Shedding light on HOVENSA's impending closure

ST. CROIX - HOVENSA's announcement last week that it will shut down its refining operations by mid-February has sparked widespread debate and speculation in the community.

The result has been a combination of fact and misinformation that has shaped the community's perspective on the matter.

Some of that has been fueled by fear and uncertainty about what the future on St. Croix looks like without smoke rising from the stacks on the south shore. Some has come from a general mistrust in statements issued by HOVENSA that many residents have felt lacked credibility during the last several years.

And some is the result of HOVENSA being a complex corporate structure operating in a complex global market.

Interviews with industry experts and HOVENSA personnel and testimony from HOVENSA representatives provide the basic facts of the refinery's shut-down.

HOVENSA is a company formed through a joint venture between two major oil companies: Hess Corp., a U.S.-based oil company that is one of the largest suppliers of oil to the east coast, and the Venezuelan state-owned oil company Petroleos de Venezuela S.A., or PDVSA. Each company established local subsidiaries - Hess Oil Virgin Islands Corp. and PDVSA V.I. Inc. - that legally own the refinery. Through those subsidiaries, Hess and PDVSA each own half of the refinery.

"Essentially, it's a company with two shareholders," said outside counsel to HOVENSA George Dudley.

It was a mutually beneficial arrangement for both shareholders when arranged in 1998.

Hess gained a partner in its refinery and a secure source of 115,000 barrels a day of crude oil from Venezuela.

PDVSA, which produces a dirty fuel, ensured it had a refinery that could process its oil.

The companies agreed to build the coker unit at a cost of almost a billion dollars in order to process the Venezuelan crude oil.

HOVENSA was a money-making enterprise for each of its investors, making enough to cover its operations and sending profits - split evenly - to Hess and PDVSA.

Senators raised concerns Thursday about whether the companies were shifting money around to make it appear that HOVENSA was struggling, but Dudley argued against such logic, asking why Hess and PDVSA would shut down a refinery that is making them money.

"If the refinery was operating in a way that was realizing profits to its owners, then the refinery would not be shut down," he said.

Like other companies and government entities, HOVENSA's operations are overseen by a governing board - its executive committee. The executive committee consists of three high-level representatives each from Hess and PDVSA, all of whom act as HOVENSA's shareholders.

While HOVENSA establishes its own business and operational plans, it is overseen by the committee. Like any publicly traded company, it has to answer to its shareholders - all of whom are interested in maintaining a profitable operation.

HOVENSA said it lost $1.3 billion during the last three years, and just as the investors gained when HOVENSA was profitable, they lost when it was not.

Unlike PDVSA, Hess is a publicly traded company that has its own shareholders to whom it must answer. For the last three years, Hess Oil's quarterly reports to those shareholders had one consistent profit loss entry on them: HOVENSA.

Hess' refining operations - of which HOVENSA accounts for the lion's share - operated at a loss of $598 million in the fourth quarter of 2011. Between 2009 and 2010, it lost about $532 million.

Those amounts represent only Hess' share.

Ultimately, the major decisions - such as the one to shut down refining operations - are made by that committee.

"Capital will only be spent where the returns are the highest," said Fadel Gheit, senior oil and gas analyst for Oppenheimer and Co. "Their objective is to maximize returns."

Some senators questioned how HOVENSA could not be turning a profit when it produces a valuable product, and the Venezuelan state oil company is a co-owner.

PDVSA does not just give HOVENSA the crude oil, however, nor does PDVSA give HOVENSA a discount. To do so would not be in PDVSA's best interest.

HOVENSA no longer has the industry clout it did 10 years ago when the coker was built because many other cokers have been built since then to accommodate Venezuelan crude.

PDVSA now has the option of selling its crude oil anywhere in the world at market price, and it would lose money by selling subsidized oil to HOVENSA.

Even if it sold at a price low enough to make HOVENSA profitable, any returns from the refinery would be cancelled out by the money PDVSA lost from the sale of the crude oil.

While Hess might benefit, PDVSA has no interest in subsidizing Hess' gains.

HOVENSA buys crude oil at market value from PDVSA and other companies, refines it and then sells the refined products at market value to various buyers, including Hess.

HOVENSA also burns some of the refined fuel it produces to generate power to run the refinery.

During the last decade, most U.S. refineries have benefited from the consistent low price of natural gas, but HOVENSA has been stuck burning fuel oil and with it hundreds of millions of dollars in lost profits.

Also during the last several years, the margins between the cost of crude oil and the revenues from refined products have been squeezed to the point that - after factoring in operating and energy costs - HOVENSA and its owners now lose money on every barrel of oil it produces.

Several factors have led to HOVENSA's movement from profit to loss. The cost of petroleum products - crude and refined - have risen exponentially while natural gas has remained comparatively inexpensive. Most refineries in the U.S. mainland now run on natural gas or some other cheap fuel source, such as coal, and do not have such high energy costs.

While HOVENSA looked into bringing in liquified natural gas to run the refinery, it was not "economically feasible" because of the costly infrastructure it would require, President and Chief Operating Officer Brian Lever said.

In addition, the demand for refined products has gone down on the world market while the number of refineries continues to increase - particularly in the developing world.

Some senators could not believe the demand for oil had dropped because demand still is high in the territory, but it is a global market, not one confined to the Virgin Islands.

Imports of foreign oil were down in the United States by almost 10 percent in 2010 from a high reached in 2005 and will continue down that path, according to the U.S. Energy Information Administration. In addition, oil consumption in the United States - where most of HOVENSA's products are sold - has seen its first significant drop in decades since the start of the global recession.

That decline in oil consumption put added pressure on an already bloated industry, with some analysts estimating there will be spare refining capacity of 6.8 million barrels per day this year.

HOVENSA no longer can compete in the market, representatives said.

Eighteen refineries have closed during the last three years in Europe and the United States, according to HOVENSA.

"Every company I know of is bailing out of refining," Gheit said.

Currently no prospective buyers for the refinery exist, Lever said. Asked whether HOVENSA had tried to sell the facility, he replied: "We explored all options."

"It doesn't matter who owns the refinery," he said. "The refinery is configured in a way that is not conducive to this economic environment."

The looming $700 million in capital improvements HOVENSA would have to make during the next 10 years to comply with the consent decree negotiated with the U.S. Environmental Protection Agency was "one factor" in the decision to close, but it was "not in itself" the reason the decision was made, Lever said.

HOVENSA will supply WAPA and the territory's gas stations with fuel through June and will stop supplying propane at the same time, Lever said.

The truck rack, which still is owned by HOVENSA, likely will be operated by a third party. Dudley said HOVENSA is willing to enter into an agreement with a company to bring in the fuel and operate the rack.

- Contact Daniel Shea at 714-9127 or email dshea@dailynews.vi.

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