Four Years after Rescue, U.S. Refinery in Crisis

A deal struck in 2012 to save the U.S. East Coast's oldest and largest refinery seemed to have all of the right elements for success: private investors, big oil and taxpayer funding, and the promise of a private-public partnership that would help job growth and consumers.

Four years after private equity firm Carlyle Group and a partner purchased Philadelphia Energy Solutions, the refinery faces another existential crisis.

A sharp decline in the price of oil sourced in North Dakota has hammered profits across the sector with layoffs mounting. Capital projects are now on ice after an industry-wide earnings slump.

Over this period, Carlyle Group and its partner - Sunoco parent Energy Transfer Partners - have banked hundreds of millions from the refinery in the form of dividend-style payouts, funded in part from a loan that put the refinery's future on less-solid footing, an analysis of corporate filings shows.

These moves, along with the saturated state of the energy sector, have burdened Philadelphia Energy Solutions' (PES) refinery with a huge debt load and a dwindling cash buffer. (For a graphic, click http://tmsnrt.rs/2feWjUK) Plans to sell stock in an initial public offering were scrapped in September.

The stakes are high. The refinery is one of the region's largest employers, and U.S. energy officials have warned that its closure would lead to price spikes at the pump and even threaten the nation's national security interests.

Carlyle officials say the refiner's misfortunes are not related to its stewardship. They point to macroeconomic factors, including the narrowing discount for domestic crude oil and the rising costs of U.S. renewable fuel regulations.

"With Carlyle's support, PES has invested nearly $750 million to upgrade the refinery, preserve 900 jobs and create hundreds more, and ensure the integrity of the fuel supply on the east coast," Carlyle spokesman Christopher Ullman said in a statement.

Energy Transfer Partners, which merged with Sunoco in 2012 around the time of the deal, declined to comment.

Carlyle put up $175 million in 2012 in exchange for two-thirds of the new company and full responsibility for day-to-day operations. Sunoco agreed to contribute the refinery's assets and be a non-controlling partner.

For a region contending with global competition, the deal offered potential relief, but the measures have failed to act as a long-term solution that could withstand pressure from fluctuating oil prices and policies.

To be sure, more favorable oil prices and improved demand could boost profits for U.S. independent refiners.

"We are committed to the long term success of PES even in challenging markets," Ullman said.

A NEW BEGINNING
In early 2013, Carlyle took out a $550 million loan for capital projects, as well as payouts to itself and Sunoco parent Energy Transfer Partners, according to filings. In total, between 2013 and 2015 payouts and tax advances reached $480.9 million, all but guaranteeing Carlyle's venture would be profitable.

About $121 million of the loan proceeds were paid as distributions to Carlyle and to ETP. The loan also funded a $25 million payment to preferred unit holders at Carlyle, filings show.

Carlyle said it took out the loan because the firm had confidence that the business plan would be successful, adding they were proved correct in the subsequent two years. The loan payouts were to help reduce Carlyle's risk, the private equity fund said.

The refinery owners enjoyed a taxpayer-funded rescue package, which included the creation of a tax-friendly zone, $25 million in grants and environmental liability waivers.

A spokesman for Philadelphia Mayor Jim Kenney, who was a councilman when the initial deal was struck, said public support was justified in light of the payouts "because it meant that the refinery remained opened and nearly 1,000 jobs stayed in Philadelphia."

U.S. Congressman Bob Brady, a Democrat credited for putting deal together, did not respond to requests for comment.

Proceeds from the loan also helped fund construction of a 280,000 barrel-per-day oil rail terminal in 2013 at the north end of the refinery, which connected the refinery to cheap crude oil flowing out of North Dakota. The terminal helped PES generate $210.8 million in net income in 2014, filings show.

BUST SETS IN
The boom turned to bust by the end of 2015, as the supply of cheap crude disappeared and margins shrunk. The timing was poor for Carlyle, as it was preparing to take PES public in August of 2015 just as the downturn worsened. The IPO valued the refinery enterprise at $1.3 billion.

Expecting a boost in cash from an IPO, Carlyle, ETP and other smaller investors took out an additional $260 million in payouts in 2015, regulatory filings show.

But public investors offered to pay "less than half" of the $15 to $18 per share PES was seeking, according to a person familiar with the offering. Investors were wary of PES's debt load and long-term contracts, two sources familiar with the offering said, and the IPO was eventually scrapped.

PES recorded a $65.7 million loss in its cash balance in 2015, due in large part to the payouts, filings show.

The company's ratio of net debt to earnings before deducting items such as depreciation and taxes was 1.0 in September 2015, in line with the industry, regulatory filings show. By year's end, the most recent figures available, it nearly doubled, climbing to 1.9, a Reuters analysis shows.

Moody's Investors Service warned in an April note - its most recent on the company - that "additional aggressive distributions" to Carlyle and ETP posed a risk to the company's B1 credit rating.

Carlyle said the payouts did not hurt PES's financial footing.

"We believe that leverage levels throughout our ownership have been prudent," Ullman, the Carlyle spokesman, said.

In recent weeks, the refiner has cut about 25 percent of non-union staff, reduced benefits and postponed capital projects, according to sources at the plant. A letter to employees from the company's CEO, Phil Rinaldi, a refinery turnaround specialist, describes the situation in stark terms.

"The company's finances are significantly stressed," Rinaldi said in the letter, sent to employees in September.

By Jarrett Renshaw and Jessica Resnick-Ault