By Robert Campbell
NEW YORK Aug 13 Independent oil refiner Tesoro
Corp is doubling its bet on California, boosting its exposure to
a niche oil market where heavy regulation and geographic
isolation can make for big profits but also big costs. (Full
Tesoro said Monday that it would pay $1.18 billion
plus the cost of inventories for oil major BP Plc's
266,000-barrel-per-day Carson City refinery and its associated
If completed, the transaction would make Tesoro the largest
refiner on the U.S. West Coast.
California already has the tightest regulation over oil
refineries, and a thicket of new rules has deterred some buyers,
according to industry analysts.
The new regulations are believed to be part of the reason
why BP has opted to exit the California market while maintaining
a presence on the West Coast with another plant in Washington
For instance, the oil industry is already blaming
California's low-carbon fuels initiative for effectively
blocking the import of some Canadian and Russian crudes into the
state, which the companies say raises their costs.
The new regulations and a declining market for gasoline have
led many industry observers to speculate that more refineries on
the U.S. West Coast may be vulnerable to closure.
But for those who know how to operate there, the situation
can also be a gold mine, particularly when a competitor suffers
an unplanned shutdown.
Twice this year, Los Angeles-area wholesale gasoline prices
have traded at 50 cents a gallon over front-month RBOB gasoline
futures, as refinery outages spurred panic buying.
Such blowout profits are hard to achieve elsewhere, since
opportunities to import needed products are relatively
The West Coast, on the other hand, is almost an island. Most
South American refineries cannot make fuel that meets
California's exacting standards, and plants in Asia that can
make California-grade fuel are a long way off by ship.
This geographic isolation cuts both ways: The high cost of
operating in California gets painful fast when demand is soft.
Tesoro reported a big loss in the fourth quarter, largely
due to weak refining margins in California.
West Coast refineries also have little access to the cheap
crude oil produced in the Midwest.
But that keeps the playing field level. Refiners are
geographically cut off from cheap crude, but their customers are
also cut off from cheap refined products. West Coast refiners
operate in a pre-shale world.
SHALE AND OTHER RISKS
This is not to say that the shale oil revolution poses no
threat to West Coast plants. Already refineries in West Texas,
New Mexico and Utah are chipping away at premium markets in
fast-growing states such as Nevada and Arizona.
Holly Energy Partners new UNEV pipeline, for
instance, provides direct access to Las Vegas for Utah refiners
running cheap Midwestern crude, allowing them to undercut the
California fuel that has traditionally supplied that market.
West Coast plants are already trying to tie themselves into
the "crude by rail" phenomenon to cut their oil costs, but this
may only offer a partial solution.
California refineries also face challenges from other U.S.
plants. The new low-carbon fuel rules discourage the use of
crude oils that are determined to be "high-carbon intensity"
because of the heavy flaring of associated natural gas.
The oils in question include those from Canada's oil sands,
Russia and even some Middle Eastern producers such as Oman.
The rules' reach may even extend to oil produced in
California, where steam injection is used to extract viscous
crude from old fields.
This is problematic, especially given the steady decline in
Alaskan oil production, once a major source of crude for the
All this may force California refineries to fight each other
for a dwindling number of "low-carbon" crudes, which will raise
costs and leave the companies vulnerable to being undercut in
some markets by out-of-state rivals.
No wonder BP is opting to keep its Washington refinery. It
will probably benefit as new rules in California raise operating
costs for competitors there.
But there is some hope for California refiners. The state
has shale oil potential of its own, and the U.S. Geological
Survey has identified a lot of promising acreage in Alaska,
where hydraulic fracturing could revive the local industry.
Due to low energy inputs in production, shale oil is likely
to avoid being designated "high-carbon," which may offer some
relief to West Coast refiners.
However, other environmental obstacles may be considerable
in both California and Alaska, although activists may eventually
come to see oil from fracking as less menacing than Canadian oil
Given all of the challenges of operating in the region,
bulking up is a logical response. Declining fuel demand and
higher costs will force some competitors out of business
That will make it more profitable to operate in California.
The big players, led by Tesoro, will probably get bigger.