This is about regionalized fracturing in the American oil and gas markets – a topic that surprised me when I first engaged with it. Surely someone would have written an article, an op-ed, something to explain to the citizenry why thousands of good refining jobs on the East coast are being pointlessly lost and why citizens living on the East and West coasts pay so much for gas relative to those living in the interior or Gulf states. As it turns out, this issue – and the fate of many thousands of direct and indirect jobs, tens of billions of dollars, and one of the major fronts in the battle for American energy independence – has barely been covered.

There is a serious lack of US oil pipeline capacity covering the east and west coasts, where refineries that must import higher priced Brent crude are being shut down. The Eastern refineries specifically must do this because there is zero excess capacity in the two Oklahoma trunk pipelines covering the east coast, so these refineries must buy crude product from the rest of the world at Brent prices rather than WTI prices, and then sell the refined product to a recessionary U.S. market. Brent has historically traded at the same price or at a discount to WTI, so it was more profitable for East Coast refineries to, rather than invest tens of billions of dollars in new east-west trunk pipelines, buy crude product at Brent prices and sell the refined hydrocarbon products at WTI prices + the value added from refining. This was a very profitable model for many decades, but was ruined with the inversion of the Brent-WTI spread. The spread, going back to 2002, can be seen below. American Eastern refiners did not anticipate Brent trading above WTI, did not anticipate the volatility of the spread (a result of geopolitical news and the ensuing, fraternal financial speculation – volatility makes hedging more expensive), and are now being financially ruined for it.

Between the lack of pipeline capacity and the fact that Americans on average pay among the lowest prices for gasoline in the world, we as a country are especially vulnerable to sharp increases in gas prices – our lower prices mean that equal movements in prices in the U.S. and Europe equate to a much larger percent movement in the American price. Pipeline capacity should ideally serve to normalize U.S. oil prices, so that all regions of the country pay something close to the average price and so that no one region is especially vulnerable to foreign political caprice. The national security implications here are so obvious as to not require elaboration (hence why the Department of Homeland Security, paragon of administrative competence, has begun to hold hearings on the issue), and I am certain that there is a link between this regionalized price fracturing, price volatility, and the dominance of gas prices in the American political narrative.

The refining capacity being shut down on the east coast equates to roughly 1.5M boepd, or roughly 8.5% of total American refining capacity. However, the northeast will be especially hard-hit; these refineries provided roughly 800,000 boepd of various fuels to the region. Setting aside the roughly 200,000 boepd of oil products coming from the HOVENSA refinery in the Virgin Islands that were primarily going to the southeast, the three big Philadelphia area refineries were producing about 40 percent of the gasoline and 60 percent of the diesel being consumed in the northeast. In addition, several European refineries, another historical source for the Northeast, are also shutting down – making us ever more reliant on product from Middle Eastern and Indian refineries.

Few things affect long-term local gas prices as much as the shutting down of an oil refinery – and right now, between these four refineries, the east coast is losing over 50% of the total capacity. The pundit community incessantly debates the potential of the Keystone XL pipeline to bring cheaper Canadian crude to the Gulf Coast. But this north-south pipeline isn’t as badly needed as west-east lines that can carry cheaper American and Canadian crude from Cushing, Oklahoma to money-losing refineries on the East Coast.[i] The Keystone pipeline would do nothing to address pipeline shortfalls on the coasts. The map of the nation’s currently existing trunk pipelines is also shown below.

Only the Midwestern and Gulf Coast refineries have access to the cheap crude oil coming from Alberta and the interior states. As a result, consumers in these regions enjoy WTI pricing – some of the lowest retail gasoline prices in the world. With available-to-use pipeline capacity coming from the interior states, refineries on the coasts are forced to use imported crude based on Brent pricing – which is currently $17.5/barrel more than WTI, and much higher than the price of Canadian oilsands crude, which Suncor is able to produce at costs ranging from $23-$27/barrel.

In summary, the refineries on the coasts are having to buy crude at higher international prices and then sell the finished product into a US market that enjoys some of, if not the, lowest retail gasoline prices in the developed world. This leads to serious financial losses for the refineries (the HOVENSA refinery alone has lost $1.3 billion over the past three years, and expects these losses to continue) and, as a natural result, more energy companies are looking to get out of the refinery business. Right now there are four refineries on the East Coast that are either up for sale or slated for destruction – two belonging to Sunoco, one belonging to ConocoPhillips, and one immense refinery in the Virgin Islands with a capacity of 500,000 boepd – and more closure announcements are expected. If these shut down, the entire eastern seaboard, but especially the US Northeast, could see a supply crunch and powerful jumps in the price as soon as this summer, just as the driving season commences. The Energy Administration estimates that it will take at least a full year, and probably 2-3, for the supply crunch to be made up for by Gulf refineries – and the Administration notes in its report that it never expects prices to fall back down to the levels where they had been beforehand. The closure of these refineries is expected to lead to indefinite and considerable variance between northeastern and nationally averaged prices at the pump.[ii] For a broader perspective, these closures are just a continuation of a national trend. According to EIA statistics, 61 refineries shut down from 1990 through 2010. In 1980 there were over 300 refineries operating in the U.S., a figure that has since fallen to 117 – and analysts predict there will be even more refineries shutting down regardless of these recent Eastern closures. The implications for American energy independence and national security are clear to see.

This situation has grave consequences for our country’s national and economic security and for the smooth operation of our energy infrastructure. While the three Philadelphia-area refineries were operating, the Northeast was assured of a steady supply of gasoline and ultra-low-sulfur diesel that was buffered from both the hurricane risk of the Gulf refineries and the price volatility of foreign oil – and these refineries provided thousands of very well paying, skilled jobs. With these refineries gone, the supply chain servicing the East coast has become longer and more fragile, thus it’s worth noting that the EIA has commented that “in the longer run, higher prices and possibly higher price volatility can result from longer supply chains.” As the situation stands, it looks like the road to energy independence for the coasts will be largely laid on the foundation of foreign refineries – despite all the reasons why this should not be so. It is exceptionally hard in the United States for a coherent national strategy on fossil energy policy to be crafted, due to the power that poorly informed environmentalists hold in the political discourse, so the private sector left to itself has few alternatives but to shut the refineries down.

To quote Tim Danahey, talk-show host of the United Steel Workers,

“We’re giving our refineries away just like we gave away America’s steel industry and manufacturing. An immense portion of American refining capacity is going to be gone. Literally torn to the ground to make room for import facilities for foreign oil. We will pay for this decision long-term, as shipping costs and the price of foreign oil increase. The entire East Coast is dependent upon two pipelines coming from the West, pipelines that are already coming through ten states that operating at near 100% capacity. The rest of Eastern consumption had been serviced by a combination of domestic refining and foreign oil. Now it will just be foreign oil. And that’s our energy future for the Eastern United States. We’re not just closing our refineries. We’re tearing them down?”

A potential criticism by the ill-informed, who would stand against investment in a new east-west oil pipeline, would be their questioning over the technical nature of the Eastern refineries that are shutting down. These refineries, with the exception of the immense Virgin Islands refinery co-owned by Hess and the Venezuelan national oil company,[iii] are configured to process low-API, “light and sweet” crudes. The costs of retrofitting a refinery for a different crude feedstock can be immense. These critics could, justifiably at first glance, raise the point that conventional production of the light and sweet crudes that these refineries need peaked globally in 2006, and thus write these refineries off as being obsolete. The problem with this argument is that the production of high-quality American crude from deep-water and ultra-deep-water offshore fields has been booming. On this count alone the supply is there. The Bakken oil shales are also of significant note, for they produce large enough amounts of very high quality crude condensate. Between these two sources, American production alone could supply most of the feedstock required by the Eastern refineries – and at WTI pricing.

Regarding the Bakken oil, the poorly informed might argue that these refineries wouldn’t be helped by new pipeline capacity linking this oil to the eastern refineries. They would argue that the oil wouldn’t be of high enough quality to be refined by the coastal refineries, and that it would cost too much to retrofit them. Here these commentators would be wrong. Canadian tar sands crude is too heavy to be refined by these refineries,[iv] but Bakken oil is another story. The wonderful thing about the Bakken oil shales is that the low-porosity shale has protected the valuable parts of the oil from dissipation and decomposition, which means that the relative amount of high quality hydrocarbons is extremely high relative to more ‘normal’ oil resources – the Bakken oil has an API averaging at 44 versus the low 30s of Arabian light and sweet crude (the higher the API, the higher quality the oil). In fact, although hydrofracking was originally used in the Dakotas to exploit natural gas, the real economic driver of continued exploration in the region is the high quality oil coming from the shales. According to personal communications with Robert Stupp, a geologist working for Occidental Petroleum, “natural gas is just a side-show in the Dakotas. The real good stuff is the condensate hydrocarbons [the light crude oils]. This stuff is so good that you can almost put it into your gar engine without refining it. You can practically use the unrefined stuff as heating oil or American diesel – it’s that high quality.”

In conclusion, the Brent-WTI spread is a temporary, if particularly long-lived, market dislocation and as such it is ludicrous to think that anyone would spend a decade and several billion dollars building new pipelines from Cushing, Oklahoma to the coasts – which is what it would take to relieve the Eastern refineries. Once Keystone’s southern section is completed (which is going ahead despite the issues with the northern section, which are being extensively debated in the pundit community), the WTI-Brent spread should narrow considerably. But, it will take more than Keystone to entirely remove the spread. Between this, Bentek Energy’s projected growth in domestic oil production, and the lack of near-term capacity capable of servicing the east coast, the northeastern refineries are doomed. Government aid of some form or another will be required to preserve them until the Brent-WTI spread finally peters out, which could easily take north of a decade given the lead times on the new infrastructure projects required. What our politicians need to understand, quickly, is that a stable, nationwide refinery system – one well connected with pipelines – is an area where the US can help control price volatility in local markets and more equally distribute the benefits of our coming energy independence to the states that need it most.