Petro Star says Alaska refiners face crippling economic challenges

In-state refineries along the trans-Alaska pipeline say that for them to survive, economic conditions that threaten to suffocate their industry need to be dealt with as soon as possible. (Stephen Nowers / Alaska Dispatch)
In-state refineries along the trans-Alaska pipeline say that for them to survive, economic conditions that threaten to suffocate their industry need to be dealt with as soon as possible.
(Stephen Nowers / Alaska Dispatch)
FAIRBANKS — Other than the cost of crude oil, the biggest expense for three refineries along the trans-Alaska pipeline is not personnel but annual payments running more than $100 million a year that benefit the major oil companies and the state.

Flint Hills plans to shut down the largest of those three refineries, in North Pole, this spring. Two others, run by a subsidiary of the Arctic Slope Regional Corp., don’t have to contend with the expensive sulfolane pollution cleanup issue facing Flint Hills, but they are dealing with daunting problems of their own, blamed in part on the “Quality Bank,” an institution that looms large over the finances of the refineries.

The Arctic Slope subsidiary, Petro Star, owner of small refineries in North Pole and Valdez, is telling lawmakers that the bank payments and other economic conditions are suffocating the industry.

“If the state wants to have an in-state refining industry, one of the few value-added businesses going here, something needs to change,” said Doug Chapados, president of Petro Star.

$525 million over nine years

In a three-page review presented to lawmakers last month, the company said that in-state refineries using Alaska North Slope oil from the pipeline are at a huge disadvantage. “Indeed, ANS prices are so high that several refineries in the Pacific Northwest — including one owned by a North Slope producer –are investing in the infrastructure necessary to transport Bakken crude from North Dakota by rail to their refineries rather than purchase ANS and other waterborne crudes delivered by tankers,” the company said.

“The state has the power to directly address the problem of high ANS crude prices by selling royalty oil to in-state refiners at prices that would broadly serve the state and its residents by helping to preserve and foster local refining capacity,” the document said.

One of the biggest issues facing the refineries is the Quality Bank, which has received more than $525 million in payments from Petro Star over the past nine years. About half of that amount has been paid over the past three years, according to the paper, “A Path To Sustainability,” posted by the Legislature on a state website.

Total Quality Bank payments from Petro Star and Flint Hills are running about $110 million per year, based on a federal formula that compensates other oil companies for what the refineries remove.

Here’s what happens:

The oil deposited in the trans-Alaska pipeline at Pump Station No. 1 is not of the same quality as the oil that is removed in Valdez. And the oil entering the pipeline is not all of the same value. For instance, oil from Kuparuk is heavier and therefore not as valuable as other supplies. In addition, the Alaska refineries only use 25 to 30 percent of the oil they withdraw from the pipeline to make such products as gasoline, heating fuel and jet fuel.

They return 70 to 75 percent of every barrel, but the fuel they return is of lower value. The Quality Bank exists to make up for the lower value. The goal is to make this a zero-sum game, in which the shippers of high-value oil are compensated by the shippers of low-value oil.

For many years, there have been arguments before federal regulators about the appropriate factors to use in setting the rules for the zero-sum game.

Arctic Slope and Petro Star told Alaska lawmakers that Quality Bank payments are now the second highest cost for the refineries, exceeded only by the cost of the crude oil itself.

“In 2013, Petro Star’s Quality Bank expense exceeded all the operating costs at both its refineries, including labor and refinery fuel,” the company said.

“The Quality Bank is getting worse at the same time market conditions are getting worse for Alaska refiners, and its effects are devastating. Over these past three years, most of the margin between Petro Star’s crude oil price and the price it received for its refined products like commercial jet fuel was paid out in Quality Bank penalties.”

‘Huge profit center’

The bank began as a way to adjust for minor changes in oil quality, but it has become a “huge profit center for Alaska’s major oil producers and the state government (through its royalty oil and tax collections from major oil producers.)”

As a result, Petro Star has put major capital improvements on hold, the company said.

The major North Slope oil companies dispute the Flint Hills and Petro Star arguments. They say the Quality Bank payments are reasonable and reflect the diminished value of the barrels of oil the refineries return to the pipeline. In January, the state agreed with the North Slope oil companies in a FERC filing, arguing that the formula should not be changed. But on Feb. 19, the state asked to withdraw the document it had filed Jan. 31.

“As a consequence of the announcement of Flints Hills Refinery that it is suspending operations at its Alaska refinery, Alaska is considering all issues that affect the economics of operating a refinery in Interior Alaska,” state attorneys said.

ExxonMobil has estimated that the changes Flint Hills wants in the formula would increase the value of the residual oil from the refineries by $19 a barrel. That would mean a $40 million annual reduction in what the refineries have to pay the bank. The big oil companies contend that the return oil, stripped of the “valuable middle cuts,” is not worth anywhere near as much as Flint Hills and Petro Star claim.

About the proposal from Flint Hills, a witness for the North Slope companies said, “Not surprisingly, the refiners, Flint Hills and Petro Star, are huge beneficiaries, standing to gain nearly $40 million/year in reduced Quality Bank payments at the expense of the lighter streams.” The change would give a boost of $25 million a year to Flint Hills, he said.

The oil companies also argue that while Flint Hills and Petro Star have the ability to place residual oil back in the pipeline, other refineries beyond Valdez can’t do that and they have to process the oil, which they usually do through additional refining.

Tesoro, an in-state refining company that is not along the pipeline, and Anadarko, a company with some North Slope holdings, also disagree with Flint Hills and Petro Star. Adopting the Flint Hills numbers would produce “nonsensical” results and make the lighter Prudhoe Bay oil worth less than heavier oil from Kuparuk, they said.

Dueling experts

Each side has its own experts contradicting each other. The FERC staff sided with the oil companies on this one and said the Flint Hills experts are wrong. In its Jan. 31 filing, the state also said that Flint Hills had not made the case for lower bank payments.

“The commission should not make any changes to the existing Quality Bank methodology for the trans-Alaska Pipeline System,” the state said before the refinery shutdown announcement.

The state said Flint Hills “has not presented any new evidence that warrants a change or any evidence that shows that the existing Quality Bank methodology has become unjust and unreasonable….”

Petro Star said that because the Quality Bank case is a federal matter, it hopes the state will push for a fair settlement. “A more equitable Quality Bank would help to forestall further attrition of instate refining capacity and the negative consumer and economic impacts that would inevitably follow,” the company said.

Related Links:

Canada: Canada’s Northwest Territories unveils ambitious energy plan, CBC News

Finland: Fennovoima permit changes face stiff opposition in Finland, Yle News

Sweden:  Sweden shares top global energy ranking, Radio Sweden

United States:  Ex-commissioner calls for Alaska energy mega-projects analysis, and ‘call bluff’ on North Slope gasline, Alaska Dispatch

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