Crude oil refiners have enjoyed a pretty good earnings season so far. Tesoro Corp. (NYSE: TSO) and Western Refining Inc. (NYSE: WNR) both posted better-than-expected revenues and profits this morning, following in the wake of a similar report yesterday from Phillips 66 (NYSE: PSX). Marathon Petroleum Corp. (NYSE: MPC) and Valero Energy Corp. (NYSE: VLO) also managed to beat both top- and bottom-line estimates.

HollyFrontier Corp. (NYSE: HFC) reports earnings next week, and the consensus EPS estimate calls for $2.25, up from $1.88 just 90 days ago. Revenues are expected to reach $5.09 billion, up from $2.97 billion a year ago. Most of the increase reflects the impact of the merger of Holly Corp. and Frontier Oil Co. which was completed in July of last year.

For all these independent refiners, the secret is a not-so-secret drop in crude prices coupled with a slower drop in pump prices and rising exports of refined products. There’s little disagreement, too, about the cause of the drop in crude prices: the weak global economy is cutting demand for energy.

Refiners like HollyFrontier and Tesoro that are able to source much of their crude domestically have benefited significantly from the differential pricing between Brent crude and WTI. An even larger benefit has accrued to those companies that can source crude from the Bakken play in North Dakota and the oil sands of Alberta.

The price of Brent crude — the international benchmark — remains about $15-$19/barrel higher than WTI, and WTI costs about $20/barrel more than Canadian light, sweet crude. It costs $5/barrel to transport oil by pipeline and $10-$15/barrel to transport the crude by rail. Even so, with gasoline pump prices pegged to Brent, refiners with access to domestic crude realize a bonus margin of about $20/barrel.

And because pipeline transportation from Alberta and North Dakota is severely constrained, railroad transportation is picking up the slack. According to the Association of American Railroads, rail transportation of crude and refined products in June was 51% higher than it was a year ago and the group estimates that “virtually all” of the increase is down to crude transportation. Burlington Northern Santa Fe, now owned by Berkshire Hathaway Inc. (NYSE: BRK-A) (NYSE: BRK-B) transports about a third of the Bakken production on unit trains carrying up to 85,000 barrels.

Tesoro announced today that it would begin running train tanker cars from the Bakken to the company’s refinery in Anacortes, Washington. The company has also expanded its expected shipping volume to 50,000 barrels/day by the end of the year. Phillips 66 plans a similar train, as does BP plc (NYSE: BP), all headed for Washington state at this time, but Tesoro is considering plans to ship crude to California. California and Washington now get most of their crude from the dwindling supply on Alaska’s North Slope, and pump prices along the West Coast are among the highest in the country.

A unit train hauling 50,000 barrels would require about 60 rail tanker cars. Tesoro expects to send out six unit trains a week from North Dakota to Washington by the end of this year.

The higher transportation costs could nibble away at refining margins, but until more pipeline capacity is added refiners with access to domestic crude by any transportation method will continue to prosper.

Paul Ausick

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