Although the price of a gallon of gas has dropped a bit from the mid-summer highs, where I live the price is still 60 cents per gallon higher than back in the Spring. A cure for the pain at the gas pump is to buy shares of refining companies that profit from high gasoline prices. My investment focus is always on the dividends, so in the refining sector the search focuses on those companies with policies to pay out large distributions to investors when they rack up big profits from fuel sales.
The challenge for crude oil refineries is to manage around fluctuating profit margins. The prices for both the input – crude oil – and the output – gasoline, diesel, other fuels and petroleum by products – are both set by supply and demand market conditions. The best scenario for a crude refiner is relatively low crude prices and high fuel prices. Yet we all know from watching the markets and filling up the car that crude and gas tend to cycle up and down together.
The current boom in crude oil production has allowed refineries to shop around for the best combination of crude and transport costs, putting the industry into one of the most profitable periods in recent memory. With almost a glut of crude coming out of Canada, North Dakota and Texas, oil out of these areas is often priced well below the benchmark West Texas Intermediate, and even further below the Brent market price that often drives the price of gasoline.
Although predicting the future is tough, evaluating past or current refining results is fairly straight forward. From these results the current market prices of crude and fuels can be used to estimate the next quarter’s profit margins. For the dividend paying refiners, this is really a quarter-by-quarter investment analysis. The driving metric for a refiner is the crack spread, which is the refining margin per barrel of crude based on the selling prices of the refined fuels. For example, the 3-2-1 crack spread is commonly used with 3 barrels of crude used to produce 2 barrels of gasoline and one barrel of diesel fuel. If the price of a barrel of crude oil is $100 and gas and diesel wholesale for $2.70 and $3.00, respectively, the 3-2-1 spread is $17.60 per barrel. (Hint, 42 gallons in a barrel).
Depending on market conditions crack spreads can range from a negative number up to the $30 per barrel range. A range of $10 into the mid-teens is typical. Refiners will report their own spread or refining margin results, so you can compare them to reported spot prices and previous results over time.
The other factor to watch is refinery utilization, reported in barrels per day of throughput. If a refinery goes down due to a problem or for the once every several years turnaround, the drop in production can significantly impact the net profits. Especially for those refiners that own one or two refineries.
The high-yield refining stocks follow the nature of their business and pay variable dividends. When crack spreads are high, payouts soar. High oil prices with fuel prices that do not keep up will reduce the spreads and the distributions to investors. Here are three refining stocks that can put some serious, if variable, cash into your brokerage account.
HollyFrontier Corporation (NYSE: HFC) operates five complex refineries with 443,000 barrels per day of crude oil processing capacity. The company produces and markets gasoline, diesel, jet fuel, asphalt, heavy products, and specialty lubricant products. For the 2014 first quarter the company reported a $14.75 per barrel gross margin. HFC currently pays a regular $0.32 per quarter dividend, providing a current yield of 2.8%. The company also pays a special, additional dividend if quarterly profits support the extra payout. A $0.50 per share special has been paid for the last three quarters, with $0.30 paid for the previous three. The specials are not regular dividends, but based on the recent quarterly total dividends, HFC has produced a 7% yield for investors.
CVR Refining LP (NYSE: CVRR) owns two refineries located in Kansas and Oklahoma. The company is set up as a master limited partnership (MLP) with a policy of full payout of net cash as quarterly distributions. As a result, the quarterly per share payment will vary and has ranged from $0.30 to $1.35 over the last year. For the 2014 second quarter, a refining margin of $13.96 per barrel produced a $0.96 quarterly distribution. Yields will vary with this type of payout, but based on the most recent distribution, CVRR yields over 15%. In late July, the company experienced a fire at one of its refineries, which may limit total production and cash available for distribution for the third quarter.
Northern Tier Energy LP (NYSE: NTI) is another refining focused MLP with a single refinery located in Minneapolis. The company also owns or franchises 240 SuperAmerica brand convenience stores located in Minnesota and Wisconsin. NTI’s variable quarterly distributions ranged from $0.31 to $0.77 over the past year. The company has paid as much as $1.48 per unit in a quarter. The 2014 first quarter distribution of $0.77 was from an $18.08 refining margin. NTI’s primary pricing advantage is the company’s ability to source and process different crude oil grades including Bakken light, Canadian heavy and Canadian syncrude.
The share or unit prices on these refining companies tend to reflect the market’s view of crude and fuel prices going forward. Crack spreads will cycle significantly so buying shares on the cheap when spreads are narrow can pay off with very big dividends when the spread again widens. The current state of crude and fuel prices should let these companies pay attractive distributions for at least through the 2014 third quarter.
Variable dividend paying stocks nothing new, but given the investing media’s fixation with blue chip 3% (or less) payers, you’ve probably never even been exposed to variable dividend stocks. I personally have a great affinity for them because you get lots of upside when the company is doing well and minimal downside (at least no worse than any other stock out there) when the market is challenged. Picking up a few of these right now as market has pulled back a few percentage points is worth considering for any investor who wants a little extra in his or her portfolio. And using select variable dividend stocks is just one of the four main strategies for outsized dividend payment and capital gains with my 30 Day Dividends service. Find out how you can use these strategies in your portfolio and details on the other three, CLICK HERE.