Philadelphia Refinery Files for Chapter 11 -- WSJ

Major East Coast supplier of gasoline blames federal rules on ethanol blending

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (January 23, 2018).

Philadelphia Energy Solutions LLC affiliates accounting for more than one-quarter of the fuel-refining capacity on the East Coast filed for bankruptcy protection, blaming the steep cost of complying with a federal environmental regulation.

The company, which operates two refineries just miles from center city Philadelphia, said in court papers on Monday that it intends to operate normally while awaiting judicial approval for its reorganization plan possibly by the end of February. Philadelphia Energy said it worked out the details with its top creditors ahead of its chapter 11 filing on Sunday.

The company cited the Clean Air Act's renewable-fuel-standard program as the primary reason for its financial distress, saying it is a victim of "regulatory compliance costs that specifically penalize independent merchant refiners." It also blamed adverse economics in the energy sector.

Independent refiners have long complained about the program, which was introduced during President George W. Bush's administration to boost the amount of ethanol in the country's gasoline supply. The Renewable Fuel Standard requires companies to either blend ethanol with the gasoline they produce or buy credits. Refiners that don't purchase the credits have to pay penalties to the government.

The credits are awarded where ethanol and gasoline are blended, which for the most part means facilities owned by integrated oil companies like Chevron Corp. and Exxon Mobil Corp. and by large retail gas-station chains. The system disadvantages smaller refiners like Philadelphia Energy with few blending facilities.

If it wants to avoid fines, Philadelphia Energy has to purchase blending credits, exposing the company to an "unpredictable, escalating, and unintended compliance burden" that has cost it $832 million since operations began in September 2012, the company said in court papers. Philadelphia Energy said it paid $13 million to comply in 2012, with the figure rising to $231 million by 2016.

For years, independent refiners have unsuccessfully lobbied the Environmental Protection Agency to move the point of obligation for adding ethanol from refiners to the retail level. Those efforts drew scrutiny when billionaire investor Carl Icahn, who holds a majority stake in independent refiner CVR Energy Inc. and was a special adviser to President Donald Trump, became involved.

The Trump administration backed away from changes to the Renewable Fuel Standard favored by independent refiners in October, after senators from corn-producing states -- corn is the major source of ethanol in the U.S. -- threatened to block its EPA nominees. CVR disclosed in November that federal prosecutors are looking into Mr. Icahn's role as adviser to Mr. Trump.

Private-equity firm Carlyle Group and Sunoco Inc., which is now a subsidiary of Energy Transfer Partners LP, formed Philadelphia Energy to buy the refining complex from Sunoco in 2012. Carlyle Group declined to comment Monday, but in a release Philadelphia Energy said Carlyle and Sunoco are investing new money into the reorganized company. Energy Transfer Partners referred questions to Philadelphia Energy.

The problems for East Coast refiners run deeper than regulatory obligations. Those refiners were in economic peril at the start of the decade because of their dependence on expensive foreign crude imported from places like Nigeria and Russia, which forced several to close between 2010 and 2012.

They saw a short-term reprieve as frackers in places like North Dakota pumped more oil. Between 2013 and 2015, East Coast refiners increased their profitability by using cheaper crude from the Bakken basin in the Northern U.S., which had been languishing due to a dearth of pipelines and a ban on exports of U.S. oil.

At one point, a barrel of U.S. oil was selling for $25 less than a foreign one. That margin disappeared once U.S. Congress lifted the export ban in 2015 and American producers started to ship crude overseas. New conduits like the Dakota Access Pipeline have also come online, connecting North Dakota's oil to U.S. refining centers on the Gulf Coast.

Despite paying billions to comply with the regulations, many independent refiners have been reaping huge profits. Over the past five years, the biggest four fuel processors that don't produce oil or gas delivered a total return of 180% to shareholders, including dividends, beating the S&P 500 index by almost 75 percentage points, according to FactSet. U.S. refiners, including Valero Energy Corp., Andeavor Corp., Marathon Petroleum Corp. and others, provided $53 billion in cash to shareholders in dividends and buybacks.

Refiners on the Gulf Coast have benefited from their close proximity to shale-oil producers in Texas and their ability to import and export through the Gulf of Mexico.

Philadelphia Energy will ask a bankruptcy judge to let it refashion its business in bankruptcy -- "free and clear" of the regulatory-compliance liabilities that it blames for snarling its finances -- by using a sale structure to transfer ownership to existing stakeholders.

At current market prices, Philadelphia Energy would have to purchase credits with an aggregate market value of about $350 million before March 31 to settle its compliance obligations, court papers say.

Philadelphia Energy Solutions, the parent company, didn't file for bankruptcy protection. It is part of the turnaround strategy, committed to contributing $65 million to retain 25% of the refinery operation once it is out of bankruptcy. The Philadelphia company's chapter 11 plan calls for a sale, but there is no outside buyer, according to spokeswoman Cherice Corley. Instead, Philadelphia Energy's operations are to be sold to existing stakeholders or reorganized if the sale proposal is rejected by the bankruptcy court, she said.

Write to Peg Brickley at peg.brickley@wsj.com and Christopher M. Matthews at christopher.matthews@wsj.com

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January 23, 2018 02:47 ET (07:47 GMT)