Group 3/Gulf Coast Arb

For all last week, those companies with access to Gulf Coast pricing and customers in the Group 3 have had the ability to take advantage of the tremendous price difference.  Early in the week we were seeing price differentials off RFG87 to 87E10 of up to .30/gallon.  Towards the end of the week that spread dropped lower to about .15/gallon, but still - for anyone with sites/customers in central - southern Oklahoma that drive from Dallas/Aledo/Euless/Ft. Worth makes sense.  There are, however, some potential issues with this option coming soon.....

Late Friday evening Coffeyville Resources (CVR) Wynnewood Refinery exploded killing one and injuring another.  I was able to speak with a representative from Coffeyville on the expected supply disruptions and he stated the terminal was already in turn around so disruptions should be non-existent.  We did hear of a possible issue regarding the Alon Big Springs Refinery.  A couple sources have told us they are currently out of ULSD and are expected to be out of Gas by Tuesday and not back up until 10/8.  With product being out (in the Magellan system) from Houston to Odessa, there were a number of people heading out to this area to pick up their product.  We were able to confirm Magellan had product back in as of yesterday, but still, this outage could have negative implications.  If Big Springs is down until 10/8 there is a very good chance the mountain region supply is going to come from Houston/San Antonio to make up for this loss.  Moving more product out of Houston/San Antonio will decrease supply and likely close this Group 3/Gulf Coast gap we're benefiting from right now.

I have yet to get a clear answer from a representative from Alon on whether or not these supply issues are 100% accurate or not, but from the associates this news was received I'm fairly confident these are real issues and we'll see the ramifications occur this week.

Bullish Outlook....For what?

With the federal government stamping a "go" on QE3 - we all can expect the value of the dollar to fall and the price of refined product to continue to rise.  Top this with the EPA coming out with a tentative adjustment to the 2013 RFS mandates on biodiesel to change the 1 billion gallons of biomassed based diesel to 1.28 billion gallons and we see nothing but bulls running in the refined/renewable energy sector.  One issue (domestically) we are going to experience where bears may make there way in, is the crude oil contracts for refineries.  I have heard from a number of sources that many of the large refiners are expected to exhaust their crude contracts at the conclusion of 2012.  Knowing this, we can expect prices to plummet as our increased capacity will not be used to full maximization.  Although refiners will be susceptible to spot pricing, knowing the contracts will exhausted will put pressure on extractors and brokers to sell their volume so wells can continue to run and pipelines continue to push product.  I would expect to see a drop on oil prices during the first quarter of the year.  Depending on which market area you're in (Group 3, Gulf Coast, NY Harbor, ect) this could play a huge benefit in terms of basis opportunity.  If the spot market drops hard, but geographic markets are slow to follow - this may be a good time to purchase some biodiesel/ethanol off an HO/RBOB benchmark as the blowout could be substantial.  Anyone remember the .75 discount to RBOB in Chicago last year?  Yeah - would have been a sweet time to own some ethanol off that contract in the Group 3.....Opportunities are the same with biodiesel.  If basis reaches (as it normally does) .15 - .20 and you're already buying the product discounted to HO .30 - .40 you're looking at .45 - .60 savings off spot rack prices.  Market that at a 5% blend (as it will still be colder during the 1st quarter) and you're looking at a blended savings of around .0225 - .03 per gallon.  Nothing to cash all your chips in on, but every little bit helps.

So the overall market still looks bullish - it is that one crude issue (in 2013) where we may see the bears take over.

Crude Oil Possibilities

Well as most of you noticed the bulls continue to run in the energy sector on refined products.  Group 3 and Gulf Coast continued their rise last week and demand drops and product draws due to refinery shut downs for Isaac.  Crude is back up over $96/bbl and we are not expecting and drops in the recent future.  The most intriguing new (in my opinion) last week, was the new proposed Keystone Pipeline track.  President Obama previously vetoed the Keystone Pipeline due to its path heading through national parks and strategic water reserves.  With this new proposal, there seems to be some very legitimate options on this opportunity coming to fruition.  Knowing the Eagleford Shale continues to boom and the Mississipian and Utica coming online, having direct crude access from Canada continues to limit the United State's dependence on foreign oil.  Long-term this could help the US economically as well.  Having the ability to continue to be a net exporter of refined product (as we were last year for the 1st time in 60 years) will continue to lower our national debt and bring back the economics we have lost over the last few years.  I'm optimistic of these new opportunities as, was as a nation, have the infrastructure and opportunity to continue to grow substantially.  There are a number of small refineries which have been "mothballed" due to production costs, and with the possibility of cheaper crude products, this will allow us to re-open the doors of these refineries and possibly have companies invest to have updated technology to hit capacity.  Crack spreads being at $30/bbl keep even the most conservative investor interested in the refinery sector.  For instance - a refinery doing only 20,000bbls per day has the ability to make:

$600,000.00 per day
$18,000,000.00 per month
$219,000,000.00 per year

This is obviously the gross profit based on today's crack spreads, but with the right financial manager, an investor interested in the refining sector can hedge his crack spread against physical product sales to maximize their capital return.  I have spoken with a couple potential refinery investors and both have stated they expect to have their investments completely paid off within the first 12 - 18 months of their investment.  Considering the value associated with an online refinery, this is an unbelievable return.  There are also some intangible benefits as well.  Being part of the "small refinery" sector can open a company up to having first rights on government contracts as they are mandated to purchase a specific amount of their overall usage from small or underprivileged companies.  I know it is hard to believe, but even people in the oil and energy sector can be considered underprivileged. 

Wholesale Market Conditions

Funny how things can change in just a few months.  In February I was flaunting the brilliance of using biodiesel as a supplemental form of income by generating increased savings and optimizing profitability.  If you wanted to take that same stance today you would see a much different savings schedule.  With RIN values deteriorating and the U.S. drought conditions spanning across the midwest the outlook on feedcost is very bullish.  RINs are dropping as EMTS numbers coming out are showing us likely to hit our obligations (on physical & RIN standards) by then end of September.  Anyone looking to maximize a Q4 physical product contract on biodiesel (like this guy) has their fingers crossed hoping for a miracle.  All is not lost though, purchasers and end users in Texas can still take advantage of the .20/gallon state incentive for using the biodiesel  adding this into the fact that basis is still swimming around .1325 in the Group 3 & .1045 in the Gulf Coast for ULSD shows there is still some value, but considering a number of refiners/shippers are trying to meet their obligations, they are mostly shipping a B2 - B5 already.  To really make an immediate impact, blending at a B15 (after the B5 from the shippers) would be the only real way to make a difference.

All is not lost yet!  There have been some good opportunities for those companies harboring unbranded contracts as the market continues its bullish rise.  With Bernanke disappointing all the QE3'ers it helped physical trading continue its rise.  I'm personally worried at the sustainability of this increase - Iraq's exports are at 2.565 million bbls per day (the most in 30 years) and US production continues to increase weekly.  Hurricane Isaac had an obvious impact on trading, but was short-lived.  Damage was less than expected to offshore assets and refineries.  Marathon was able to get 1 million barrels from the reserve from congress and has to pay back (with interest) in the next 60 days....not much an impact really.  Wholesalers can "hedge" their position on sales, by offering both current day & previous day Platts contracts.  In an up market your previous day contract stays constant and pricing will not fluctuate with market conditions.  On a down day your current day contract will encompass that day's trading and your costs will likely be lower than available low rack.  This is a way to offer different options for your customers and show your support in their continued growth.

It has been a tough few months on the renewable fuel front, but keeping a constant watch on both the refined and renewable markets will keep you in touch on ways to be versatile on your offering.  Continue to grow with both markets because it always seems as soon as you ignore one side, that is the side where your marginal value lies.  Grow in both markets and find ways to use them to supplement each side's business.  This will alleviate risk of failure and sustain your company's market value.

Branded Products - Oklahoma City/Western Oklahoma

Over the last few weeks in Oklahoma City, we have noticed a change in how our Branded suppliers have decided to price their product and divvy allocations.  We are seeing one supplier post 300% daily allocations when they are normally at a consistent 125%.  Normally our customers will pay a premium for the brand name, which in essence nullifies the increase in supply availability, but not this time.  We are actually seeing a .08 differential from our Branded to Unbranded suppliers, giving our customers a competitive advantage to hold the brand.  Given previous market conditions, it has always been difficult to sell retailers on Branding their site as their pricing is less competitive than others in the market (such as On Cue or 7-11).  We are now seeing our Branded customers hold an advantage against these retail giants to finally give a true value to branding their facilities.  This is also beneficial from a marketing perspective as we are able to help the smaller unbranded retailer due to our significant increase in allocations.  Normally if there is ever a beneficial price spread, we are limited at the amount of fuel we can sell because our allocations are at the previously stated number of 125%.  With having a 300% allocation we can take this cheaper product and any rebate incentives we have to show our customers we have the best supply available at the cheapest possible price.  We have noticed higher loyalty offering these prices to our unbranded retailers as their contracts all state they will receive the cheapest available Unbranded supplier.  By us offering them a Branded supplier they realize we are giving them a price they are contractually not obligated to receive.  It is showing superior customer care as well financial understanding.  Along with Oklahoma City, we are seeing an arbitrage of approximately .21 on Shell Branded product out of McKee, TX vs. Scott City, KS.  Between the two, you are looking at about a 205 mile difference in rack locations, but given the difference in cost, our customers are happy to pay the extra in freight.  By offering these prices to customers in Western Oklahoma & Southern Kansas we are showing a quality of using our organization.  We are maximizing our supply for our customers by keeping a watchful eye on price differentials and passing the significant savings on to them to maximize their returns.  Saving a customer money is keeping a customer for life.  We have noticed transparency is the most lucrative option for most customers as their main concern is knowing their wholesaler is doing everything they can to alleviate price costs.  Customer satisfaction is always key.

Biodiesel

So far this year we have noticed a a few hurdles as it pertains to the plausibility of biodiesel for everyday use.  "RIN Gate" has been a terrible setback for us so far this year as the EPA has mandated all the majors to guarantee the viability of every blended gallon they sell.  This shouldn't be that big of an issue, but what we are seeing in the market place is all the majors only doing business with major biodiesel producers such as ADM or Cargill....this is killing the little guy.  We have a great company we use out of High Hill, MO who has had to shut down production because we can not sell their RINs forward to lock in a price to sell to our customer.  We could take the chance of purchasing the product and hoping someone buys our RINs off us once they are transferred from a K1 to a K2, but then we are running the risk of the value dropping significantly or even worse - not being able to sell them at all.  We are having our producer complete their RIN Attest right now in hopes this solves the problem and I will be sure to revert back one to process is completed to let you all know how it has changed the situation.  The main concern with all this is the fact that biodiesel has, again, become a lucrative blending option for those customers using biodiesel.  On closing Friday we saw the market finish with RINs trading on the high side at 1.45.  This brings a blended value up to 2.175.  We saw the NYMEX settle HO out at 3.1889 and Group 3 Platts Avg. end at 3.1152.  Assuming you have a Platts contract with a supplier at Platts previous day Avg. + 2.75 you would see your diesel price at 3.1427.  Assuming basis stays on this consistent level (or goes higher) and RIN values do not drop below the 1.45 (or you can sell them forward) you can purchase biodiesel and generate a blended competitive advantage at HO + 2.10/gallon.  This is incredible because right now, we are seeing offers at HO + 1.75 delivered.  At HO + 1.75 your economics would play out as listed:

Biodiesel cost - 3.1889 + 1.75 = 4.9389
RIN value = 1.45*1.5 = 2.175
Blended biodiesel cost = 2.7639
Diesel cost = 3.1152
B5 Blend = 3.0977 (.0176 savings)
B10 Blend = 3.0801 (.0351 savings)

These savings are not only savings on the side of wholesale, but also a competitive advantage for the jobbers in this area.  I'm excited to get back to moving the volume we had last year, but until RIN Gate gets settled we are at the mercy of the market.  The indication we received at HO + 1.75 isn't something that gets thrown around very often as the majors are sending teams of people into different biodiesel facilities to Vett their operations and make sure the RINs are valid and their reporting structure is concise.  Luckily we have made good friends in this industry and the opportunities present themselves when we need them most.  Afterall....it's not what you know it's who you know.

Basis/Marketing Opportunities

As I'm sure you have all noticed, this year is proving to be one not forgotten in the energy industry.  We  are showing crack spreads at very high levels and demand at a 117 month low.  Our basic economics of supply and demand are being questioned by the refiners' ability to produce product at maximum capacity and flood the pipelines with product while speculators take advantage of arbitrage opportunities and offer overseas political issues as a source of price spikes.  Basis is the game I would be playing right now.....Right now Chicago is showing subgrade gasoline basis at (0.6525).  Compare that with Group 3 economics showing a conventional 87 basis at (0.1400).  You're showing an arbitrage of 0.5125; assume you can transport the product from the Chicago market into the Group at a transportation cost of approximately 0.3000 (FSC included) and your netback comes to 0.2125/gallon (this is without even using pipeline transportation!).  Rather than taking a physical position on this product I think traders need to entertain the idea of using this 0.2125 as a liquidation opportunity and focus the majority of their time on buying CBOB basis in Chicago.  Knowing the time of the year, we can all expect prices to continue to rise, and we can expect the basis gap to close as April quickly approaches and RVP season comes rushing in.  You all may remember last year at this time Chicago basis was at (0.2000) right around February/March; after the RVP change Chicago quickly skyrocketed up to .1500, giving traders who were long basis a VERY happy payday.  Rather than merely trading basis, I would suggest to the wholesale jobbers in the Dayton/Columbus Ohio markets to start heading east towards the unbranded customers being supplied by the NY Harbor.  Right now Chicago's discount to the Harbor is approximately 0.6265 poising jobbers and wholesalers with supply rights out of these terminals a tremendous advantage to customers in western/eastern Pennsylvania.  With the branded suppliers in this market continuing to be aggressive, the price and rebate incentives offered could create chaos for jobbers in the Pennsylvania market with limited Chicago economics.  My preference would be for all my Econ classes I took during my undergrad and Corporate Finance classes taken during my Masters to ring true so I can justify my $1 trillion in student loans, but it seems the Wall Street and all its traders still holds the crystal ball....I just hope to get a peek.