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Carlyle in Sunoco Talks Shows Private Equity Sees Rebound

Carlyle Group (CG)’s talks to buy a majority stake in Sunoco Inc. (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) 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, 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 could improve if the company is able to buy cheaper oil produced in Canada and North Dakota, John Auers, senior vice president of Turner Mason & Co., a Dallas-based energy consulting firm.

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 Co. 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)’s Minnesota refining holdings for about $900 million, the firm’s largest investment in fuel making and delivery.

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.

Rescuing Petroplus

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 Holding 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.

Petroplus’s stock doubled in the first eight months after the IPO in November 2006. The next year, with the financial crisis looming, the shares started to slump. The company sought protection from creditors this year after profit margins shrank from pressures similar to the ones Sunoco and other competitors face.

On The Block

So-called “integrated” energy companies including Exxon Mobil Corp. (XOM) and Chevron Corp. that extract and process crude have been shedding refining capacity since 2011 to focus on the business of producing oil, which has become more profitable as crude prices surged to $126.65 on April 8, the highest since 2008, according to data compiled by Bloomberg.

Refining is a cyclical business that can reap a bounty depending on product prices, the location of a given plant and its processing capabilities. The ability to process heavier, cheaper grades of crude, or lower-priced oil produced in North Dakota and other areas in the Midwest last year drove profits for refiners such as Valero Energy Corp. (VLO) and HollyFrontier Corp. (HFC) to the highest level since 2007.

Tightening Capacity

On the East Coast, refineries have been at a disadvantage because of falling demand for gasoline, excess supply from European imports and competitors’ ability to buy crude for lower prices in other parts of the country. Oil produced in North Dakota sold for $46.25 less than the global benchmark on Feb. 9, according to data compiled by Bloomberg.

Sunoco said Sept. 6 that it would seek a buyer or shut its 330,000 barrel-a-day Philadelphia refinery in July. About 1.7 million barrels a day of refining capacity on the U.S. East Coast and in Europe is set to close due to tightening margins, the largest reduction in more than 10 years, according to a Bloomberg Industries refining analysis. Another 1.3 million barrels a day is either for sale or slated for closure, according to the analysis.

Pennsylvania politicians and union leaders have rallied to oppose East Coast refinery closures and have asked the companies to find buyers for the assets, rather than idling them. Also on the block is ConocoPhillips (COP)’ Trainer, Pennsylvania refinery, which has seen interest from Delta Air Lines Inc., according to a person familiar with the matter.

Saving Jobs

“It is a heavy lift and we are not sure a solution is possible, but we are doing the work,” Rodney S. Cohen, a managing director of the Carlyle Group, said in the statement announcing the talks with Sunoco.

Sunoco Chief Executive Officer Brian MacDonald, who took over in March, has sought a buyer for the Philadelphia plant so the company can focus on expanding its pipeline business. While talks are under way, Sunoco will keep it open until August, the company said yesterday.

The refinery deals may help private equity as it seeks to make the case that it can save or create jobs. The industry’s role in the broader economy has come to the fore with the U.S. presidential candidacy of Mitt Romney, the former chief executive officer of Bain Capital LLC, who’s faced criticism for firing workers at some companies Bain purchased.

PBF, the Blackstone and First Reserve-backed joint venture, threw an event last October to celebrate the reopening of the Delaware City facility. Flanked by the state’s governor and other elected officials and a union representative, Blackstone president Tony James noted that PBF spent $450 million to renovate the facility, which has about 500 full-time employees and 250 contract workers.

To contact the reporters on this story: Jason Kelly in New York at jkelly14@bloomberg.net; Bradley Olson in Houston at bradleyolson@bloomberg.net

To contact the editors responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net; Susan Warren at susanwarren@bloomberg.net

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