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Tesoro, looking to lower costs with Bakken oil, doesn't need state subsidy

Dermot Cole

JUNEAU -- The Legislature and the Parnell administration say they won’t play favorites in bestowing subsidies on two in-state Alaska refining companies. The problem with this thinking is that the two companies in line for financial aid -- Petro Star and Tesoro -- are hardly in the same circumstances.

A bill up for a final legislative action this weekend would provide tax credits or cash payments of up to $10 million a year in exchange for an investment of $25 million a year at each refinery.

The subsidy is structured on a per-refinery basis, not a per-company basis, so Petro Star could quality for up to $20 million if it spent $50 million on its two facilities in a year.

Lawmakers and the governor have argued that there is a public interest in keeping the refineries in North Pole and Valdez in operation, especially after Flint Hills announced plans to shut down its North Pole refinery in the spring.

State officials said they are worried that Petro Star may not continue in business unless it gets financial help and that a shutdown would threaten the future of Eielson Air Force Base, lead to higher energy costs, and eliminate jobs throughout the region.

“While we will continue to operate in Alaska with the long-term on the horizon, uncertainties surrounding the continued viability of refining in Alaska makes us question whether we should employ our assets elsewhere,” Arctic Slope Regional Corp. Vice President Tara Sweeney and Petro Star President Doug Chapados told legislators last week.

The subsidy for Tesoro, a company with refineries in California, Utah, Washington and North Dakota, has been justified on the basis that to withhold assistance while offering help to Petro Star would not be fair. No one has said that Tesoro is likely to shut down, so the public interest argument is limited to the notion of equal treatment.

But that would only make sense if the economics were equal. We don't really know all the details, but there are clear differences.

Difference 1: 'Advantaged crudes'

Flint Hills faces a major cleanup expense with sulfolane pollution, a hurdle that Petro Star does not have. But Petro Star, which is owned by Arctic Slope Regional Corp., the largest Alaska-based company, says its survival is threatened by its dependence on high-priced North Slope crude oil and tens of millions in payments to the so-called “Quality Bank.”

Tesoro doesn't face these threats. It is taking steps to diversify its crude oil supplies, which include plans to ship cheaper oil from North Dakota's Bakken shale formation to Kenai.

And Tesoro is on the opposite side of Petro Star on the Quality Bank dispute, defending a methodology that Petro Star attacks as grossly unfair.

Regarding its fuel supply, Tesoro hopes to improve its profits by getting North Dakota oil to Alaska.

“At Kenai, between the increased production of Cook Inlet and the delivery of Bakken, the potential is to satisfy more than two-thirds of the crude appetite with advantaged crudes,” Keith Casey, senior vice president of strategy and business development for Tesoro, told stock analysts in December.

“Advantaged crudes” is the term that Tesoro uses for oil supplies that are less expensive than North Slope crude oil, which is what Petro Star receives from the trans-Alaska pipeline.

“Part of our strategy has been to invest in rail unloading facilities that allow for the delivery of cost-advantaged North American crude oil to the U.S. West Coast,” Tesoro told the Securities and Exchange Commission in its latest annual report.

Alaska North Slope oil still sells at a higher price, a situation that Tesoro hopes will eventually change as more “advantaged crude” enters the West Coast market and competition increases. Lower prices on the West Coast would improve Petro Star's position in time, though it would mean reduced revenue for the state.

While for many years Alaska North Slope crude oil sold at a discount to oil from other parts of the country, that situation reversed itself several years ago when bottlenecks in shipping led to lower prices in parts of the Lower 48. The premium for Alaska North Slope oil is diminishing, but it still exists.

Greg Goff, president and CEO of Tesoro, told investors that an expected growth in Cook Inlet production, from 8,000 to 10,000 barrels more per day, “helps the crude supply cost position” of the Kenai refinery.

“And then with the ability to have that integrated West Coast system and take -- potentially take Bakken crude oil up over there only strengthens that asset,” he said.

Difference 2: 'The Quality Bank'

The second issue on which Petro Star and Tesoro are divided is the Quality Bank. This is the program under which Petro Star pays a penalty for the oil it injects back into the pipeline. It only refines about 30 percent of every gallon it removes from the pipeline; it returns the rest. The return oil is of lower quality and is not worth as much. Tesoro also has to deal with the expense of handling lower-cost portions of each gallon not turned into fuel at its refinery, but it doesn't have to put it back into a pipeline and pay a penalty.

The Quality Bank methodology is a formula that decides how much the return oil is worth. Petro Star says it has paid $525 million into the bank over the last nine years, with about half of that amount in the past three years. It says the formula is unfair. Tesoro defends the formula.

In proceedings before the Federal Energy Regulatory Commission, Petro Star has sought a new Quality Bank methodology that would  allow it to lower its payments, while Tesoro argues that the system works just fine.

The major North Slope oil producers agree with Tesoro, as does the FERC staff and until recently, the state. On Jan. 31, the state filed a document with FERC saying, “Flint Hills has simply failed to provide any evidence that would support its proposed changes to the Quality Bank methodology.”

The state asked that no changes be made in the methodology. It withdrew that statement after Flint Hills announced its plan to stop refining oil.

Hard not to pick and choose

Natural Resources Commissioner Joe Balash said in deciding to offer incentives, the administration wanted to “ensure that we do not, through that policy, pick winners and losers and help specific companies.”

The path chosen was to “address the industry as a whole.”

“We did look at the possibility of doing a Quality Bank credit. That’s something that certainly would have helped Flint Hills. It would help Petro Star. It would not help Tesoro in any way,” he said.

“That kind of a policy would have resulted in a benefit going to one company, but not both.  So, for that reason, we took a pass on that particular path,” he said.

He said that the administration did look at the finances of Petro Star, but won't make that private information public.

In a Feb. 6 conference call with stock analysts, Tesoro President Greg Goff responded to question about the Flint Hills closure and said “it does have some opportunities.”

He said Tesoro has supplied products to Flint Hills and the company expects that to continue. One analyst asked if the Flint Hills shutdown would allow Tesoro to run its Kenai plan “a little harder.”

“That is very likely,” Goff said.

I don't think that a financial aid plan that can be defended is “picking winners and losers.” A sound public policy, which would be more difficult to craft, should be based on something other than an offhand notion that the fair thing to do is offer subsidies without regard to specifics.