An interesting development over the last year in the master limited partnership space has been the IPOs of three crude oil refinery limited partnerships over the last year. All three of the companies have taken advantage of very high crack spreads to pay investors dividends that have been in the 5% per quarter neighborhood. However, the spreads these refiners can earn have been tightening, and now we are searching for the ones that will perform best in tougher markets. From a review of the second quarter earnings releases and conference call information, it looks like Northern Tier Energy LP (NTI) will be best able to maintain high distributions through the second half of the year.
Note: MLP companies such as Northern Tier Energy 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.
The Refiner MLPs
The Northern Tier Energy IPO was in July 2012. The company owns and operates a 90,000 barrel per day refinery located in St. Paul Park, Minnesota. Alon USA Partners LP. (ALDW) went public in November 2012 and this refiner owns a 70,000 bpd refinery located in Big Springs, Texas. Finally, in January 2013, CVR Refining, LP (CVRR) was spun off by CVR Energy (CVI). CVR Refining owns two refineries located close to the crude oil storage hub in Cushing, Oklahoma. My article Year Of The Refiner For Income Investors from earlier in the year provides a broader outline of these companies.
All three of these refinery MLPs have a policy of a full payout each quarter of distributable cash flow, with the quarterly results dependent on the average "crack spread" the companies earn over the quarter. Crack spread is the difference between the prices a refinery receives for the gasoline and distillate fuels - diesel, heating oil, jet - and the cost of crude oil that is the raw material to be refined. The crack spread or refining margin will be stated in dollars per barrel of oil refined. Out of the gross profits of the crack spread times number of barrels refined, a refiner pays its operating cost, general expenses and sets aside some money to cover capital improvements and repairs, and pre-pay the cost of the refinery turnaround, which takes place every 3 to 5 years.
Second Quarter Results
Alon USA Partners: For the second quarter, the company reported record total crude throughput of 72,124 barrels per day. Alon Partners stated the refinery had an operating margin of $16.21 per barrel. In this case, I believe operating margin is the realized crack spread minus operating cost per barrel. The company declared a $0.71 dividend for the quarter. For the 2013 first quarter, the numbers were 59,475 barrels of throughput per day, a $28.76 per barrel operating margin and a dividend of $1.48 per unit.
CVR Refining LP: Second quarter results reported throughput of both refineries of 201,925 barrels per day and an average realized refining margin of $19.18. A $1.35 per unit dividend was declared. In the first quarter, the results included a combined crude throughput rate of 194,816 barrels per day, refining margin of $26.44 per barrel and a $1.58 dividend.
Northern Tier Energy LP: The Northern Tier refinery was down for one-third of the second quarter as the plant went through a full turnaround. As a result, throughput dropped to 55,486 barrels per day. The average gross refining margin was $23.92 per barrel. A $0.68 dividend was declared. In the first quarter, throughput was 85,365 barrels per day, margin was $25.81 and a $1.23 dividend was paid.
A Word About RINs
There was significant discussion on the earnings conference calls about how much the refining companies had spent on RINs - costs a refinery must pay if it does not blend a mandated amount of renewable/bio fuel into the petroleum based fuels it produces. In 2013, RINs went from pennies per gallon to well over $1.00 when the required amount by law of renewable fuels ran into the "blend wall" of not enough overall fuel being produced and sold at current blend percentages to meet the legal requirements. The math gets complicated, so if you want details check out the articles written by Tristan Brown here on Seeking Alpha.
Even though the refineries are shelling out serious cash to buy RINs, the jury is out whether or not those costs are baked into the wholesale price of gasoline. When the EPA made noise about relaxing some of the requirements, the wholesale price of gas on the NYMEX dropped. During the Q&A of the recent Valero Energy (VLO) earnings conference call, there was some discussion on where the actual cost of RINs was being paid.
Both Alon USA Partners and CVR Refining are looking at some hefty RINs charges based on current assumptions. Since Northern Tier Energy owns its own retail distribution arm and blends a lot of renewable fuels, RINs will be less of an expense factor for the Minnesota refining company.
Tighter Crack Spreads and Investment Potential
All three refining MLPs have in the recent past been able to pick up additional refining margin by sourcing crude oil at significant discounts to the WTI benchmark. Also, for CVRR and NTI, the local retail pricing market has added to the spread potential. In the second quarter, you can see from the numbers above that a lot of the crude oil price advantages for CVR Refining and Alon USA Partners disappeared. Alon now seems to be closely tied to the relatively tight Gulf Coast market. CVR Refining graphically put the results into its second half distribution guidance when the company expects to pay distributions between $1.17 and $1.87 in total for the remaining two quarters of the year compared to $2.93 paid over the first two quarters.
Northern Tier Energy appears to have a better chance of paying $2.00 or more per unit for the rest of the year. The company's direct trucking of Bakken crude provides some built-in spread advantage, and as production gets back up to speed in North Dakota, the oil there should get cheaper in competition with WTI. Northern Tier can also use Canadian heavy or synthetic crude if there is a pricing advantage. A $4.00 annualized dividend rate is an 18% yield on the current NTI share price. Finally, with the April turnaround, the capacity of the refinery was increased to 90,000 plus barrels per day, up from an 80,000 barrel rating.
With these refining MLP companies, the realized refining spreads and resulting distribution paid to investors will fluctuate significantly with the swings in the energy markets, and those price changes could be abrupt. The investment theme here is to buy shares when they are beaten down and wait patiently for the big dividends that will be paid for either a single quarter or a string of them. However, you need to be aware that the gross margins could be much tighter than recent results for extended periods of time. Right here and now, Northern Tier Energy is the most attractive based on share price and potential to generate an attractive refining spread.