoline and diesel would be on the rise. Get used to it. These refinery closings are just one more reason why those of us in the Northeast will be paying more.

Natural gas, anyone?

Good Investing,

David Fessler