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Refinery shutdown creates serious problems for Alaska Railroad

Dermot Cole

FAIRBANKS -- Even before the Flint Hills Refinery announced it would be shutting down, the Alaska Railroad warned of financial problems just down the track.

“Today, the Alaska Railroad faces a serious financial challenge,” President Bill O’Leary wrote last fall in the introduction to the 2014 report to the state. “Two key freight business lines -- refined petroleum and export coal -- declined unexpectedly, leaving a substantial operations revenue gap.”

With the news this week of the Flint Hills Refinery closure, the challenge has suddenly become a whole lot more serious, as the state-owned railroad stands to see a significant portion of its southbound freight traffic vanish.

There have been numerous warnings about this over the years from the refinery and the railroad.

Flint Hills has said the high operating costs at North Pole made it difficult for the company to compete against products made by refineries in places like Singapore.

Compounding the situation, the state encouraged the development of infrastructure in Anchorage that allowed for the easy importation of jet fuel, the commodity that was the economic foundation of the North Pole refinery and the state-owned railroad.

The state could have taken steps to make it more difficult for importers in an attempt to save Flint Hills. But any state actions that would have improved the economics for the refinery would have touched off an instant political debate about the cost/benefits of any incentives given to a private company.

What’s clear is this: State agencies have made no overall economic analysis that considered the complex factors at play -- balancing the value of the jobs in North Pole, the importance of the continued existence of the industrial facility, the dollars paid in local taxes, the economics of the railroad, the cost of cleaning up the sulfolane spill and the money paid to the state for royalty oil.

By comparison, the economics of the airline business in Anchorage presented a clearer calculation.

The geographic advantages of being close to Asia don’t count for much for companies like UPS and FedEx if fuel supplies are not stable or if the price is too high.

Had the state blocked efforts to import jet fuel, the airlines that consume hundreds of millions of gallons of fuel a year would have taken at least some of their business elsewhere.

The major airlines joined together in a consortium to build storage facilities, which allowed foreign suppliers to steadily gain market share at the expense of Flint Hills. The expansion of storage facilities allowed large tankers, carrying about 14 million gallons, to bring fuel in from overseas.

The state didn’t build these facilities or consider the value of the in-state refining industry. The commissioner of the Department of Transportation and Public Facilities said in a hearing two years ago that his agency was simply an observer and that the fuel business was a private matter.

A deputy DOT commissioner said importing fuel by tanker was a “mutually beneficial” solution for the airport and the airlines.

At the time, Flint Hills’ share of the Anchorage business had slipped to 30 percent.

The increased sales in Anchorage of fuel imported from overseas have also come at the expense of the Alaska Railroad, which has a symbiotic relationship with the refinery.

A business that was once worth $45 million a year to the railroad is shrinking to the point of disappearing.

For many years it could be said that the railroad helped make the refinery viable and the refinery did the same for the railroad.

“I can’t overestimate how critical Flint Hills is to the Alaska Railroad,” Bill O’Leary, now president of the railroad, told a legislative committee in 2011 when the decline in fuel shipments was already at an advanced stage. “As Flint Hills goes often, so goes the Alaska Railroad from a financial perspective.”

Flint Hills said Tuesday it will cease refinery operations in the spring, which means the railroad is going to be facing a new round of budget cutbacks and layoffs. In the last six years, the railroad has cut about 300 jobs in response to reductions in revenue.

Longtime railroad board member John Binkley of Fairbanks said the railroad staff is developing response plans, which he said are likely to lead to significant changes in the state-owned railroad,

"Immediately we're going to have to look at short-term changes to adjust, and then at the midterm. It's not good news for the railroad," he said. "It's a huge blow. But we are a resilient railroad with dedicated employees and we will survive." 

A smaller Alaska Railroad is likely to emerge from this action, though railroad officials say it’s too soon to talk about specifics.

Flint Hills will not be ending its use of the railroad, as it will be importing oil and selling to fuel companies from tanks on the property. Larger shipments from Anchorage to Fairbanks of gasoline and heating oil will not come close to matching what the company has been sending in the other direction.

The final decision by Flint Hills comes after a decade of production cuts, triggered by changes in world markets and handicaps unique to Alaska, such as the high price of North Slope oil.

Nearly a decade ago, Flint Hills stopped exporting naphtha, which it said was a low-margin product, to Asia and South America. When the U.S. economy collapsed in 2008, it had jet fuel it couldn’t sell and it shut down Tower No. 3, curtailing production.

Fuel consumption at the Anchorage airport dropped by 28 percent in fiscal year 2009.

When the demand for jet fuel showed an unexpected increase as the economy began to recover, officials in Anchorage said they were losing business because airlines reported difficulty in finding fuel supplies.

That’s when the supply chain for importing fuel developed in a big way.

 “Our analysis of the jet fuel market shows that the buyers, airlines operating from the Anchorage International Airport, have taken steps to diversify their choices of where and when to buy jet fuel. Many of these changes may have been precipitated by cutbacks on jet fuel production at the Flint Hills refinery during the recession,” a 2013 report by the Institute of Social and Economic Research said.

The Anchorage fuel consortium of 19 airlines, which includes passenger and freight operators such as UPS and FedEx, focuses on coordinating on infrastructure, but not necessarily on buying fuel.

“Each airline has its own contracts with multiple fuel providers,” ISER said. “Each contract may be for a different price.This is all proprietary information not made available to the airport, which is managed by the state. The consortium also does not tell the airport what each airline pays to belong to the consortium.”

Jet fuel sales approached nearly 1 billion gallons in 2006/2007, ISER said, about 2.7 million gallons a day.

That dropped to about 625 million gallons a year during the economic collapse but has since increased to about 700 million gallons, ISER said.

On Jan. 31, 2012, at a hearing of the House Finance Committee, Rep. Mark Neuman asked then-DOT Commissioner Marc Luiken if there was a contingency plan in case Flint Hills closed down.

Luiken said that the airline fuel consortium had found suppliers “who are willing to supply, probably 100 percent of the fuel” if Flint Hills shut down.

Rep. Tammie Wilson asked if anyone did the math to see if state policies on oil sales were putting the company at a disadvantage.

“Whose responsibility is that?” she said.

Luiken said the transportation department was not in the fuel business and he did not know who was responsible.

Dermot Cole can be reached at Follow him on Twitter at @DermotMCole.