This hasn't been a good year for refiners, as lower refining margins have taken a big bite out of profitability. The trend was apparent in CVR Refining's (NYSE:CVRR) second-quarter release, as the company's profits declined by 65% over this time last year and the company elected to preserve cash rather than pay a distribution. Let's look at what happened with the company and why management has such a dire outlook for the rest of the year.
By the numbers
|Metric||Q2 2016||Q1 2016||Q2 2015|
|Cash available for distribution||$0||$0||$114.2|
What makes CVR Refining's earnings figures discouraging is that the company did everything right when it comes to the operations of a refiner. Compared with this time last year, CVR Refining increased its use of disadvantaged crudes such as heavy, sour crude that typically cost less than light, sweet crude; it increased its percentage yield of higher-value gasoline and diesel per barrel produced; and it reduced operational costs per barrel produced across the board. Among its operational blips, throughput decreased from some turnaround activity, as well as some takeaway capacity restrictions as Magellan Midstream Partners works on its refined petroleum product system.
So we can pretty much chalk up CVR Refining's issues this quarter to refining margins, which fell 44% compared with this time last year, after taking into account the company's inventory value adjustment. What made the situation worse, according to management, was the increase in renewable identification numbers (RINs) that are related to blending ethanol into gasoline to comply with the EPA's renewable-fuel standard. The cost for RINs in the quarter were $51 million, up 38% ove3r this time last year. These higher costs for compliance, along with some retained cash for future maintenance work, was a large reason the company saw muted results and why the board decided to not make any cash available for distribution and not pay a distribution to shareholders.
From management's mouth
Most of the time, press-release statements are very muted affairs that talk about a company's focus on operational efficiency and costs. This quarter, though, CEO Jack Lipinski unloaded on the way in which RINs are priced and how it's having unintended detrimental effects on the industry:
RINs, which we have to purchase to comply with the renewable-fuel standard (RFS), have become completely disconnected from the cost of blending and instead have become a source of windfall profits for blenders [whom] the Environmental Protection Agency chose to exempt from the program. The RFS program, as currently managed by the EPA, fails on many fronts. Not only are exempt blenders earning windfall profits from selling RINs to refiners who cannot blend, the RFS program allows exempt blenders to retain the profits and not increase biofuel usage in the U.S.
RINs have become a black pool allowing exempt parties, and even speculators, to drive prices to confiscatory levels. We believe the market may be cornered, the effect of which will be to bring small merchant refiners to the brink of bankruptcy while unjustly enriching speculators and exempt blenders. RINs were intended to be a compliance tool for refiners, not a device to extract windfall profits from obligated parties.
CVR Refining is not alone in dealing with the frustrations of the renewable-fuel standard. Valero Energy (NYSE:VLO) estimates that its cost of compliance with the renewable-fuel standards this year will be $750 million to $850 million, well above the $440 million it spent on RIN credits in 2015. Keep in mind that Valero also is a biofuel manufacturer that is able to generate RIN credits with its biofuels. However, the RIN credit market is very opaque and has been subject to fraud for years, with the result that the price of RINs vary wildly with the fuels they are supposed to represent.
What a Fool believes
From an investor's standpoint, there are a lot of reasons this quarter would be very frustrating. One of the goals of investing is to buy companies that can execute well on their operations, and by just about every measure, CVR Refining did so this quarter. However, lower refining margins and the ongoing pricing issues with regard to compliance with the renewable-fuel standards sapped the company of any chance at profitability or paying a distribution this quarter.
CVR Refining's management appears to be battening down the hatches for the rest of the year as it prepares for a tough operating environment, so don't be surprised if the company posts similar results in the upcoming quarters.