In last week’s issue I discussed the basics of the refining sector. Today I will provide an overview of four MLPs that hold refining assets.

To review, the refining sector was very profitable in 2012 thanks to unusually high crack spreads, which for many US refiners are approximated by the price differential between Brent and West Texas Intermediate (WTI) crude oils. For a more thorough explanation of this phenomenon, please refer to last week’s issue.

After years of trading at a $1 to $3 per barrel discount to WTI, Brent began fetching a premium a few years ago as a glut of crude developed in the mid-continent area of the US. In 2011 the Brent-WTI price differential increased to more than $25/bbl, and it remained historically high in 2012.

But pipeline capacity started to catch up this year, and the share prices of refiners retreated as the glut began to dissipate and the Brent-WTI differential shrank. In Q3 2012, the Brent-WTI differential averaged $17.43/bbl, but by Q3 of this year, the differential had fallen to $4.43/bbl. This promises bad news for refiners about to report Q3 earnings.

Many analysts downgraded the refining sector in Q3, but as the differential fell below $5/bbl it was hard to imagine that the news could get much worse. With poor Q3 results largely priced in, the differential subsequently rose back above $10/bbl, signaling better refining margins moving into Q4.

Refiners began to post earnings this past week, and as expected they were weak. Valero (NYSE: VLO) reported slightly higher revenues year-over-year, but net earnings fell more than 50 percent from a year ago. Nevertheless, they beat the extremely pessimistic expectations of analysts, and Valero shares rose on the news.

Phillips 66’s (NYSE: PSX) refining unit actually posted a loss, but its chemical business turned in a solid quarter which more than compensated for the disappointing refining results.

The rest of the refiners will report earnings over the next few weeks, and the results will be much the same. Refiners that predominantly buy the domestic crudes sold at such a steep discount a year ago are going to see earnings come in much lower than they did a year ago. Refining earnings will also weigh on the earnings of integrated oil companies. But conditions look to be improving going into Q4, and some of the refining MLPs are starting to look cheap.

CVR Refining

CVR Energy (NYSE: CVI) spun off CVR Refining (NYSE: CVRR) in January, and both companies remain majority-owned by Carl Icahn. CVR Refining’s policy is to pay variable distributions consisting of all available cash not needed for refinery upgrades or maintenance.

CVR Refining’s primary assets are two refineries, in Kansas and Oklahoma, with a combined processing capacity of approximately 185,000 barrels per day (bpd). These refineries are strategically located near the major Cushing, Oklahoma shipment and storage hub, with easy access to discounted feedstock from the nearby Permian basin as well as the Bakken shale and Canadian oil sands.

As a result of the aforementioned collapse in Brent-WTI differentials — as well as some unscheduled downtime — CVRR turned in sharply lower Q3 results. Because the partnership pays a variable distribution, its Q1 distribution was $1.58 per unit, but the Q2 payout fell to $1.35 per unit as margins worsened.

It should not be surprising, especially if you read last week’s issue, that CVRR’s Q3 distribution announced on Nov. 1st was only $0.30/unit. Unit prices promptly fell 9 percent in response to what should have been obvious weeks ago: the Q3 distribution was going to take a hit. (Though it should be noted that CVRR cut its annual distribution forecast as well.) In any case, Q4 will almost certainly be better for CVRR.

Alon USA Partners

Alon USA Partners (NYSE: ALDW) was spun off a year ago by parent Alon USA Energy (NYSE: ALJ), which owns an 81.6 percent stake. Its primary asset is a crude oil refinery in Big Spring, Texas, in the heart of the Permian Basin. Total throughput capacity of the refinery is approximately 70,000 bpd.

The Big Spring refinery has historically run West Texas Sour (WTS) as the largest component of its crude slate. Approximately 75 percent of Big Spring’s throughput in the first half of 2013 was WTS, which is generally priced below WTI in Midland because of its higher sulfur content. (A crude oil is considered sour if it contains more than 0.5 percent sulfur). Sour crudes usually trade at a discount because they require more processing in order to remove the sulfur.

But ALDW is not a pure refining play. The partnership also includes a wholesale fuels marketing business which is integrated through the Big Spring refinery system and which markets gasoline and diesel to ~640 sites under the ALON brand, including Alon stores.

Like CVVR, ALDW slashed its Q2 distribution, in its case to $0.71 per unit from $1.48 per unit for Q1. At the current unit price the first half distributions translate into an annual yield of over 17 percent, but you can expect this high yield to decline when ALDW releases third-quarter results Nov. 6.

Northern Tier Energy

Like ALDW, Northern Tier Energy (NYSE:NTI) isn’t a pure refining play. The partnership owns one refinery in St. Paul Park, Minnesota with a capacity to refine 89,500 bpd of crude oil. The refinery’s complexity allows it to process a variety of crudes, and its proximity to the Canadian border and to the Bakken in North Dakota gives it access to crudes that are often further discounted from the price of WTI.

In addition to the refinery, Northern Tier Energy operates 163 convenience stores and supports 73 franchised convenience stores, primarily in Minnesota and Wisconsin, under the SuperAmerica brand name. SuperAmerica filling stations are clustered around the refinery, which supplies their gasoline at prices that tend to give Northern Tier a margin premium over the regional crack spread, and of course the retail network lets NTI capture retail margins as well.

Northern Tier Energy also owns a 17 percent interest in the Minnesota Pipe Line Company, which owns and operates the Minnesota Pipeline, a 455,000 bpd crude oil pipeline system that transports crude oil (primarily from Western Canada and North Dakota) from the Enbridge pipeline hub at Clearbrook, Minnesota to the refinery. The Minnesota Pipeline transports the majority of the crude oil processed in the refinery.

NTI’s distribution fell from $1.23 per unit following the first quarter to $0.68 per unit in the second quarter. The third-quarter distribution is scheduled to be announced along with third-quarter earnings on Nov 11.

Calumet Specialty Products Partners          

As its name suggests, Calumet Specialty Products Partners (Nasdaq: CLMT) isn’t a conventional refiner. It’s a refiner of petroleum-based specialty products and fuels, with 11 domestic production facilities spread across Louisiana, Texas, Montana, Wisconsin and Pennsylvania. In addition to gasoline, diesel, jet fuel and asphalt, the partnership produces solvents, mineral oils, waxes and specialty lubricants.

The partnership has shown outstanding performance since its 2006 IPO, with adjusted EBITDA growing at a 26 percent compound annual rate in 2008-2012, and distributions growing at a 10 percent annual rate for the last four years.

Because of its diverse product mix, CLMT hasn’t experienced the same margin volatility as the more conventional oil refiners. Nor has the partnership been as susceptible to the changing Brent-WTI differential, primarily because its refineries are small and geographically diverse, and sell many of their products into local markets.

While more conventional refiners were cutting their distribution during the 2nd quarter, Calumet actually slightly increased its distribution from $0.68 in Q1 to $0.685 in Q2 (even though distributable cash flow for the quarter was slightly negative). The partnership recently announced that the Q3 distribution would also be $0.685. At the current unit price, this translates into an annual yield of 9.2 percent.

Many of the refiners have begun to recover as the Brent-WTI differential has started to bounce back in the fourth quarter. Valero, for example, has advanced more than 20 percent in the past month. The refinery MLPs profiled here haven’t fared nearly as well, with CVR Refining actually declining more than 10 percent in the past month. But conditions are improving, and chances are you can find a bargain for your MLP portfolio among these names.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

Icahn Flying High, Oaktree Dip Bought

The decision to recommend two investing partnerships in September was a controversial one, but it’s proven profitable for subscribers who followed us into these names, which in addition to decent yields hold out the promise of profiting from the investing acumen of some of the smartest money managers on the planet.

Carl Icahn’s majority-owned investment vehicle, Icahn Enterprises (NYSE: IEP), had already racked up a 37 percent return since Sept. 9 as of 10 days ago, when we recommended that subscribers along for the ride sell half of their position. The other half is now up more than 40 percent following today’s 6.5 percent jump in response to earnings that proved better than expected.

IEP announced that consolidated EBITDA (earnings excluding interest, taxes, depreciation and amortization) attributable to the partnership jumped 43 percent year over year, and is up 75 percent for the first nine months of the year from the same span in 2012. The latest quarter’s haul of $472 million in net income attributable to IEP, including the non-cash depreciation and amortization, would still be enough to cover a distribution more than three times as large as the $1.25 per unit IEP declared.

The results goyt a big boost from Icahn’s investment gains in the likes of Netflix (Nasdaq: NFLX) and Chesapeake Energy (NYSE: CHK). The investing segment in which IEP holds $3.6 billion in assets as of Sept. 30 returned a strong 18.4 percent in the third quarter alone, and is now up 26.3 percent on the year. These gains, along with strength in auto parts, with which IEP is involved via its stake in Federal-Mogul (Nasdaq: FDML) offset a decline in energy as the refining downturn squeezed CVR Refining’s (Nasdaq: CVRR) margins.

And despite the investment portfolio’s heady recent gains, Icahn used the release to repeat his claim that the best days for his brand of shareholder activism still lie ahead, as low interest rates favor investment in underperforming companies that can be overhauled quickly.

Icahn has quickly become the leading champion of this bull market, as evidenced by the expanding premium IEP now fetches over its own estimate of its net asset value. When we recommended IEP two months ago, the premium was still a modest 5.6 percent. But during the last quarter, the indicative net asset value has remained remained at $71 even as the unit price rockted from the mid-70s to well over $100. At this price, the premium over the estimated net asset value is a hefty 53 percent.

And while it could keep rising based on Icahn’s high current standing, the current price implies a lot of faith in his continuing ability to hit investing home runs.

We’re comfortable recommending that you hold half of the original September purchase but don’t regret the recent advice to lighten up. Icahn is without question one of the greatest living investors, but even legends fall out of fashion now and then, and despite Icahn’s sales pitch we’re not early in this bull market. Continue to hold a reduced stake in IEP and sell half if you haven’t already done so.

In contrast with the steady distribution at IEP, investors in Oaktree Capital (NYSE: OAK) saw a 50 percent sequential payout cut as the prior payment was boosted by the profitable liquidation of an unusually large distressed debt fund. Still, this top alternative asset manager remains on track with 30 percent year-over-year growth in distributable earnings and $3.7 billion of gross capital raised for the quarter. Oaktree units initially slumped 5 percent on earnings news, but much of that discount evaporated in a matter of hours, underscoring strong investor support for this partnership, which has given us a 10 percent capital gain in under two months. Continue buying OAK on pullbacks below $56.

— Igor Greenwald