April 24, 2012:

Carlyle Group (CG) (CG)’s talks to buy a majority stake in Sunoco Inc. (SUN) (SUN)’s Philadelphia refinery show private equity is betting the business abandoned by public oil companies may be poised for a long-term rebound. If the talks are successful, Washington-based Carlyle would pay cash into a joint venture that would oversee day-to-day operations at the plant, according to a statement yesterday. Sunoco, based in Philadelphia, would have no ongoing capital requirements at the refinery. No terms were disclosed and an agreement hasn’t been finalized.

Carlyle would join Blackstone Group (BX) (BX) and TPG Capital, which made refinery deals in the past two years to expand natural resources investments. Unlike public companies, which have to answer to shareholders every quarter, private-equity funds can make longer-term bets on a business or an industry because their capital is usually locked up for 10 years. “They’re looking to pick up a cash-generating asset at a good price and flip it in four or five years,” said Neil Earnest, practice leader for mergers and acquisitions at Muse Stancil & Co., a Dallas-based consulting firm that specializes in the energy industry. “They want to buy something cheap and sell high.”

Private-equity firms are turning to refining assets on the U.S. East Coast and in Europe as the lowest margin in nearly a decade has transformed profitable plants into money-losers, reducing the value enough to make a turnaround bet an attractive proposition, Earnest said in a telephone interview yesterday.

East Coast Disadvantage

Refineries on the East Coast have been hurt because their only source of crude is based on Brent, the global benchmark, which sold for an average $15.69 a barrel higher in 2011 than U.S.-produced oil, according to data compiled by Bloomberg. The difference between the cost of crude and the price at which refiners can sell fuel on the U.S. East Coast sunk to an average of $7.94 a barrel last year, the lowest point since 2003, according to data compiled by Bloomberg. Although Sunoco has lost money in refining in 10 of the last 11 quarters, the fortunes of the Philadelphia plant might improve if the company is able to buy cheaper oil produced in Canada and North Dakota, said John Auers, senior vice president of Turner Mason & Co., a Dallas-based energy consulting firm. Sunoco rose 1.4 percent to $40.02 at the close in New York. The shares have risen 17 percent this year.

O’Malley’s Deals

With oil companies selling, buyout firms have picked up refining assets on the cheap. Blackstone, the world’s largest private-equity firm, and energy specialist First Reserve formed PBF Energy Inc. in 2008 with Thomas O’Malley, a veteran oil- industry investor and trader. PBF bought a Delaware City, Delaware, refinery for $220 million in 2010. PBF, which also bought plants in New Jersey and Toledo, Ohio, filed for an initial public offering last November.

“You have to buy very cheaply, and have an exceptional management team that knows how to operate the assets safely and reliably and can source and finance purchases of crude oil and the sale of refined products efficiently,” said David Foley, a senior managing director at Blackstone. “Petroleum refining is a very tricky, very volatile industry. Even if you buy a refinery for almost nothing, you still have to invest a lot of capital for maintenance, environmental compliance and crude-oil inventories.” TPG Capital, the private-equity firm run by David Bonderman, in October of 2010 agreed to acquire most of Marathon Oil Corp. (MRO) (MRO)’s Minnesota refining holdings for about $900 million, the firm’s largest investment in fuel making and delivery.

That deal was led by Washington-based ACON Investments LLC and the resulting company, Northern Tier Energy LLC, has filed for an IPO. The assets purchased by the investors included a 75,000-barrel-a-day refinery, a pipeline interest and more than 200 convenience stores and gas stations.

Rescuing Petroplus

KKR & Co., the private-equity firm run by Henry Kravis and George Roberts, has been among the most aggressive buyout investors in energy, targeting deals tied to tapping natural-gas reserves. The New York firm last year led a group of investors to buy Tulsa, Oklahoma-based Samson Investment Co. for $7.2 billion. KKR has yet to announce a refinery deal along the lines of the PBF transaction or Carlyle’s proposed tie-up with Sunoco. Earlier this year, KKR’s asset-management unit was among the investors providing a financial lifeline to a refinery owned by insolvent Petroplus Holdings AG. (PPHN) Morgan Stanley and AtlasInvest also participated in the deal.

Petroplus itself has a private-equity history. Carlyle bought Petroplus in 2005 and made about six times its investment when the company went public and it sold most of its stake. Along the way, it hired O’Malley, who bought up plants in France, England and Germany.

By Bloomberg