This latest spiel from Keith Schaefer ties in so many of the things we love to see in a hypetastic ad — international intrigue, conspiracies, companies with unfair advantages and, of course, windfall profits. Who can resist, right?
The basic idea is that Schaefer has found a company that’s benefitting from the fact that Canada’s oil can’t easily go anywhere other than straight South to the U.S., and that his favorite refiner is making gobs of money as a result … but of course, that’s not sexy enough to get your attention. Here’s how he launches the new ad:
“Right now Canada is just… giving away… $35 billion a year.
“It isn’t part of any tariff, treaty, or trade agreement.
“It isn’t foreign aid, either… not in the literal sense.
“It isn’t anything like that.
“This $35 billion is a gift – presented right into the arms of a smiling Uncle Sam.”
So that undoubtedly serves to get some of his Canadian readers a bit riled up … and his US readers sniffing around for the beneficiaries. He gets into a bit more detail, too:
“According to the Conference Board of Canada, total oil sands production will grow by 4.8% a year from 2010 to 2035.
“And it will most likely continue as a major global energy source for the next 60 – 80 years.
“Some say it has as much as an entire century’s worth of oil.
“It is God’s gift to Canada, an incredible resource that will help keep energy prices low and stable for ALL North Americans for decades.
“So with all this new oil supply, simple economics says Canada should be benefiting royally from the oil sands.
“Instead, Canada is getting… well, let’s say – pinched.
“Short-changed, in fact, by a huge pricing gap – an oil pricing phenomenon.
“You see, worldwide crude oil prices right now are $90 to $100 a barrel.
“That’s the Brent, or international, oil price – what 60% of the world pays.
“So what is Canada getting for every barrel of heavy oil it produces?
“Canadian heavy oil producers are lucky to get half that.
“And it’s Uncle Sam who is pocketing this huge difference… a $40 – $50 dollar a barrel price difference.”
It’s the almost-landlocked nature of Canada’s oil business that’s leading to these profits:
“I want to explain why Canada is losing $35 billion a year to the United States.Are you getting our free Daily Update
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“It’s simple: it has no oil pipeline to its northwest coast – the Pacific Ocean.
“In fact if there was just one, 1,000-mile pipeline from Alberta’s oil sands to the northwest Pacific, Asian buyers would pay Canada’s producers world prices, and ship it to their energy-hungry refineries.
“It sounds simple, but it’s outside the box for North American energy.
“Canada has some refining capacity, but most of its oil is piped down to refineries along the Mississippi down to the Gulf Coast.
“Right now, ALL the pipeline go to the U.S.
“NONE go to Canada’s east or northwest coast.
“Politics and community pressure have delayed and perhaps stopped the one proposal that would bring tens of billions of dollars to this country every single year.”
He then gets into the conspiracy part of the story — that US environmentalists are backing the Canadian environmental movement in its efforts to stop export via new British Columbia tanker ports … and that, to take it a step further, the US oil majors and refiners are also secretly plotting to make sure Canada doesn’t develop a major Asian export capacity.
I suspect the environmental stuff is true to at least some extent, since environmentalists look at the tar sands/oil sands as a hugely dangerous resource. That’s the major environmental argument against the extension of the Keystone pipeline to bring more Canadian oil the the US Gulf Coast refineries where it could get a better price, that we need to not encourage tar sands oil development by buying even more of it.
But that particular effort, whether or not you think it’s important, doesn’t make much economic difference in terms of progress in developing the oil sands if the oil sands have another willing and large customer — it does little good, in terms of slowing tar sands development, to make that spigot to the US smaller if you’re simultaneously seeing Canada open up major exports via tanker direct to an even thirstier customer in China. In fact, if you’re exporting tar sands by tanker to China that has a worse environmental impact than exporting them to the US via pipeline — both because the oil will be burned less cleanly in China, and because shipping by tanker brings more opportunity for spills and consumers more energy in the shipment.
So that’s the problem in the fungible global market for crude oil — the only real differentiating factors are the transportation system used, the transport distance, and the quality of the crude oil. Heavy crude from Canada (or Venezuela) is lower quality anyway — I’m no refining expert so I don’t know if “lower quality” is the best term, but it takes more work to turn it into gasoline and refined products, so it’s worth less than light, sweet crude oil like you get from the Bakken or from the North Sea or from much of Saudi Arabia.
Which means that Canada’s Syncrude, the heavy crude that is manufactured from the Alberta Oil Sands, can’t be handled by every refinery (each refinery has to set up their systems for particular parameters when it comes to their input stock, and switching is not particularly fast or easy), and not much of that Syncrude can get easily exported by tanker. There is an export terminal in Vancouver for Alberta crude oil, but it is capacity constrained and they’re trying to raise capacity by 500% with a port expansion and an expanded pipeline (that particular pipe is owned by Kinder Morgan) — the expansion of that pipeline is being questioned by the US government, partly because that would mean a lot more tanker traffic in sensitive US waters, including around a marine sanctuary, and there is also a thorough brouhaha running about Enbridge’s plans to build a new oil tanker export port (and the pipes to feed it from Alberta) in Kitimat, in Northern British Columbia.
However you slice it, that export capacity is not going to rapidly increase anytime soon. And even little hints about possibly maybe someday reversing the Northeastern pipelines to bring Canadian crude to New England are already getting folks twisted up in Vermont, so any changes to pipelines are quite charged these days.
So that means that the constantly increasing production of Syncrude from Alberta won’t get an international price — just like Bakken crude that’s pipeline constrained and shipped largely by more expensive railcars doesn’t get the international price (Brent Crude is the benchmark, it’s roughly what we’d pay to import from Nigeria or Saudi Arabia).
Only Syncrude is less valuable than light, sweet Bakken crude and has fewer customers who can easily refine it, so it’s cheaper still. That’s the basic situation that creates pricing differentials that can be exploited by lucky or well-positioned refiners — if gasoline or kerosene or diesel can be sold for almost the same price in Chicago or Milwaukee or Sioux Falls as in New York or Houston (before taxes, which are different), and the midwestern/northern plains states refiner gets a much cheaper feedstock, they should be able to make much more money. Here’s how Schaefer puts it:
“… when I laid everything out, I came to what I think is an incredibly sound investment strategy…
“A trade the the Street never saw coming, a play that I think is one of the safest of any energy investment you can make today…..
“Who in the U.S. is making the most money off Canada’s cheap oil subsidy to Uncle Sam?….
“It’s the U.S. refinery sector
“But it’s not ALL the American refineries… just the ones tha buy super cheap Canadian oil
“There are several such refineries.
“But I’ve found the best one.
“And once I began studying this major profit centre, I discovered an added, very profitable bonus.
“You see, not only are they getting all this Canadian oil – as much as they can handle – at the steep discounts I just mentioned…
“They’re also getting the cheapest American oil.”
So yes, that “cheapest American oil” is the North Dakota crude that’s socked with extra costs because it’s less accessible — there aren’t huge pipeline gathering systems set up, so there’s a lot of truck shipment into terminals and a lot of rail shipment by tanker car that adds significantly to the transport price. The oil is still imminently profitable and desirable, but it’s cheap enough that there are all kinds of oil company strategies in place to move the oil, mostly by tanker, to the Gulf or to the East and West coasts where they can make even stronger per-barrel profits, even with the increased carriage costs, than they can with the much-more-expensive Brent Crude as their input.
Which means, as you can imagine, that though Keith Schaefer is touting refiners in general, and he does also indicate that he specifically like Valero (VLO), he has a favorite refiner that is even more levered to the cheapest crude oil … here’s a last bit of the spiel for you:
“… my refinery stock gets U.S. oil $8 cheaper than most everyone else.
“This is a new, long-term structural advantage for my refinery stock.
“… it gave me the highest dividend payout of my investing career.
“And I expect the payouts to keep coming.
“My research shows 2, 3 years – perhaps even 5 years – of a pricing window that keeps my top refinery play happily locking in great profits…
“And churning out dividends like clockwork.
“In fact, I’m now getting more than one cent a day in dividends – every day – for every share I own.
“So when you have a business model like my top pick does:
“Buy Low, Sell High…
“And a business location that has leverage over the competition…
“You have one of the best ways to profit the energy markets have to offer, hands down.
“Like I said, it buys low-cost Canadian heavy oil – sometimes as cheap as $48 a barrel – as it did in December 2012…
“And it gets to sell its products based on $110 a barrel, making a killing on extremely high margins.
“It’s not the only game in town. It’s the best game in town.
“And now I’ll explain why this game – for sure – will last 3 to 4 years… but could last a whole decade.
“You see, 3 to 4 years is how long it will take to permit and build a huge refinery.
“But production is growing so fast in North America?more than 1 million barrels per day, per year?that it would take several refineries to kill this golden goose.”
So yes, after all that blather Keith Schaefer is still touting the same high-yielding, volatile refinery stock that he first brought to our attention back in December, Northern Tier Energy LP (NTI).
NTI is structured like a master limited partnership, which are everyone’s favorite income investments these days — most MLPs own pipelines or midstream processing assets and tend to run tariff-based and predictable businesses with steady profit margins, but NTI is a bit different. Their major asset is a refinery, so they take on substantially more commodity price risk than does an interstate pipeline operator — pipeline operators are paid a toll for each barrel moved, refiners make their money based on the spread between the price they pay for feedstock (crude oil) and the price they can get for their refined products (diesel, gasoline, etc.).
Which is why Northern Tier trades at an expected yield of something like 15-20%, and Kinder Morgan Partners (KMP) and the other big pipeline operators tend to have yield more in the 5-6% neighborhood. People are concerned about the risk of having your investment concentrated in a single refinery (their main asset is the St. Paul Park refinery in the Twin Cities — they also own a chain of SuperAmerica convenience stores/gas stations, but they don’t make a meaningful amount of money), and they’re also worried that the current windfall profits won’t last forever.
Which is probably true, they won’t last forever. Even markets that aren’t completely free and flexible don’t usually allow for substantial mispricing forever … but if they last for a long time, then perhaps Keith Schaefer will be right and NTI will continue to bank some really impressive cash flows … and direct those cash flows straight to investors like you. So if you ignore the risk that the refinery will have problems or a fire or have to shut down for more than their planned maintenance (they’re planning to have two big shutdowns for maintenance and upgrades this year, in April and October, so there will be downtime and quarters with lower cash flow), then it’s really a question of whether NTI will keep these nice refining spreads for a year, or for three or four or five years (or even a decade), as Schaefer expects. They get a lot of oil from the Bakken, where it’s flowing nicely, and they can handle up to about 30% heavy syncrude in their system, so they are profiting from those differentials in a big way now. Competition is rising from folks willing to pay the $8-15 extra to ship Bakken crude by rail to their refineries, so that differential may slip over time as more and more rail cars will with oil in North Dakota, but the Canadian Syncrude isn’t as easy to move because there are fewer refineries who are set up to use it.
Predicting long-term advantages for NTI, which are predicated on their good pipeline access to both the Bakken crude and the Canadian syncrude, means predicting either new refineries or refinery expansions and new pipelines will fail to soon push the market into something close to global equilibrium. I don’t know enough about the status of other refineries in the upper midwest or in Canada to make any judgements about capacity, nor do I know enough about pipeline plans or directions or expansion, but NTI is trying to up their capacity by about 10% with an expansion project that they think will be accretive to cash flow within a year or so.
And the rub for income investors, who prefer to see steady or steadily rising payouts, is that NTI pays a high but variable distribution, and they have very little history to indicate how they’re going to structure payouts. They’ve paid only two distributions so far, and the first one was of an odd size because it covered more than one quarter (they went public last Summer), so we can look at the most recent quarterly payout of $1.27, annualize it to $5.08 a year (“annualize” means “multiply by four, but use a fancy word so investors think you’re smart”), and say that NTI carries a yield of 17% ($5.08 is 17% of $28, the current unit price).
But investors are almost certainly not going to get $5.08 in distributions over the next four quarters — the company has gone far, far out of its way to emphasize that they pay out irregular amounts, including in the last conference call, and they mentioned their two shutdowns on the calendar and the seasonal nature of the business several times, so they’re clearly trying to get people to accept the fact that some of the upcoming quarterly payouts will be lower than the most recent $1.27. Of course, it’s also possible that the payouts could be higher — maybe gasoline prices spike and crude prices fall for other reasons, who knows.
So it comes down to a company that owns one refinery, in a sweet spot for margins, and which is investing some in expanding their capacity to make some hay while the sun shines (they’re investing in some trucking in North Dakota to help lower costs, in addition to expanding the refinery) … sound like a good investment to you? Think they can maintain the current ~$5/year distribution, or will investors see more or less than that in 2013? You pays your money and you makes your guesses — if you’ve got a prediction for NTI (or refiners in general) to share with us, let us know with a comment below.
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