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Cenovus, Husky tout integrated strategy as oil-price gap hits refining business

Cenovus, owner of the Christina Lake oil sands operations in Alberta, earned $370-million in the third quarter.

RICHARD PERRY/NYT

A big squeeze in the difference between North American and international oil prices hit the U.S. refining operations of Cenovus Energy Inc. and Husky Energy Inc. hard in the third quarter, though their ability to process more heavy crude offers some protection as the situation persists.

Cash flow from Cenovus's joint-venture refineries in Illinois and Texas sank by 75 per cent from the same period a year ago. Husky's two plants in Ohio were pressured by the same factors, though the company reports refining and marketing results using net income rather than cash flow. It sank 78 per cent.

Both companies touted their strategy of integrated operations, which allows heavy oil and oil sands production businesses in Canada to reap the rewards when profit margins in refining shrink.

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It's a turnaround in the industry's fortunes. Until this year, refineries, especially in the U.S. Midwest, a main market for Canadian oil, profited handsomely from a wide discount on U.S. light and Canadian heavy oil prices versus international benchmark Brent oil, caused largely by insufficient pipeline capacity to move supplies out of the huge Cushing, Okla., storage hub.

Those spreads have narrowed as new transport capacity has started up between Cushing and the U.S. Gulf Coast, alleviating the glut, and as more volumes have moved by rail. Now the refining margin, or difference between the cost of crude oil feedstock and the price of wholesale gasoline, has dwindled.

"It's not just them, it's even the big oils like Chevron and names like that," said Lanny Pendill, analyst at Edward Jones in St. Louis. "What has simply happened is the cost of their feedstock has gone up relative to where it was priced in the past. That has been a direct hit to the margins across the industry."

Cenovus, best known for its Foster Creek and Christina Lake oil sands operations in Alberta, earned $370-million, or 49 cents per share in the third quarter, up 28 per cent from year-earlier $289-million, or 38 cents per share.

Profit at Husky, the Calgary-based company controlled by Hong Kong billionaire Li Ka-shing, dipped about 3 per cent to $512-million, or 52 cents per share, from $526-million, or 53 cents a share.

On Thursday, Husky said it started designing a project worth "in the hundreds of millions of dollars" to boost capacity to run Canadian heavy crude at its Lima, Ohio, refinery. Cenovus and its refining partner, ConocoPhillips, recently completed a $3.8-billion (U.S.) upgrade of their Wood River, Ill., plant that nearly doubled its ability to process such oil.

Husky chief executive Asim Ghosh said his company's structure as both a refiner and producer allows it to avoid some of the volatility in earnings that comes with gyrating oil prices.

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"We've had a series of shorter-term issues going in different directions – upgrader turnarounds, new capacity coming on stream. Our strategy is to try to mitigate the effects of this differential so that value moves between our U.S. downstream and Canadian upstream," he said.

For Cenovus, U.S. fuel regulations also played a role in weaker refining results. The Environmental Protection Agency requires companies that do not blend renewable fuels such as ethanol into gasoline and diesel to buy so-called renewable identification numbers. Cenovus's spending on RINs increased $55-million, compared with $10-million a year earlier.

Costs tied to RINs, however, are dropping. Cenovus said the EPA has suggested it might change the rules, which has pushed down the spot price for RINs. "There should be less volatility, therefore greater stability [for refiners]," Cenovus CEO Brian Ferguson said in an interview.

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About the Authors
Mergers and Acquisitions Reporter

Jeffrey Jones is a veteran journalist specializing in mergers, acquisitions and private equity for The Globe and Mail’s Report on Business. Before joining The Globe and Mail in 2013, he was a senior reporter for Reuters, writing news, features and analysis on energy deals, pipelines, politics and general topics. More

Carrie Tait joined the Globe in January, 2011, mainly reporting on energy from the Calgary bureau. Previously, she spent six years working for the National Post in both Calgary and Toronto. She has a master’s degree in journalism from the University of Western Ontario and a bachelor’s degree in political studies from the University of Saskatchewan. More

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