BP Plc (NYSE:BP) recently announced the start-up of a new coking unit at its Whiting refinery located in Northwest Indiana.  With this, the company successfully commissioned all the major new units associated with the Whiting refinery modernization project. We expect the project along with other refinery upgrades undertaken by BP to improve its adjusted downstream EBITDA margins in the coming years. According to our estimates, the company’s downstream (refining and marketing) operations contribute almost 15% to its value.
Headquartered in London, BP is one of the world’s leading oil & gas multinationals with operations in more than 80 countries. As a vertically integrated oil and gas major, it has both upstream as well as downstream operations. The upstream division primarily includes exploration and production activities for oil and gas, while the downstream division focuses on producing refined petroleum products such as gasoline.
We currently have $50 price estimate for BP, which is around 5% above its current market price.
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The Whiting Modernization Project
BP began the Whiting refinery modernization project in 2008 in order to enhance the refinery’s heavy crude processing capacity from around 20% today up to 85% after completion. In other words, the upgrade will increase its Canadian crude processing capacity from 85,000 barrels of oil per day (bpd) to 350,000 bpd, though the plant’s overall capacity will remain the same. Heavy crude processing at the refinery would be ramped up to its full capacity by the end of the first quarter next year. 
July this year, BP completed the upgrade of the largest crude processing unit at the Whiting refinery, which had been shut down since the fourth quarter last year. It allowed the company to operate the refinery at its full capacity of 413,000 bpd, which is more than 15% of BP’s total crude distillation capacity. The new delayed coking unit BP just commissioned at the Whiting refinery is the second largest in the world with a processing capacity of 102,000 bpd. It will allow the company to increase its production of petroleum coke and naphtha from residual oil. Apart from this, the upgraded refinery is also equipped with a new hydrotreater or a hydrodesulfurization unit, which will improve its capacity to remove sulfur from refined products. This helps reducing Sulfur Dioxide (SO2) emissions from automobiles. 
The Western Canadian Select (WCS) crude trades at a discount to the WTI and the Brent crude. This is primarily due to a glut of supply from the Canadian oil sands, a lack of pipeline infrastructure to the gulf coast as well as a higher proportion of impurities present in the WCS. On December 24th, the February 2014 futures contract of the WCS crude closed at a discount of more than $23 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 more than $4 billion modernization project of the Whiting refinery was primarily driven by this favorable feedstock scenario.
The enhanced capability to refine 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 modernization of 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 $50 price estimate for the company, we have factored in an increase in its adjusted downstream EBITDA margin to over 3% in the long run.Notes:
- BP Completes Commissioning of Whiting Refinery Units, bp.com [↩]
- Whiting Refinery Modernization Project, bp.com [↩] [↩]