Image source: CVR Refining investor presentation.
This past quarter was a tough one for CVR Refining (CVRR). Not only is the company dealing with a decline in refining margins as well as the rising costs to comply with the U.S. EPA's Renewable Fuel Standards, but this cost of compliance is so prohibitively high that a majority of CVR's conference call was dedicated to discussing its impact on the income statement and what the company can do to deal with it.
Here are five important quotes from CVR's most recent conference call that will give you an idea of management's mindset today.
This wasn't what we were expecting
Commodity markets like oil and gas are almost impossible to predictably forecast, even when you are deeply embedded in the business, like CVR Refining's management team. CVR Refining CEO Jack Lipinski even admitted that the company's forecast for the market was not what it was planning it to be in the second quarter:
As discussed on our last earnings call, we're optimistic for a strong rebound in crack spreads during the second quarter due to the anticipated strength of gasoline and distillate demand. However, crack spreads realized in the second quarter fell short of our earlier expectations as a result of continued high product inventories in the U.S. and in Group 3. In the second quarter, Magellan [Midstream Partners] gasoline inventories averaged 1.8 million barrels higher than 2015, while distillate averaged 300,000 barrels below 2015. Today, the Magellan system gasoline inventories are 1.4 million barrels over last year, and distillate is 450,000 barrels over last year.
If there's any solace from these numbers, it's that this is completely out of the company's control. The only thing it can do to mitigate this is to run its refineries efficiently and at as low a cost as possible.
No cash for you
For the past couple of years, CVR Refining has been paying very generous distributions. Unfortunately, that is coming to an end for a while as the company deals with the tougher refining market today:
After consideration of the reserves established for future environmental and maintenance CapEx, major scheduled turnarounds, and setting aside approximately $20 million for future operating needs, there's no available cash for distribution. As a reminder, we are a variable distribution master limited partnership. And as a result, our quarterly distribution, if any, will vary from quarter-to-quarter due to several factors, for example: crude oil and feedstock prices, refined product prices, crude throughput rates, RINs expense and prices, capital needs and other reserves deemed necessary by the Board of Directors.
This is a clear-cut example of the benefits and disadvantages of owning a variable rate master limited partnership. Since the company is clear it will only pay out what it can on a quarterly basis, that prevents it from distributing cash when there isn't enough available to distribute, and it makes it more sustainable over the long term. The downside for investors, though, is that you can go a few quarters without a dividend check.
RINs taking a toll...
One major challenge for CVR Refining and other refiners across the U.S. has been the increasing costs of complying with the Renewable Fuel Standards through the purchase of Renewable Identification Numbers, also known as RINs. These ID numbers are traded separately from the actual fuel, and that distinction has caused headaches for refiners.
Lipinski is one of the most outspoken critics of the way in which RIN market operates, and he had some very choice words this call:
RINs continue to be an egregious tax on our business and have become our single largest operating expense, exceeding labor and maintenance and energy costs. As a matter of fact, RINs are double our labor costs. Since 2013, we spent nearly $500 million on RINs, and we estimate our RINs exposure in 2016 to be approximately $200 million to $235 million. CVR Refining cannot pass along its RINs expenses because it's competing at third-party racks with exempt blenders who have no RIN obligation, and they control the blending and the downstream from there. We believe the basic tenets of the RFS are not being met due to the misplacement of the point of obligation [...] Fundamentals don't support RIN prices nearing $1. Today, ethanol is $0.15 to $0.20 over the price of gasoline. With a few pennies for transaction costs, a D6 RIN should costs $0.20 to $0.25, not $1. The difference is price speculation.
CVR Refining isn't the only company to comment on the high costs or RINs this past quarter. Valero Energy's management said on its most recent conference call that it expects its RIN costs to be more than double what they were last year, in the range of $750 million to $850 million.
Lipinski was pretty clear: He and his team at CVR aren't against the use of renewable fuels, but rather the opacity of the RIN market and the need for better regulation.
...but it's not a good time for CVR to try and buy its way out of the problem
One of the ways CVR Refining could potentially rectify this RIN cost problem would be to add some retail or wholesale distribution assets that can blend ethanol and generate RINs for its own fuels. According to Lipinski, though, that would be prohibitively expensive today, and it's not really an option that makes a lot of sense for the company. (Note: A "rack" in the quote below is a basically a wholesale terminal where fuel is picked up by trucks and delivered to retail stores).
[B]ecause of our location, we're located in Wynnewood, Oklahoma, and Coffeyville, Kansas, and those are the only 2 owned controlled racks that the company has, and those are the only 2 racks where we can force ethanol blending. We ship the remainder of our product on the Magellan [Midstream Partners] pipeline system, which also enters the NuStar [Energy] system, and we are in numerous terminals throughout that area. But we compete with anywhere from 6 to 20 different sellers at those racks, and we cannot force the blending. And because of our location, it's just not a simple matter of adding more racks. Everybody has to understand, the market is fully supplied as it exists today. So going into retail is not an option for us. I mean, we don't want to be a retailer. And if you have to buy retail, you would be sitting in a situation of having to buy retailers whose price has escalated because of the RIN. We would end up having to spend several times our market cap to buy a retail company suitable in size for us to control the blending. So the short answer is there's not a lot more that we can do. We can't export from where we're at. We're blending maximum amounts that we can.
Time to buy?
One of the things you could fault CVR Refining for is that its operations are very geographically concentrated, with all of its assets within a couple hundred miles of each other. So, if the market in this particular part of the U.S. is affected more or less than others, CVR will most certainly feel it.
When asked by analyst Chi Chow of with Tudor, Pickering, & Holt if the company might perhaps acquire some refining assets, here's what Lipinski had to say:
[T]his really is the perfect segue into what CVI could do, the parent company, CVR Energy (CVI -2.57%). We have always said it, that CVR Energy will be the acquisition vehicle for the underlying sister companies, CVR Partners in fertilizer and CVR Refining. To this day, CVR Refining -- CVR Energy has no debt and has cash. It would be the vehicle that we would use to acquire, and we are looking. I mean, we're very well aware that it would be nice to separate our exposure or to get exposure to other areas. With that said, Chi, I mean, we had very good results as a Midcontinent refiner in the group and in an oversupplied market. And I'd say, some of that goes back to some of my comments about how much money we put into our plants to make them competitive in a low-margin environment.
That may be the biggest challenge for CVR if it did decide to make an acquisition. It's not the price tag to buy the assets themselves, but rather the amount of money the company may need to put into it to get them performing at similar levels as CVR's existing facilities. This is certainly something to keep in mind if CVR does make any big moves in the future.
