For the first new refinery in the U.S. in seven years, the idea was simple: Buy cheap oil from shale producers, then score a quick profit by selling it right back to them as more expensive diesel needed to power their trucks and drilling rigs.
Now the shale boom is threatening to ruin a renaissance in small refineries, known as teapots, before it even begins.
When Dakota Prairie Refining LLC—co-owned by Indianapolis-based Calumet Specialty Products Partners LP and Bismarck, North Dakota-based MDU Resources Group Inc.—was building its $430 million plant in 2014, it could buy some of the cheapest oil in America and sell among the most expensive diesel in America. But the oil bust obliterated its local diesel market, along with the fat premium the fuel used to fetch, as its potential customers shut down operations.
In the fall of 2014, when tiny Dakota Prairie was getting ready to open its processing plant in Dickinson, North Dakota, diesel fuel near the state’s Bakken oil fields sold for $100 a barrel more than the oil produced there. Now it’s selling for just $16 a barrel more.
"The last thing you want to be doing right now is running a refinery that makes a lot of diesel and very little gasoline," said Robert Campbell, head of oil-products research at Energy Aspects Ltd. It’s a "double whammy," he said, as the diesel market weakens worldwide and demand in their specific local market plunges. Dakota Prairie lacks the pipelines and storage units a larger refiner uses to sell to customers farther away, and it’s not equipped to make vehicle-ready gasoline instead of diesel.
"These guys don’t have alternative markets, and they don’t have a lot of competitiveness to export, so they’re pretty stuck," Campbell said.
MDU Resources Group and Calumet Specialty co-own the Bakken-oil processing plant, which has the capacity to generate 20,000 barrels a day of diesel, compared with conventional-sized refineries that process more than 100,000 barrels a day. Other companies reopened two small refineries in Texas and Kentucky and announced plans to build at least four others at the height of the shale boom.
The shale boom was a rising tide for U.S. refiners, who were able to take advantage of a flood of cheap new oil. They were able to buy and process oil, which was often made even cheaper because it was stranded by a lack of pipelines, into more expensive gasoline and diesel fuels.
A Bloomberg Intelligence index of U.S. refining companies rose 137 percent in the past five years, almost triple the 46 percent rise in the S&P 500. Meanwhile the S&P’s energy sector index, which includes producers, declined 22 percent in the period as plunging crude prices sucked the life out of the drilling industry last year.
In North Dakota, a processing plant could buy oil directly from Bakken drillers for less than the U.S. benchmark crude sold in Oklahoma, then sell diesel for more than the benchmark fuel price in New York. Diesel sold near Minot, North Dakota fetched an average premium of between $56 to $69 a barrel over the wellhead price of Bakken oil from 2011 to 2014. The premium peaked at $100 a barrel on Nov. 19, 2014.
After some setbacks, the Dakota Prairie refinery began commercial operations in May 2015. By then, the diesel premium had fallen into the $30s. It was $17.57 a barrel Sunday.
The plant opened to a loss in its first quarter of production. MDU said its after-tax portion of the loss was $5.8 million, and blamed the poor performance on "challenging market conditions," in a Nov. 3 conference call with analysts.
Calumet and MDU said in November that they would delay plans for a second refinery in the Minot area of North Dakota.
"The pricing environment might not be where we’d like it to be right now, but we can’t control that," said Tony Spilde, a spokesman for MDU Resources. "What we can control is operating the refinery efficiently and continuing to be innovative."
Although the current commodity price environment remains volatile, co-owner Calumet believes niche refineries of inland fuels with access to cost advantaged crude oil will be competitively advantaged in the long-term, according to Noel Ryan, spokesman for Calumet, which saw its stock price decrease by 21 percent in December.
Market fluctuations were built into the company’s long-term business plans, according to Sam Margolin, lead analyst at Cowen & Co. LLC. "But, in the near-term, it’s reasonable to expect the owners to be punished against this back drop," he said.
"I think the opportunity is still there," Margolin said. "These reserves have a long life; certainly a life that extends beyond one commodity cycle. If you analyze anything in the trough of the commodity that underpins it, it’s never going to look really good."
Calumet shares were up 2 percent Tuesday morning, to $18.53 each, down from $26.05 a year ago.