Refinery's future hangs in balance

Review may result in closing of plant

Posted: Saturday, April 22, 2000

Tesoro Petroleum Co. has averaged a 3 percent return on capital employed in Alaska, and that is unacceptable, said Ron Noel, vice president of Tesoro Alaska Petroleum Co.

"Tesoro has put in place a 60-day review, looking at cost-cutting and also looking at whether it would make economic sense for Tesoro to close or sell the Kenai refinery," he said.

Noel said one option, if the refinery closes, is to import fuel for its retail outlets and distribution system. Tesoro Alaska operates roughly 31 company-owned service stations and also sells its gasoline and diesel through close to 150 independently owned Tesoro-brand stations statewide.

It sells home heating fuel through distributors in Anchorage, the Kenai Peninsula and other cities, and sells marine fuels over its Nikiski dock to barges from companies such as Petro Marine and Delta Western.

Noel said it may make more sense to supply Alaska from Outside, where refining costs are cheaper. He said the Nikiski refinery lost close to $3.3 million in the fourth quarter.

"If you look back at the last 10 years, we've averaged a 3 percent return on capital employed in Alaska, which is unacceptable," he said. "You could put that money in a bank and you'd get a better return."

In 1998, Tesoro Petroleum Corp. paid $252 million and promised another $50 million by 2013 for a 95,000-barrel-per-day refinery and 32 service stations in Hawaii. It also paid $280 million for a 108,000-barrel-per-day refinery in Anacortes, Wash.

The acquisitions are expected to triple Tesoro's historical annual revenues and significantly increase the scope of its refining and marketing operations, company officials said in September.

In November 1999, Tesoro announced the sale of its domestic exploration and production business for $215 million. In December, it announced the sale of its Bolivian exploration and production business for $100 million. Managers planned to use the money to pay down debts and take advantage of anticipated opportunities.

Tesoro expected integrating the Alaska, Washington and Hawaii refineries to produce $25 million per year in cost savings and revenue enhancements. Its net earnings for the first nine months of 1999 were $58.1 million, up from $20.1 million for the first nine months of 1998.

In February, though, Tesoro reported a fourth-quarter loss from continuing operations of $23.6 million, compared with earnings from operations of $4.3 million during the fourth quarter of 1998.

"Clearly, we are disappointed with our fourth-quarter results," said Bruce A. Smith, president, chairman and chief executive.

He blamed the dismal fourth-quarter results on the 10-year high in crude prices following production cuts among members of the Organization of Petroleum Exporting Countries and the failure of gasoline and diesel prices to keep pace.

The price of crude more than doubled from around $12 per barrel a year ago to nearly $30 per barrel in early February, said Rod Cason, manager of the Nikiski refinery. The local price of gasoline has risen 15 cents per gallon, roughly 11 percent.

Smith said profit margins at Tesoro's Alaska and Hawaii refineries fell from $6.10 per barrel during the fourth quarter of 1998 to $3.40 per barrel during the fourth quarter of 1999.

"In contrast, fourth-quarter 1999 margins for our West Coast operations improved to approximately $5.35 per barrel, or almost 90 cents per barrel higher than the same quarter in 1998," he said.

Tesoro Petroleum will accelerate programs to allow sustained profitability during periods of low margins, he said. Its three-year goal is to improve its return on capital employed to 12 percent.

As if current fiscal woes were not enough, this winter, the state sent Tesoro Alaska bills for $24 million in royalty payments it says were miscalculated 16 years ago, and $3 million for disputes over tariffs through Cook Inlet pipelines.

John Shively, commissioner of the Department of Natural Resources, said the $24 million bill stems from a revaluation of royalty oil the state sold to Tesoro in 1984-85. The state charged Tesoro based on oil prices the holders of Cook Inlet oil leases reported on production tax returns. He wrote Tesoro that when the state audited those returns, it determined that the lessees had under-reported the value of Cook Inlet oil.

Shively said there was no dishonesty on Tesoro's part, and the state's bill is just the first step in what likely will be a long negotiation. Tesoro was not pleased.

"It was very upsetting for us to receive a bill for expenses incurred 16 years ago," Noel said.

The state also is investigating whether Tesoro has engaged in price fixing. Attorney General Bruce Botelho has subpoenaed large volumes of documents.

"That whole thing with the state is ridiculous," Noel said. "Our 3 percent return on capital will tell you there's nothing to that."

He said the investigation has cost Tesoro $2 million, so far.

Jeff Sinz, Kenai Peninsula Borough finance director, said Tesoro's assets here are worth nearly $90 million, and Tesoro pays more than $1 million per year in property taxes. Homer Electric Association spokeswoman Sandra Ghormley said Tesoro Alaska is a huge customer.

Borough assembly member Jack Brown said closing the refinery, which employs 175 people, would be devastating.

"Our Homer Electric Association bills are going to go up," he said. "Our tax bills are going to go up. Tesoro is the largest part of Cook Inlet Spill Prevention and Response Inc., so our spill response is going to be radically altered."



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