Analysts scrutinize BlackRock's Marathon move

12/16/2012
BY JON CHAVEZ
BLADE BUSINESS WRITER
This refinery in Canton, Ohio, is one of four in the Midwest where Marathon Petroleum Corp. can refine light sweet crude. the others are in Detroit, Catlettsburg, Ky., and Robinson, Ill.
This refinery in Canton, Ohio, is one of four in the Midwest where Marathon Petroleum Corp. can refine light sweet crude. the others are in Detroit, Catlettsburg, Ky., and Robinson, Ill.

From the outside, the scenario at Marathon Petroleum Corp. last week may have looked eerily similar to what befell the Findlay-based oil refining giant nearly a year ago.

A billion-dollar New York-based investment firm, BlackRock Inc. — already Marathon Petroleum’s largest shareholder with a 7.4 percent stake — had suddenly upped its stake in the company to just a shade over 10 percent by purchasing 7.5 million shares on Dec. 6.

Would this be like last January when New York-based hedge fund Jana Partners LLC swooped in and used a 5.4 percent stake to pressure management into creating a new subsidiary, MPLX LP, to control the company’s Midwest and Gulf Coast network of pipelines and oil storage facilities?

Or does BlackRock, now with nearly double the shares of the second-largest investor, Fidelity Investments, have an even bolder vision and greater changes in store for Marathon Petroleum — created in July, 2011, when Houston-based Marathon Oil Co. spun off its network of pipelines and refining assets.

The likely answer, analysts say, involves neither future changes nor nefarious plans. BlackRock, it would appear, just likes Marathon Petroleum and its especially tempting financial prospects.

“BlackRock is not Jana Partners. They are a completely different animal,” said Fadel Gheit, an oil industry analyst for Oppenheimer & Co. Inc. “BlackRock invests pension funds and manages assets. It is not a typical hedge fund. They are not a hit-and-run shop.”


When BlackRock looks at Marathon Petroleum, it sees a company with “very, very strong [fundamentals]. They are loaded with cash and they recently made a very smart acquisition of BP’s refinery in Texas City, Texas.,” Mr. Gheit said.

A second analyst, who asked not to be named, said BlackRock knows Marathon Petroleum is a good play right now for investors. “They are worth taking a bigger equity stake,” he said.

A BlackRock spokesman said the company does not comment on its investments.

Since being spun off, Marathon Petroleum, whose New York Stock Exchange ticker symbol is MPC, has seen its share price rise from $37.25 to $62 a share this week — double the share price of its former parent company, Marathon Oil.

Through a combination of strategically advantageous locations for its refineries, having the right refining technology to process burgeoning U.S. crude oil supplies, an unexpected fundamental shift in world crude oil pricing, and some luck, Marathon Petroleum finds itself in an enviable position in the traditionally financially-volatile refining industry.

Oil refining has always been the temperamental child of the oil industry. Beset with high expenses, low margins, and costly accidents, many refineries have been closed and several major oil companies have sold their refining assets. It was those unpredictable aspects of refining that caused Marathon Oil to spin off its refining operations in order to concentrate on exploration, drilling, and crude oil production, known as "upstream" operations.

But recently, “There’s a structured change in the industry” benefiting refiners, or "downstream" companies like Marathon Petroleum, Mr. Gheit said.

“The idea of refining being a bad business to be in is over. Over the last two years things have changed, taking everyone by surprise, including the company itself even,” Mr. Gheit said. “Marathon never thought this could ever happen this early and that the change could last years, not months.”

One of the structural changes is the cost of natural gas. Refineries are powered primarily by natural gas, whose fluctuating prices previously could eat into profit margins. But they now have cheap and plentiful natural gas available that cuts their operating costs and capital spending.

Sweet crude

An even bigger development — one that favors Marathon Petroleum in particular — is an unexpected two-year-old divergence in crude oil prices.

Historically, two-thirds of the crude oil sold on the world oil market is priced according to the international benchmark “Brent Crude,” which is European crude oil mainly from the North Sea. Brent Crude is both “sweet” (low sulphur content) and “light” (a low density) and used extensively at U.S. refineries.

But in the last four years, U.S.-based drillers armed with new drilling technologies -- including hydraulic fracturing or “fracking” -- have begun extracting large quantities of crude oil from North Dakota and South Texas. The majority of it is “West Texas Intermediate” crude, or WTI, which is also light and sweet.

With the U.S. now starting to produce a glut of WTI, its price, which used to be higher than Brent Crude, has become significantly lower than Brent.

“WTI is heavily discounted compared to Brent Crude,” said John Felny, chief economist for the American Petroleum Institute in Washington.

“The issue comes down to types of crude. Marathon, who is doing very well, they are refining light sweet crude, mainly West Texas Intermediate,” Mr. Felny said. Last week on the oil market, Brent Crude was priced at $116 a barrel, WTI at about $93 a barrel.

Many of Marathon’s competitors no doubt would prefer to refine discounted West Texas Intermediate crude, but their locations make that difficult. East Coast and Gulf Coast refineries are set up to receive crude from overseas. Pipelines don’t provide access to North Dakota or South Texas crude. Rail transport is possible, but expensive.

“The refineries on the coasts are tied to Brent Crude,” Mr. Felny said. “They’re been struggling because of that competitive challenge.”

Location key

Conversely, Marathon’s refineries and pipeline networks happen to be perfectly situated.

“They’ve got a very elaborate network of pipelines and storage facilities in the Midwest and near-Midwest and it goes pretty far south as well,” said Scott Richter, an energy analyst and portfolio manager for the Westfield Insurance Group in Medina, Ohio.

Four of the company’s refineries are in the Midwest, where they can easily obtain West Texas Intermediate crude from an oil distribution hub in Cushing, Okla., and a fifth refinery is in eastern Texas. All five can refine light sweet crude, and Marathon will soon own a sixth refinery that can refine sweet light crude — BP Inc.’s huge Texas City complex, the third-largest refinery in the U.S.

Only a Marathon Petroleum refinery in Garyville, La. is limited to heavy sour crude, which it obtains from Canada.

“Marathon is able to buy cheaper raw inputs and refine, then market their [fuel] products at world prices,” Mr. Richter said.

“I don’t know that it was any grand plan on their part for this to happen, but it just so happened that the stars aligned for them,” Mr. Richter said. “I think Marathon is in one of the strongest positions to take advantage of this dynamic,” he said.

The Findlay refining company also has lucked into another advantage. Many of its U.S. competitors over the last decade retooled their refineries to process heavy sour crude with the expectation that the growth of such supplies from the oil sands region of Canada would dominate the world oil market.

But getting that crude has been difficult with the delay of the Keystone XL Pipeline. Until that is completed,  processing of Canadian crude is limited mainly to coastal refineries.

Will it last?

For now the key question for Marathon Petroleum seems to be whether the large price spread between Brent Crude and West Texas Intermediate will last.

“Fracking is unlocking a lot of lighter sweeter crude from North Dakota. The Bakken region there is now producing over 7,000 barrels a day,” Mr. Felny said. “You’re also seeing the same development in South Texas. And we’re even starting to see that kind of development in eastern Ohio.”

But it is too soon to see what the production level will be and if it is sustainable, Mr. Felny said.

Mr. Richter said its possible that the U.S.-based crude supplies will remain plentiful for the foreseeable future for two reasons:

-- Domestic demand for gasoline and other fuels has slowed.

-- Technology is allowing much more crude to be extracted from old wells and new oil fields than it was thought possible.

“We have over the last decade become very proficient at doing fracking and horizontal drilling. And you can use the same technology for oil and they’ve been releasing a lot of oil,” he said. “In the Dakotas, they’re absolutely on fire. We’re making so much oil that’s coming out of that area that it doesn’t really have a home to go and it’s tough to get it to the Gulf.

“It’s created a big surplus of oil coming into Cushing, Okla. As a result, they’ve got to take a discount on because they can’t move it elsewhere,” Mr. Richter said.

“So the question is will that spread stay wide like it is or will it converge with people maybe reversing pipeline flows and using railcars” to ship light sweet crude to coastal refineries, Mr. Richter said. “Some people will say no and some say it will.”

Wall Street investment firm J.P. Morgan is betting the spread between foreign-based oil and domestic oil will remain as is — highly favorable to Marathon Petroleum.

In an extensive November report, its analysts said the price divergence between Brent and WTI that emerged in 2011 was merely “a precursor to a larger issue likely to emerge in North America in the next three years.”

In the near future, J.P. Morgan said, the United States will satisfy the nation’s demand for light sweet crude in its domestic refining system. Heavier foreign crude will still be required and help offset surplus light grade supplies through blending, “the highest quality of waterborne imports are likely to be replaced with domestic shale crude oil supplies.”

By 2015, the report said, “we estimate that supply will overcome refinery appetite for light crude, and more widespread and deeper discounts will probably be realized for U.S. crude oil.”

Contact Jon Chavez at:
jchavez@theblade.com
or 419-724-6128.