Brentwood, Tenn., Geography Lets Refiner Buy Oil Cheap
December 3, 2012
Buy low, sell high. That's been a formula for success for petroleum refiner Delek US Holdings for almost two years.
Unlike refiners on the Gulf Coast, its inland refinery locations give it the ability to buy more discounted Midland, Texas-sourced crude oil, pegged to West Texas Intermediate (WTI) prices.
"Midland crude is one of the cheapest crudes in North America right now and both of our refineries are enjoying access to it," said Assi Ginzburg, executive vice president of Delek US.
Crude coming from booming inland oil sources such as the Bakken Shale basin in North Dakota and from southern Canada can't move easily to the Gulf because of inadequate pipelines, giving inland refiners such as Delek an edge.
While it buys feedstock at the discounted prices, Delek sells refined gasoline and diesel at the higher Gulf Coast price, which is linked to the Brent international benchmark.
"A transportation bottleneck for crude in North America depresses prices of WTI inland, but product prices are still set by the Brent because most refinery capacity is on the coast," said analyst Sam Margolin of Dahlman Rose.
Rails are being put to more use, but they're more costly than pipelines.
The difference between WTI and Brent has been unusually high, recently $23 a barrel, the highest it's been all year, Margolin says.
"Delek has $23 a barrel in savings that (Brent buyers) don't have," he said.
Delek's two refineries are in El Dorado, Ark., and Tyler, Texas, with a combined capacity of 140,000 barrels of crude oil a day.
Delek's refined products are mostly sold at wholesale to customers such as Exxon Mobil and Chevron.
As petroleum refiners go, Brentwood, Tenn.-based Delek US is one of the smaller players. That's true even among independent-operator peers, including Valero, Western Refining and Holly Frontier, among others.
But Delek makes up for its size with good returns and shares that have more than doubled this year on the back of strong earnings.
Ginzburg says that while Delek buys some Brent-priced crude now, the goal by the end of 2013's first quarter is not to buy any, unless the price drops.
"Between our rail and our next (pipeline) connections to Midland crude, we will not need any Gulf Coast crude," he said.
Besides local sources, it gets crude from the Bakken, the Permian in West Texas and Canada, he says.
In the third quarter, strong refined margins helped Delek post record net income of $100.3 million, or $1.67 a share, vs. $85.3 million, or $1.46 a share, a year earlier. Delek had a cash balance of $318 million.
Using its strong cash flow, the firm reduced net debt to $55 million from $205 million a year ago.
What's more, the board approved a 160% increase in the regular quarterly dividend, to 10 cents a share. Special dividends are on top of that.
"The industry has been so flush with cash the last two years that they'll all be increasing dividends next year and that's what investors are focused on," Margolin said.
That may offset concerns about slower earnings growth next year if the WTI and Brent spread narrows as new pipelines come online.
A Thomson Reuters analysts' poll has Delek's per-share earnings falling 23% next year to $3.49 from this year's expected $4.56, which would be a 78% rise over last year.
In 2011, Delek earned $2.56, up more than 800% from 2010's 36-cent loss.
Margolin thinks the pricing differential, while tough to predict, will be better than expected next year, though likely down from this year.
"Pipelines being built are only going to replace what's being used for rail," he said. "If rail activity decreases, there is going to be just as much trapped crude as this year, factoring in higher production from E&P companies."
In a recent report, Tudor Pickering & Holt noted in regard to new pipeline capacity, "precedent suggests the market will absorb the capacity within a handful of months."
Margin may come down due to more take-away capacity, Ginz-burg says. But he points out that while about 50% of its crude this year is sourced from discounted Midland and local crude, it'll go up to 80% next year as new pipelines serving its refineries come online.
"That's a huge shift in the crude slate, which in today's environment should increase the profitability of the company," he said.
But today's pricing environment may not be the same.
Delek US is a subsidiary of Israeli conglomerate Delek Group, which owns 53% of its US offshoot. It began in 2001 with two convenience-store-chain acquisitions.
It entered the refining business the same way, taking advantage of low prices in a down cycle. It bought its first one in Texas in 2004, a second in Arkansas in 2010.
Delek added logistics assets such as pipelines and storage. They are now part of a Master Limited Partnership spun off on Nov. 2, Delek Logistics Partners.
Delek US raised $176.2 million from the offering and owns 62.4% of the partnership.
"The MLP is expected to be a cash-flow generator for (Delek US), while pursuing growth both organically and through acquisitions," wrote the Tudor Pickering analysts.
Delek's 372 convenience stores, most of them in the Southeast, are a hedge against the typical volatility of the refining business.
The MLP, meanwhile, "gives us another currency to grow the company," Ginzburg said. "We are an acquisitive company. We have more than $500 million in cash now after our (MLP) IPO."
Source: Investor's Business Daily
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