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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Here’s How To Play Low Oil Prices

Here’s How To Play Low Oil Prices

Energy stocks have been a great investment for a decade now and a staple in many investors’ portfolios. However, all stocks move in two directions, up and down, and in the last year energy sector investors are finding that out the hard way. But even in today’s volatile energy environment, there are still plenty of opportunities. One of the best of these opportunities is a little known refining company.

CVR Refining trades under the ticker symbol CVRR and is a master limited partnership (MLP). The company is controlled by its parent company CVR Energy (CVI). CVR Energy is a refinery and nitrogen fertilizer manufacturer operating through two limited partnerships – CVRR and CVR Partners LP (UAN). CVR Partners operates the nitrogen manufacturing business using feedstock supplied by CVRR. This is important to understand in that it creates a permanent customer for CVRR, and one that is unrelated to the direct energy business. CVRR is the more interesting of the two companies right now though.

CVRR owns two refineries; one in Coffeyville, KS (capacity of 115 thousand barrels per day) and one in Wynnewood, OK (capacity of 70 thousand barrels per day). The company also has a small pipeline business, and an oil storage business. Coffeyville is the most important asset for CVRR and part of the poor year the stock has had over the last 12 months can surely be attributed to a fire last July at that facility that impacted production. It took a few months, but by September, CVRR had the refinery up and running again. The other major factor that drives CVRR over time is the refining crack spread. Related: This Is Why Californians Pay More For Their Gasoline?

Crack spreads refer to the amount of money a refinery can earn by cracking a barrel of oil. In the U.S., three barrels of oil are used by refiners to produce two barrels of gasoline and one barrel of diesel. If refineries can buy oil inexpensively and sell gas and diesel for more, then they earn a substantial profit.

This is what makes CVRR very interesting right now. The world is awash in oil and the only reason that prices are as low as they are is because participants in the oil markets are storing an enormous amount of product. In contrast, the limited production capacity of refineries is helping to keep gasoline prices from falling as much as oil prices have. Oil prices are roughly half what they were a year ago, while gas prices are only down about 20 to 25 percent depending on the region. This is a recipe for strong crack spreads going forward. Related: Can This Next Shale Hotspot Live Up To The Hype?

CVRR cratered at the start of the year and while it has recovered somewhat, the stock is still considerably cheaper than it was last summer. Yet the stock price performance here belies the company’s financial performance. CVRR varies their dividend each quarter based on how much cash the company earns. Investors never have to worry about whether a dividend is sustainable or not. When things are good, the company pays out a lot, when things are not as good, the company pays out less. As an MLP, it has to operate this way.

So how has CVRR been doing recently? The company has been trading as an MLP for a little over two years now and paid out nine quarters of dividends. During that time, the company has paid out $7.29 per share in dividends or an average of $0.81 a quarter. Even excluding the first two quarters which were particularly strong, CVRR has paid out an average of roughly $0.63 per share per quarter. At current prices, these average dividend yields translates to a total return of more than 12.5 percent. And all of this income is tax-advantaged because of CVRR’s MLP status. Related: More Job Losses Coming To U.S. Shale

CVRR’s price has suffered over the last year as investors worried about the impact of low oil prices on the bottom line. This concern was magnified because the stock is an MLP and hence a favorite of retail investors who may not understand the business model completely.

But the reality is that CVRR’s business is doing fine even in the current low oil price environment. And there is no indication that is about to change. In fact, the distortions in the oil price market currently make the refining business as a whole very attractive. CVRR’s storage and pipeline assets are more useful than ever, and the firm’s exposure to a large nitrogen producer through CVI helps insulate it from oil prices even more. Investors worrying about CVRR’s future should stop worrying and instead spend their time watching the income roll in. In today’s low yield environment, there are few comparable income alternatives.

By Michael McDonald for Oilprice.com

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  • Ken Church on July 22 2015 said:
    The profitability of the nitrogen fertilizer business will have more to do with its cost of natural gas as a feedstock. If the company has forward purchased gas at a higher price than its competitors that is bad news. If it is buying gas on the open market today that puts it in as good a position as any of its competitors that are doing likewise. The Nitrogen fertilizer that it manufactures today will be sold mainly in the fall and the spring.

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