Life is good for refiners right now. Crude prices are low, finished product prices are high, and the discrepancies in midstream infrastructure give the appearance that this trend could continue for a while. Of all the refiners out there, HollyFrontier (NYSE: HFC ) has serendipitously found itself in an ideal position to capitalize on the unconventional shale boom. Let's check in with the company and see how it landed in this lucky spot.
A cough here, a burp there
Hopefully, you ignored the buzz about how the company missed earnings estimates earlier this week, because it doesn't do the company justice. Yes, the company missed EPS targets, but this was in large part because it experienced some extra costs and some longer delays during some of its facility maintenance. If you look at the margins the company had on what it did process, you would see that the company had some almost absurd crack spreads. The company reported that it had crack spreads for its mid-continent operations of $38 per barrel, which eclipses the 2007 to 2012 average of $7 to $24 per barrel.
The operational fits HollyFrontier experienced this quarter are more than likely a one-time event, and not really an indication of the company's health. Other smaller, independent refiners similar to HollyFrontier had better-than-expected results for the quarter and expect to continue those results for the foreseeable future.
Just lucky, I guess
What may be considered a great stroke of luck could potentially be one of HollyFrontier's greatest competitive advantages going forward. Unlike large competitors Phillips 66 (NYSE: PSX ) and Valero (NYSE: VLO ) , which have a majority of their refining capacity in the Gulf of Mexico or on the coasts, HollyFrontier's five refineries are all located in the mid-continent, Rockies, and southwest regions, which puts them all smack-dab in the middle of the Mississippian Lime, Niobrara, Permian, and Uinta formations.
Valero Refining locations (Source: Company Website)
Phillips 66 US Operations, Red represents refineries (Source: Company Website)
HollyFrontier Operations, white squares represent refineries (Source: Company Website)
This could be a huge opportunity for the company for two reasons. First, these crudes won't need to travel far, so the transportation costs to get them to the facilities could be much less than for its competitors that need to move it to their facilities.
Second, most of these unconventional plays lack sufficient capacity. So E&P companies that have leveraged their entire portfolios into a single play -- think SandRidge Energy (NYSE: SD ) and its 1.85 million acres in the Mississippian Lime -- will need to rely heavily on local refiners to buy product. A bottlenecked market could lead to discounted prices for local crudes. Bad for E&P, very good for HollyFrontier.
As of right now, several of the younger shale plays, like the Mississippian lime and the Niobrara, have yet to deliver crude to HollyFrontier refiners, because the company's refineries are currently designed to handle Western Canadian Select blend and Christina Lake crudes. This is probably due to change, though. CEO Michael Jennings recently stated in a conference call that he believes the company will start to see opportunity from these basins within a year. What also makes this path so attractive is that Gulf refiners such as Phillips 66 and Valero seem more keen on processing heavy oil from the Canadian oil sands rather than mid-continent crudes because of the oil sands' similarity to its current feedstocks.
What a Fool believes
Despite those little operational hiccups this past quarter that dropped total throughput volumes, HollyFrontier still crushed year-over-year numbers thanks to those wonderful crack spreads the refining business experienced in 2012. Don't be surprised if the company goes back to leaving earnings estimates in the dust next quarter. If the recent crack spreads and the potential market position aren't enough to convince you of the opportunity with HollyFrontier, then perhaps its shareholder-friendly dividend will. The company just announced that it will raise its quarterly dividend by 50%, and management does have a history of giving out several special dividends throughout the year. I made an outperform call on CAPS for HollyFrontier already, but this is just further evidence that it's a solid call.
With almost 60% of Holly Frontier's refining capacity in the mid-contient region, plays like the Mississippian Lime formation will be a big determinant of how the company sources its feedstock for the region. To get a better sense of what's in store for the Mississippian Lime, look no further than Sandridge Eenrgy. The company has pinned much of its prospects on the region, and its moves could be a strong bellwether for what to expect in the region. To better understand this region and its biggest fan, you should view this brand-new premium report detailing SandRidge's game plan and what to expect from the company going forward. To get started, click here!