BP Plc (NYSE:BP) recently announced the start-up of a new crude processing unit at its Whiting refinery located in Northwest Indiana.  The company commissioned the new crude distillation unit as a part of its ongoing Whiting refinery modernization project. We expect the project along with other refinery upgrades undertaken by BP to improve its downstream adjusted EBITDA margins by more than 250 basis points in the long run. According to our estimates, the company’s downstream (refining and marketing) operations contribute almost 15% to its value.
About The Whiting Modernization Project
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BP began the Whiting refinery modernization project, which is expected to enhance the refinery’s capability of processing heavy crude from around 20% today up to 85% after completion, in 2008. During the fourth quarter last year, the company had shut down the largest crude distillation unit at the refinery, Pipestill 12, with a throughput capacity of 225,000 barrels per day. Albeit the refinery will not start processing the heavier grades of crude oil until the remaining upgrades are completed, successful commissioning of the new crude unit will at least allow it to operate at its full capacity of 413,000 barrels of oil per day.
Now, the ability of the refinery to process heavier grades of crude oil primarily hinges on the successful commissioning of the new coking and the hydrotreating units, which are expected to come online during the second half of this year. The new delayed coking unit at the Whiting refinery will be the second largest in the world with a capacity of processing ~102,000 barrels of oil per day. It will allow the company to increase its production of petroleum coke and naphtha from residual oil. The new hydrotreater or a hydrodesulfurization unit will improve the refinery’s capacity of removing sulfur from refined products, which helps reducing the Sulfur Dioxide (SO2) emissions from automobiles. 
A supply glut from the Canadian oil sands, a lack of pipeline infrastructure to the gulf coast as well as the proportion of impurities present in the Western Canadian Select (WCS) crude, are responsible for its double-digit price differential to the WTI and the Brent crude. As on July 3rd, the WCS crude was trading at a discount of more than $12 per barrel to the WTI. BP’s Whiting is the largest refinery in the Midwest region that has access to this cheaper, albeit heavier crude oil from Canada. The company’s decision to undertake a ~$4 billion modernization project of the Whiting refinery was primarily driven by this favorable feedstock scenario.
The enhanced capability to refine the heavier grades of crude oil will help BP in improving its refining margins. The company expects to generate incremental cash flows of ~$1 billion annually from the project. A potential increase in the WCS crude prices due to increasing demand from refineries and expansion of the pipeline network poses a downward risk to the commercial viability of this project. However, BP’s vertical integration into the production of crude oil from Canadian oil sands partially insulates it from this risk.
Apart from the ongoing modernization project at the Whiting refinery, BP’s downstream profitability will also improve with upgrades at its Cherry Point refinery in Washington and Toledo refinery in Ohio. In our $47 price estimate for the company, we have factored in an increase in the company’s downstream adjusted EBITDA margins to over 3% from around 0.6% in 2012.Notes: