The recent IPO's of three MLP organized refining companies could not have been better timed. In the central U.S., normal range crack spreads have widened to the point that the LP companies are producing enough cash flow to pass 20% plus distribution rate through to investors. The latest IPO was CVR Refining LP (CVRR), which went public on January 23, 2013. CVR Refining has now published guidance for the year with a distribution projection knocking at the door of a 20% yield.
Note: MLP companies such as Calumet Specialty Products have units and pay distributions. The words stock, shares and dividends may be used here with the understanding that the rules of MLP units apply including the tax consequences of investing in MLP units.
Less than a month ago I wrote Year Of The Refiner For Income Investors to give Seeking Alpha readers a heads-up on the potential of the three new refining MLPs. Since then CVRR is up 3.7%, Northern Tier Energy LP (NTI) has gained 4.1% and Alon USA Partners LP (ALDW) has dropped by 6.6%. The S&P 500 has added 2.2% during the same time frame. Although CVR Refining popped by 6% this week with the release of the year-end financials, the market has not yet realized the level of distributions these LP stocks can pay.
Breaking Down the Guidance
In the IPO prospectus, CVR Refining gave a projected 2013 distribution of $4.72 per unit. That projection was based on an average crack spread of $27.50 for the year, positive cost differential of $2.00 per barrel and average daily throughput of 155,000 barrels per day for the company's two refineries.
2013 has started off much better than the IPO projections. During the normally slow winter season, CVR Refining averaged 190,000 barrels a day of production for the first two months of the year, the WTI 2-1-1 crack spread has been in the mid-$30's and CVR's has been buying oil at a $3.00 positive differential. As a result, the company upgraded its distribution projection to a range of $5.50 to $6.50 for the full year. At the bottom end of the range and the current $33.50 unit price, the yield on CVRR would be 16.4%. Investors should expect about a $1.20 distribution for the pro-rated first quarter starting with the IPO date.
Crack Spread Considerations
The crack spread is the difference between the cost of a barrel of oil and how much the refinery can sell the fuels produced from that barrel. By historical standards, $35 crack spreads are almost unheard of. Refiners often make money on spreads of $10 or less and it is not uncommon for the spread to go negative for periods of time. The current wide cracks spreads in middle America are driven by the Brent - WTI price differential and the growing crude oil production of light sweet crude from Texas to North Dakota. This oil is a long way from the major east and gulf coast refiners and transportation costs are one reason for the price differential. Another reason is that the closer gulf coast refineries are set up to primary handle heavier grades of crude oil.
The CVR refineries sit right on top of the Cushing, Oklahoma oil distribution complex, allowing CVR to buy crude with minimal transportation costs, thus the positive price differential. The company is very well situated to take advantage of the Brent - WTI differential and the added transport costs other refineries would pay to access the lower cost light sweet crude production.
The energy markets have an expectation that the Brent - WTI spread will narrow as midstream assets come on line to transport more oil from Cushing to the Gulf coast. The push against any narrowing is the continued production growth in the oil plays throughout middle America. How this plays out would be pure speculation on anyone's part.
Whichever way the crack spread goes in the future, you can be confident that there will be highs and lows as the new-energy America figures out how to transport and price the growing crude oil production. The crack spread for CVR Refining could collapse later in the year, making a $6 annual distribution just a dream. I do not expect something like that in the near future, but it is a possibility and one reason why the projected yield is so high.
An investment in CVR Refining can be handled in two ways. One option is to pick up shares at the current unit price and be ready to sell and take profits if you hit a 30% to 40% gain. A couple of $1.40 to $1.50 quarterly distributions will turn the income investing public into believers and push up the share price. An investor who wants to buy CVRR for the long term needs to keep an eye on the WTI 2-1-1 crack spread linked above. If the spread manages to stay above $25, the yield on CVRR should stay very attractive. If the spread moves to a lower level, an investment in CVRR should be re-evaluated to see what the company can pay with lower gross profit margins.