By Ernest Scheyder
DICKINSON, North Dakota (Reuters) - On a windswept North Dakota prairie in late March, Governor Jack Dalrymple drove a bulldozer into the fertile black earth and broke ground on the first new U.S. refinery since 1976.
The state's two U.S. senators, as well as dozens of other politicians and investors, stood nearby wearing hard hats, eagerly sharing hopes that this new refinery will help resolve North Dakota's diesel demand problem.
Thanks to the Bakken shale formation, an extensive layer of oil-rich rock two miles deep, North Dakota produces more crude oil than any state except Texas. But because the state only has one refinery, it imports more than half of the roughly 53,000 barrels of diesel consumed each day by rigs that suck oil out of the ground, and trucks and trains that transport it.
That daily need is forecast to hit 75,000 barrels by 2025, making the new refinery from MDU Resources Group Inc and Calumet Specialty Products Partners critical for the energy sector in the state.
Despite producing thousands of barrels of oil each day, North Dakota relies on refineries on the U.S. Gulf Coast and elsewhere for much of its diesel. Dalrymple and others are counting on the MDU/Calumet project attracting a new wave of investors eager to construct Bakken refineries.
"Diesel fuel is something that's highly valued around North Dakota," Dalrymple, a Republican, said in an interview after the groundbreaking. "Refineries will allow us to use our Bakken crude right here at home."
When it comes to the economics and politics of building a refinery, North Dakota is an unusual case.
The state has one of the lowest population densities in the United States and has little of the political, environmental or community opposition that's helped scuttle all other refinery projects since Jimmy Carter was president.
MDU and Calumet hope to be making about 8,000 barrels of diesel per day within 20 months, far less than refineries on the Gulf Coast. The smaller size of the refinery will make it easier to build, and its modular design will give the owners the option of moving it in future should market conditions change.
The plant will be built by Ventech, an engineering firm that designs diesel refineries specifically for use in remote locations.
Refineries are usually built near major population centers, but North Dakota refineries will cater to a different kind of market. Forecasts indicate there will be good demand for diesel for a long time.
Even the most-conservative analysts estimate North Dakota has at least 50 years supply of oil thanks to recent developments in hydraulic fracturing, also known as fracking.
The state Department of Mineral Resources forecasts that North Dakota's oil output will hit 850,000 barrels a day by early next year. As of last September, about 64 percent of oil produced in the state is transported via diesel-guzzling trucks from more than 8,000 oil-producing wells, according to the state's pipeline authority.
With the stars so aligned, there are no less than three new refinery proposals on the table.
The second project, a $450 million hydrocracker refinery planned by the three affiliated American Indian tribes of the MHA Nation, will use a mix of tribal funds and tax-exempt Tribal Economic Development Bonds through the U.S. Department of the Treasury.
"We want to be able to control our own natural resources and our own destiny," said Richard Mayer, head of the MHA Nation refinery project. The tribes, which hope to break ground by May on their refinery, strictly control access to oil drilling on their land.
When it seemed for a time that no new refineries would come, North Dakota politicians - known for their conservative track record - mulled what many saw as unthinkable: using state funds to back risky refinery loans to attract investors.
A third planned refinery was proposed seven years ago, by Dakota Oil Processing, LLC. After some private investors in South Korea withdrew support in 2012, the company asked the state to backstop its bonds, a controversial proposal as no other state supports private refinery loans.
Members of the state senate's finance and taxation committee said they seriously considered the request, which was sponsored by one senator. They ultimately decided against it when MDU and Calumet announced they would use their own money for their $300 million refinery.
"The MDU-Calumet refinery took a lot of pressure off the state legislature, because we need diesel here," said Jim Dotzenrod, a state senator. "We didn't want to set a precedent of using tax dollars" to support refinery projects.
Dakota Oil cannot break ground on its refinery until it secures private financing, a step it said was made harder by the state's rejection.
BOOM & BUST
The boom-bust cycle in the refinery business is not for the faint of heart. Many investors were burned five years ago when oil prices neared $150 per barrel and a slate of U.S. refineries were forced to close.
High oil prices erode profit margins for most refineries, a risk that state politicians said scared them away from supporting Dakota Oil's bonds. North Dakota ranks first in credit quality among the 50 U.S. states, according to insurance asset manager Conning.
Still, with North Dakota diesel prices around $4.50 per gallon, a local supply of abundant Bakken oil that is roughly 4 percent cheaper than benchmark crude, and rising demand, diesel refining is a tempting proposition.
It's not clear how much cheaper locally produced diesel would be, as prices can vary depending on location, weather and access. But the basic geography is persuasive.
"The cost of moving diesel on a truck to a retail site is much less if you're selling near the refinery," said Argus Research Group analyst Phil Weiss.
Dave Goodin, MDU's chief executive, said the opportunity to supply diesel "in our own back yard" was too attractive to pass up. The company, based in North Dakota's capital, Bismarck, is already one of the largest power providers in the region.
MDU will supply oil from its own drilling operations, and Calumet, which runs several refineries throughout the United States, will help operate the facility.
Officials at the three refinery projects believe there is room for all three in the market, pointing to the need for diesel to power many of the machines drilling for oil and farming for wheat, still a major part of the state's economy.
The three refineries would, if built, supply a total of roughly 26,000 barrels of daily diesel production, less than the state imports currently and far less than projected demand.
Regional leaders are hoping that fact alone fuels more interest in the North Dakota refining business.
"If the MDU/Calumet refinery works as a prototype," said Tom Rolfstad, the economic development director in Williston, North Dakota, "you'll see a whole lot more of them."
(Reporting by Ernest Scheyder; Editing by Patricia Kranz and Claudia Parsons)