Why Oil Prices Could Plummet in 2014

Marie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Filling up the gas tank is always a challenge. It's painful to watch as the dollar amount rises far more quickly than the gallons going into your tank.  Thankfully, there’s hope: new pipelines to Gulf Coast refineries bring the (hopeful) promise of lower gas prices to drivers throughout the United States. But while construction may yield some tangible results for consumers, investors are in the best position to reap strong rewards.

Pipeline projects in the works

The U.S. imports a great deal of crude oil. However, our own “cheaper” domestic supply is actually quite high. American oil companies do not face problems finding or even drilling for the oil. Instead, the real problem lies with moving the crude oil from the drill sites to refineries, where the oil is processed and packaged for sale.

One company providing a solution to this problem is Magellan Midstream Partners (NYSE: MMP)Magellan completed a new pipeline this spring that runs from West Texas to Houston. Magellan’s project is the first of seven pipelines that will run from various locations in Texas and Oklahoma to the refineries along the Gulf Coast, in states like Louisiana and Texas. At completion, these pipelines are expected to transport up to 2 million barrels of crude oil a day, representing an incredible 10% of the 19.20 million barrels of oil the U.S. uses each day.

Cheaper gas in your future

Crude production reached a 17-year high in June, pumping out roughly 8.9 million barrels a day. The move higher was influenced by energy drillers’ flight from drilling for natural gas, which is experiencing persistent low prices. On the surface, increased oil production sounds like it would lead to lower prices. But in reality, it had little impact on Gulf Coast refineries due to a lack of pipelines.

Marathon Petroleum (NYSE: MPC), for example, currently lacks access to most onshore domestic crude oil produced in the U.S. Without the vital pipelines to connect onshore crude oil sites to refiners, Marathon instead imported foreign crude oil to refine and sell.

From a profit standpoint, the problem is that such foreign oil doesn’t come cheap. The price of Brent crude oil (which makes up two-thirds of the world’s internationally traded crude oil) reached $101.51 per barrel on June 25. In contrast, crude oil from the U.S. reached $95.25 per barrel on the same date, effectively 6.6% cheaper.

While Marathon likely had some of its oil procurement costs hedged, a 6.6% spread between what you pay and what you could pay is a substantial gap. Especially when raw material costs can run into the hundreds of millions of dollars.

Luckily, high import prices will not be a problem for long. Magellan Midstream Partners built the first completed pipeline, and the other six pipelines are expected to be up and running within the next 18 months.

Coastal refiners pipe away their costs

The U.S. is prohibited from exporting most of its crude oil, because more supply in the U.S. means lower energy prices. Therefore, U.S. energy firms have only one choice: Refine it. Because of the seven new pipelines spanning Oklahoma and Texas, and the high onshore crude oil production and offshore deep-sea drilling, Gulf Coast refineries will have plenty of domestic oil to refine.

This year, Valero (NYSE: VLO) paid a minimum of $97 per barrel for foreign oil. High prices for crude only allowed the firm a $10.50 gross margin per barrel in 2011 and 2012. Due to the increased supply of domestic oil, some forecast that the price per barrel will significantly drop in the next few years.

Amy Jaffe, the executive director of energy and sustainability at the University of California, predicts that prices will drop as low as $50 - $70 per barrel. Decreased prices to oil refiners will allow for larger gross margins per barrel produced. Morningstar projects Valero will earn a $12.80 gross margin per barrel in 2013-2017, a 22% jump.

<table> <thead> <tr><th> <p><strong>Company</strong></p> </th><th> <p><strong>Gross Margin per barrel 2012</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>Marathon Petroleum</p> </td> <td> <p>$9.17</p> </td> </tr> <tr> <td> <p>Valero</p> </td> <td> <p>$10.50</p> </td> </tr> <tr> <td> <p>Phillips 66</p> </td> <td> <p>$11.40</p> </td> </tr> <tr> <td> <p>CVR Energy</p> </td> <td> <p>$10.23</p> </td> </tr> </tbody> </table>

Source: Companies’ reports.

Another Gulf Coast refiner who stands to benefit is Phillips 66 (NYSE: PSX). In 2011 and 2012, Phillips 66 earned an $11.40 profit margin per barrel. With an increased domestic oil supply, Morningstar predicts Phillips 66 will earn $13.50 per barrel in 2013-2017.

Though these pipelines are great news for the Gulf Coast, they bring bittersweet news to the Midwest refiners.

Midwest refiners take a hit

For years the crude oil drilled in the Midwest and through certain parts of Texas was only accessible to local refiners. Local refiners such as CVR Energy (NYSE: CVI) held a monopoly over this supply and could buy it at a discount. Currently that discount is about $6 per barrel, but just last February it was as high as $20.

Even though the Midwesterners spent less on crude than their Gulf Coast counterparts, these refiners charged the same price per barrel. As these firms lose their grasp on the crude oil supply, they will also lose their large profit margins.

<img alt="" src="http://media.ycharts.com/charts/3da04d87756205c33737aea5cf8cc92c.png" />

As you can see from CVR’s share price, investors are already picking up on the changing winds.

Conclusion

You and I will (hopefully) pay less to fill up our tanks as Gulf Coast refineries obtain access to more domestic oil and become less dependent on expensive foreign oil. Greater supply will also help Gulf Coast refineries profit more from production efforts.

However, this win-win situation looks rather bleak for Midwest refiners, which dominated domestic oil supply up to this point. The first pipeline completion is only the beginning. During the next 12 months, keep a close eye on the completion status of the remaining pipelines, which can help you take the pulse of the energy market.


This article was written by Michele Milheim and edited by Chris Marasco. Chris Marasco is Head Editor of ADifferentAngle. Neither has a position in any stocks mentioned.The Motley Fool recommends Magellan Midstream Partners, L.P.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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