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Tesoro rejects Petro Star claims it seeks to stifle refinery competition

Dermot Cole

FAIRBANKS -- Of the nearly three dozen bills and resolutions from the 2014 Alaska Legislature awaiting final approval from Gov. Sean Parnell, one calls upon the administration to seek a plan before January to “reduce the cost of quality bank adjustments paid by in-state refiners of Alaska North Slope crude oil.”

A related measure would provide subsidies to refinery owners Tesoro and Petro Star, justifying the state aid by arguing that the so-called “Quality Bank” has created a severe drain on refinery finances and helped lead to the shutdown of the Flint Hills Refinery in North Pole in May.

The bank exists as a way of leveling payments because the quality and value of oil shipped in the pipeline varies from oil field to oil field and emerges from Valdez as a single stream. Oil from Prudhoe Bay is of higher quality than oil from Kuparuk, so there is a balancing act there and among the other fields.

The refineries have long argued that they are shortchanged by the bank. For every barrel of oil removed from the pipeline by a refinery, about three-quarters of that oil is returned to the pipeline by another connecting line. The refineries use the high-value portions of the flow to create products such as jet fuel and heating fuel.

The refineries pay a penalty to the bank on the amount they return because that oil is worth less after the higher value segments are removed and processed. The refineries have argued that the penalties on the return oil, which have totaled about $110 million per year for Flint Hills and Petro Star, are about $40 million a year too high.

Tesoro, which supports the Quality Bank formula, didn’t seek a subsidy, but it will be in line to qualify for one as the governor plans to sign these measures next week in Kenai, his office said.

Tesoro and Petro Star disagree about the quality of the Quality Bank, taking opposite sides on its merits in a case with the Federal Energy Regulatory Commission.

“The commission should totally disregard Petro Star’s argument that Tesoro is only involved in this case to stifle in-state competition,” Tesoro said in a filing last month with FERC about the Quality Bank.

For its part, Petro Star charged that it finds itself facing the North Slope oil companies and Tesoro, which operates in Kenai and relies on oil drawn from Cook Inlet and other sources and is not dependent upon the pipeline.

Petro Star said Tesoro benefits from the Quality Bank “to the extent that its in-state competition is weakened or eliminated" and that the system threatens the viability of in-state refining along the pipeline.

Legislators and the governor opted to overlook that fundamental fight between Petro Star and Tesoro -- backing an annual subsidy equal to 40 percent of infrastructure expenditures, capped at $10 million per refinery, on expenditures of $25 million.

The bill provides the tax or cash-back option for the “purchase, installation or modification of tangible personal property” used in instate refining and transportation operations. The tax cut is aimed at countering some of the consequences of the Quality Bank.

Flint Hills and Petro Star had argued for a rewrite of the FERC methodology that would have meant a $40 million benefit to them in total, money that would have come out of reduced payments to the North Slope oil companies and the state.

But contrary to the wishes expressed in the legislative resolution, which was approved 56-0 with next-to-no research on the matter, there is next-to-no chance that the state will be able to get FERC to reduce the cost of Quality Bank payments.

The forces aligned against changes to the methodology are formidable, including the three major North Slope oil companies, legal precedent, the staff of the federal commission, an administrative law judge, Tesoro and even the state of Alaska, which argued in January that no change was needed.

“Flint Hills has simply failed to provide any evidence that would support its proposed changes to the quality bank methodology,” the state said in January. The state backed off from that position after Flint Hills announced its plans to close the refinery.

In June, it said the refining industry is “fragile and small” in Alaska, citing the closing of the Flint Hills North Pole refinery in May. The goal should be a Quality Bank methodology “as free from competitive distortions as possible so as not to exacerbate already difficult market conditions,” the state said.

Take it to the bank

The controversy stems from a system designed to make all parties come out even in the end, though the bank customers have argued for decades about what is even.

With Flint Hills shut down, Tesoro told FERC the commission should consider whether the case ought to be closed because Petro Star and the state did not produce any witnesses or enter any documents into the record at a hearing in February.

Tesoro said that while Flint Hills claimed the Quality Bank methodology might affect its ability to sell the now-closed refinery, “it has offered no evidence of any interested buyer and it makes no sense to presume that a successor-buyer could operate the facility profitably when the incumbent owner could not.”

Tesoro said the state legal representative “sat in the audience and did not participate in argument or ask a single question of a single witness throughout the hearing.” The state assertions raised afterward that the Quality Bank “might somehow impact competition” are speculative and unsupported, according to Tesoro.

The trial staff said there was “overwhelming evidence” that Flint Hills and Petro Star did not make their case, a position largely endorsed by FERC Administrative Law Judge H. Peter Young in his initial decision in May.

The Quality Bank “threatens the viability of a competitive Alaska refining industry. That threat in turn will affect Alaska consumers and Alaska businesses as well as significant civil and armed services operations in Interior Alaska,” Petro Star said in June.

Petro Star, which is owned by the Arctic Slope Regional Corp., told the Legislature the company paid almost $500 million to the bank over the past nine years, with about half of that in the last three years. Far from being a great equalizer, the bank has become a “critical influence” on the Alaska economy, according to Petro Star.

The major oil companies made clear in their responses to Young's initial decision that they didn't buy the ideas put forward by Flint Hills and Petro Star.

“There is no record evidence to support any of the allegations that the QB methodology is having deleterious impacts in Alaska,” BP said.

ExxonMobil agreed that no one made the case as to how the Quality Bank harms the refining industry.

“Like Petro Star, the state did not avail itself of the opportunity to present witnesses and evidence in this proceeding,” Exxon said. “Accordingly, the factual assertions it makes in support of its policy considerations regarding competitive conditions and competition generally are wholly unsupported and cannot serve as a basis for reasoned commission decision making.”

The commission staff concurred with the oil companies.  

“In sum, the impact of the current QB methodology on competition in the Alaska refinery market was entirely absent from this case,” the staff said June 30.

Tesoro said that since the state offered no evidence about instate refinery competitiveness during the hearing, its arguments “merit no response and are entitled to no weight.”

“Free and open competition is important to protecting the interests of all consumers of refined products in Alaska,” the state argued June 9, responding to the initial decision by the judge in one of the shortest documents filed in the case. "The commission should not adopt a ruling that could allow the TAPS Quality Bank methodology to negatively influence such competition."