And then there were two. The variable distribution refinery MLPs have provided an interesting and profitable way to actually make money from the steep declines in crude oil and fuels prices. The latter did not drop as fast as crude oil, setting refining companies up to make very nice profits through 2015. However, the crude oil to fuels prices relationship has shifted and refining profits will be much lower when Q4 results are announced. This may come as an additional shock to investors who own units in the variable payout refining MLPs.
Currently, there are three variable payout refinery owning MLPs:
Northern Tier Energy is in the process of being bought out by the holder of its general partner, Western Refining, Inc. (NYSE:WNR). This means the NTI unit value is mostly tied to the WNR share price. The distribution to be paid by NTI will be similarly affected by the factors I will discuss for the other two MLPs, but I am not going to put an estimate out on the NTI fourth quarter distribution amount.
Benchmark Refining Spread Numbers
The interesting aspect of the refining business is that refiners have little control over their profit margins. Both the crude oil raw material and end product fuels prices are set by trading markets that reflect supply and demand forces. Crack spreads are calculated using published prices for crude oil, gasoline, and heating and/or diesel fuel. Many refiners also publish crack spreads based on their own service area energy prices. I maintain a running spread using the NYMEX spot prices for WTI crude, New York Harbor gasoline and New York Harbor No. 2 ultra-low sulfur Diesel fuel. Howard Weil publishes a weekly refining report that includes several regional spreads. Here are some various crack spread numbers for the 2015 third and fourth quarters to set a baseline from which to calculate the MLP profits and distributions.
- 2015 Third Quarter
- NYMEX based crack spread: $21.18 per barrel
- Gulf Coast Louisiana Light Sweet crude 3-2-1 spread: $15.51/bbl
- Chicago WTI 2-1-1 crack spread: $22.29/bbl
- 2015 Fourth Quarter
- NYMEX based crack spread: $14.59 per barrel
- Gulf Coast Louisiana Light Sweet crude 3-2-1 spread: $9.28/bbl
- Chicago WTI 2-1-1 crack spread: $15.23/bbl
You can see that for the fourth quarter, spreads tightened by $6 to $7 per barrel across the different regions where the refining MLPs operate. Although refining margins vary from refinery to refinery and region to region, we can probably assume the refining MLPs experienced a similar reduction in their gross refining margins for the fourth quarter compared to the third. Here are last quarter's numbers and a Q4 distribution estimate for each.
In the third quarter, Alon USA Partners was able to run its Big Springs refinery at near maximum capacity, averaging a throughput of 76,000 barrels per day. Here are the pertinent financial numbers for the quarter:
- Gulf Coast WTI 3-2-1 crack spread: $19.08/bbl - this is the benchmark spread reported by ALDW
- Refinery gross operating margin: $16.71/bbl
- Refinery direct operating expense: $3.46/bbl
- General and administrative expenses: $8.5 million
- Net income: $53 million or $0.86 per unit
- Depreciation and amortization: $13.7 million
- Free cash flow $66.7 million or $1.06 per unit
- ALDW declared a $0.98 per unit cash distribution
Analysis: A $6 to $7 reduction in operating margin for Q4, will reduce Alon's net operating margin from Q3's approximately $13/bbl by approximately half. Last quarter cash flow before G&A was about $75 million. Reduced by half gives $37.5 million and subtracting $8.5 million of G&A leaves distributable cash flow of $29 million. Divided by the 62.5 million units outstanding and you get DCF of $0.46 per unit. Allowing for refinery specific factors, I estimate that the Q4 distribution will be $0.40 to $0.50 when it is announced in early February.
CVR Refining LP operates two refineries located in Coffeyville, Kansas and in Wynnewood, Oklahoma with a total throughput capacity of 185,000 barrels per day. In the 2015 third quarter, CVRR exceeded its placard capacity and reported average production of 200,000 barrels per day. Here are the important financial factors from Q3:
- Refinery gross operating margin: $18.65/bbl
- Refinery direct operating expense: $5.27/bbl
- General and administrative expenses: $18.2 million
- Net income: $138.9 million or $0.94 per unit
- Depreciation and amortization: $29.9 million
- Free cash flow $168.8 million or $1.14 per unit
- CVRR declared a $1.01 per unit cash distribution
Analysis: The $6 to $7 reduction in operating margin for Q4, will reduce CVRR's net operating margin from approximately $13.50/bbl by about 50%, very similar to the effect on ALDW. Last quarter cash flow before G&A was approximately $187 million. Reduced by half gives $93.5 million and backing out G&A leaves distributable cash flow of $75 million. Divided by the 147.6 million units outstanding and you get DCF of $0.51 per unit. Allowing for refinery specific factors, I estimate that the CVRR Q4 distribution will also be in a range $0.40 to $0.50 when it is announced in early February.
If my distribution estimates are in the ballpark, the Q4 payouts will be slightly less than half of the Q3 distributions per unit. The projected rates come as a significant reduction compared to what ALDW paid a year ago and somewhat higher than the payout from CVRR. Many investors who own these two MLPs buy based on the current yield and do not quite grasp that the quarterly distributions can vary - sometimes by a significant amount. A much lower distribution announcement for Q4 compared to Q3 will lead to selling pressure on the units.
Another factor to consider is that ALDW and CVRR have generated the best year-over-year returns in the entire MLP space. Investors who have participated in the 79% and 45% gains over the last year may want to consider selling now to lock in those gains. It is very possible (probable?) that the unit values will drop a lot when the lower Q4 distribution rates are announced. The selling proceeds could then be reinvested at the lower prices, building a base for nice gains when refining margins improve following the Q2 and Q3 heavy driving seasons.
Disclosure: I am/we are long WNR.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.