Filed with the SEC from Feb 09 to Feb 15:
CVR Energy (CVI)
Carl Icahn's Icahn Associates said in a Feb. 13 filing that it had suggested to CVR Energy's management, after the company announced that it would begin paying a dividend, that it believed that shareholders would be better served if CVR commenced a process to put itself up for sale. Icahn Associates also said that there are three or four possible acquirers that could benefit greatly from the synergies that could be realized from a future "combination." Icahn had previously disclosed owning 12,584,227 shares (14.5% of all voting shares outstanding), and that its stake included some underlying call options on the shares.
CVR Energy, Inc. and, unless the context otherwise requires, its subsidiaries (â€śCVR Energyâ€ť, the â€śCompanyâ€ť, â€śweâ€ť, â€śusâ€ť, or â€śourâ€ť) is an independent petroleum refiner and marketer of high value transportation fuels. In addition, we currently own all of the interests (other than the managing general partner interest and associated incentive distribution rights (the â€śIDRsâ€ť)) in CVR Partners, LP (the â€śPartnershipâ€ť), a limited partnership which produces nitrogen fertilizers in the form of ammonia and UAN.
Our petroleum business includes a 115,000 bpd complex full coking medium-sour crude oil refinery in Coffeyville, Kansas. In addition to the refinery, we own and operate supporting businesses that include:
â€˘ a crude oil gathering system with a gathering capacity of approximately 35,000 bpd serving Kansas, Oklahoma, western Missouri, and southwestern Nebraska which is supported by approximately 300 miles of Company owned and leased pipeline;
â€˘ a rack marketing division supplying product through tanker trucks directly to customers located in close geographic proximity to Coffeyville and Phillipsburg, Kansas and to customers at throughput terminals on Magellan and NuStar Energy, LPâ€™s (â€śNuStarâ€ť) refined products distribution systems;
â€˘ a 145,000 bpd pipeline system that transports crude oil to our refinery with 1.2 million barrels of associated company-owned storage tanks and an additional 2.7 million barrels of leased storage capacity located at Cushing, Oklahoma; and
â€˘ storage and terminal facilities for refined fuels and asphalt in Phillipsburg, Kansas.
The nitrogen fertilizer business consists of a nitrogen fertilizer facility in Coffeyville, Kansas that is the only operation in North America that uses a petroleum coke, or pet coke, gasification process to produce nitrogen fertilizer (based on data provided by Blue Johnson & Associates, Inc., â€śBlue Johnsonâ€ť). The nitrogen fertilizer facility includes a 1,225 ton-per-day ammonia unit, a 2,025 ton-per-day UAN unit and a gasifier complex having a capacity of 84 million standard cubic feet per day. The nitrogen fertilizer businessâ€™ gasifier is a dual-train facility, with each gasifier able to function independently of the other, thereby providing redundancy and improving its reliability. A majority of the ammonia produced by the nitrogen fertilizer plant is further upgraded to UAN, which has historically commanded a premium price over ammonia.
We have two business segments: petroleum and nitrogen fertilizer. For the fiscal years ended December 31, 2010, 2009 and 2008, we generated consolidated net sales of $4.1 billion, $3.1 billion and $5.0 billion, respectively, and operating income of $93.1 million, $208.2 million and $148.7 million, respectively. Our petroleum business generated $3.9 billion, $2.9 billion and $4.8 billion of net sales, for the years ended December 31, 2010, 2009 and 2008, respectively. Our nitrogen fertilizer business generated $180.5 million, $208.4 million and $263.0 million of net sales for the years ended December 31, 2010, 2009 and 2008, respectively. Our petroleum business generated operating income of $104.6 million, $170.2 million and $31.9 million for the years ended December 31, 2010, 2009 and 2008, respectively. Our nitrogen fertilizer business generated operating income of $20.4 million, $48.9 million and $116.8 million for the years ended December 31, 2010, 2009 and 2008, respectively. Our consolidated results of operations include certain other unallocated corporate activities and the elimination of intercompany transactions and, therefore, are not a sum of the operating results of the petroleum and nitrogen fertilizer businesses.
Our refinery, which began operations in 1906, and the nitrogen fertilizer plant, built in 2000, were operated as components of Farmland Industries, Inc. (â€śFarmlandâ€ť), an agricultural cooperative, and its predecessors until March 3, 2004.
Coffeyville Resources, LLC (â€śCRLLCâ€ť), a subsidiary of Coffeyville Group Holdings, LLC, won a bankruptcy court auction for Farmlandâ€™s petroleum business and a nitrogen fertilizer plant located in Coffeyville, Kansas and completed the purchase of these assets on March 3, 2004. Coffeyville Group Holdings, LLC operated our business from March 3, 2004 through June 24, 2005.
On June 24, 2005, Coffeyville Acquisition LLC (â€śCALLCâ€ť), which was formed by certain funds affiliated with Goldman, Sachs & Co. and Kelso & Company, L.P. (the â€śGoldman Sachs Fundsâ€ť and the â€śKelso Funds,â€ť respectively), acquired all of the subsidiaries of Coffeyville Group Holdings, LLC. CALLC operated our business from June 24, 2005 until CVR Energyâ€™s initial public offering in October 2007. CVR Energy was formed in September 2006 as a subsidiary of CALLC in order to consummate an initial public offering of the businesses operated by CALLC. Immediately prior to CVR Energyâ€™s initial public offering in October 2007:
â€˘ CALLC transferred all of its businesses to CVR Energy in exchange for all of CVR Energyâ€™s common stock;
â€˘ CALLC was effectively split into two entities, with the Kelso Funds controlling CALLC and the Goldman Sachs Funds controlling Coffeyville Acquisition II LLC (â€śCALLC IIâ€ť) and CVR Energyâ€™s senior management receiving an equivalent position in each of the two entities;
â€˘ we transferred our nitrogen fertilizer business to the Partnership in exchange for all of the partnership interests in the Partnership; and
â€˘ we sold all of the interests of the managing general partner of the Partnership to Coffeyville Acquisition III LLC (â€śCALLC IIIâ€ť), an entity owned by our controlling stockholders, at that time, and senior management at fair market value on the date of the transfer.
CVR Energy consummated its initial public offering on October 26, 2007. CVR is subject to the rules and regulations of the New York Stock Exchange (â€śNYSEâ€ť) where its shares are traded under the symbol â€śCVI.â€ť At December 31, 2010, approximately 40% of CVRâ€™s outstanding shares were beneficially owned by the Goldman Sachs Funds (17%) and Kelso Funds (23%). Subsequent to December 31, 2010, the Goldman Sachs Funds and Kelso Funds completed a sale of shares pursuant to a registered public offering. As a result of this offering, the Goldman Sachs Funds are no longer shareholders of the Company and the Kelso Funds beneficially own approximately 9% of the Company as of the date of this Report.
On December 20, 2010, the Partnership filed a registration statement on Form S-1 (File No. 333-171270) (the â€śRegistration Statementâ€ť) to effect an initial public offering of its common units representing limited partner interests. The number of common units to be sold in the offering has not yet been determined. The initial public offering is subject to numerous conditions, including, without limitation, market conditions, pricing, regulatory approvals (including clearance from the Securities and Exchange Commission (â€śSECâ€ť)), compliance with contractual obligations, and reaching agreements with underwriters and lenders. Accordingly, the initial public offering may not occur on the terms described in the Registration Statement or at all. The Registration Statement is not effective and is currently under review by the SEC. Any comments issued by the SEC could be material and could require the Partnership to make material changes to the disclosures contained in the Registration Statement and this Form 10-K. We are not making any offers to sell, or soliciting any offers to buy, common units of the Partnership.
We operate a 115,000 bpd complex full coking medium-sour crude oil refinery in Coffeyville, Kansas. Our refineryâ€™s production capacity represents approximately 15% of our regionâ€™s output. The facility is situated on approximately 440 acres in southeast Kansas, approximately 100 miles from Cushing, Oklahoma, a major crude oil trading and storage hub.
For the year ended December 31, 2010, our refineryâ€™s product yield included gasoline (mainly regular unleaded) (49%), diesel fuel (primarily ultra low sulfur diesel) (41%), and pet coke and other refined products such as NGC (propane, butane), slurry, sulfur and gas oil (10%).
Our petroleum business also includes the following auxiliary operating assets:
â€˘ Crude Oil Gathering System. We own and operate a crude oil gathering system serving Kansas, Oklahoma, western Missouri and southwestern Nebraska. The system has field offices in Bartlesville, Oklahoma and Plainville and Winfield, Kansas. The system is comprised of approximately 300 miles of feeder and trunk pipelines, 95 trucks, and associated storage facilities for gathering sweet Kansas, Nebraska, Oklahoma and Missouri crude oils purchased from independent crude oil producers. We also lease a section of a pipeline from Magellan, which is incorporated into our crude oil gathering system. Our crude oil gathering system has a gathering capacity of approximately 35,000 bpd. Gathered crude oil provides a base supply of feedstock for our refinery and serves as an attractive and competitive supply of crude oil. During 2010, we gathered an average of approximately 31,000 bpd.
â€˘ Phillipsburg Terminal. We own storage and terminalling facilities for refined fuels in Phillipsburg, Kansas. The asphalt storage and terminalling facilities are used to receive, store and redeliver asphalt for another oil company for a fee pursuant to an asphalt services agreement.
â€˘ Pipelines. We own a proprietary pipeline system capable of transporting approximately 145,000 bpd of crude oil from Caney, Kansas to our refinery. Crude oils sourced outside of our proprietary gathering system are delivered by common carrier pipelines into various terminals in Cushing, Oklahoma, where they are blended and then delivered to Caney, Kansas via a pipeline owned by Plains Pipeline L.P. (â€śPlainsâ€ť). We also own associated crude oil storage tanks with a capacity of approximately 1.2 million barrels located outside our refinery.
Our refineryâ€™s complexity allows us to optimize the yields (the percentage of refined product that is produced from crude oil and other feedstocks) of higher value transportation fuels (gasoline and diesel). Complexity is a measure of a refineryâ€™s ability to process lower quality crude oil in an economic manner. As a result of key investments in our refining assets, our refineryâ€™s complexity score has increased to 12.9 from 12.2, and we have achieved significant increases in our refinery crude oil throughput rate over historical levels. Our higher complexity provides us the flexibility to increase our refining margin over comparable refiners with lower complexities.
Our refinery has the capability to process blends of a variety of crude oil ranging from heavy sour to light sweet crude oil. Currently, our refinery processes crude oil from a broad array of sources. We have access to foreign crude oil from Latin America, South America, West Africa, the Middle East, the North Sea and Canada. We purchase domestic crude oil from Kansas, Oklahoma, Nebraska, Texas, North Dakota, Missouri, and offshore deepwater Gulf of Mexico production. While crude oil has historically constituted over 90% of our feedstock inputs during the last five years, other feedstock inputs include normal butane, natural gasoline, alky feed, naphtha, gas oil and vacuum tower bottoms.
Crude oil is supplied to our refinery through our wholly-owned gathering system and by pipeline. We have continued to increase the number of barrels of crude oil supplied through our crude oil gathering system in 2010 and it now has the capacity of supplying approximately 35,000 bpd of crude oil to the refinery. For 2010, the gathering system supplied approximately 27% of the refineryâ€™s crude oil demand. Locally produced crude oils are delivered to the refinery at a discount to WTI, and although slightly heavier and more sour, offer good economics to the refinery. These crude oils are light and sweet enough to allow us to blend higher percentages of lower cost crude oils such as heavy sour Canadian crude oil while maintaining our target medium sour blend with an API gravity of between 28 and 36 degrees and between 0.9% and 1.2% sulfur. Crude oils sourced outside of our proprietary gathering system are delivered to Cushing, Oklahoma by various pipelines including Seaway, Basin and Spearhead and subsequently to Coffeyville via the Plains pipeline and our own 145,000 bpd proprietary pipeline system. Beginning in March 2011, crude oils were also delivered through the Keystone pipeline.
For the year ended December 31, 2010, our crude oil supply blend was comprised of approximately 79% light sweet crude oil, 7% medium/light sour crude oil and 14% heavy sour crude oil. The light sweet crude oil includes our locally gathered crude oil.
For 2010, we obtained approximately 73% of the crude oil for our refinery, under a Crude Oil Supply Agreement, as amended (the â€śSupply Agreementâ€ť) with Vitol Inc. (â€śVitolâ€ť) that expires December 31, 2012. Under the Supply Agreement, Vitol supplies us with crude oil and intermediation logistics, which helps us reduce our inventory position and mitigate crude oil pricing risk.
Marketing and Distribution
We focus our petroleum product marketing efforts in the central mid-continent and Rocky Mountain areas because of their relative proximity to our refinery and their pipeline access. We engage in rack marketing, which is the supply of product through tanker trucks directly to customers located in close geographic proximity to our refinery and Phillipsburg terminal and to customers at throughput terminals on Magellanâ€™s and NuStarâ€™s refined products distribution systems. For the year ended December 31, 2010, approximately 36% of the refineryâ€™s products were sold through the rack system directly to retail and wholesale customers while the remaining 64% was sold through pipelines via bulk spot and term contracts. We make bulk sales (sales into third party pipelines) into the mid-continent markets via Magellan and into Colorado and other destinations utilizing the product pipeline networks owned by Magellan, Enterprise Products Operating, L.P. (â€śEnterpriseâ€ť) and NuStar.
Customers for our petroleum products include other refiners, convenience store companies, railroads and farm cooperatives. We have bulk term contracts in place with many of these customers, which typically extend from a few months to one year in length. For the year ended December 31, 2010, QuikTrip Corporation and Growmark, Inc. accounted for approximately 14% and 11%, respectively, of our petroleum business sales and approximately 66% of our petroleum sales were made to our ten largest customers. We sell bulk products based on industry market related indices such as Platts, Oil Price Information Service (â€śOPISâ€ť) or at a spot market price based on a Group 3 differential to the New York Mercantile Exchange (â€śNYMEXâ€ť). Through our rack marketing division, the rack sales are at daily posted prices which are influenced by the NYMEX, competitor pricing and Group 3 spot market differentials.
Our petroleum business competes primarily on the basis of price, reliability of supply, availability of multiple grades of products and location. The principal competitive factors affecting our refining operations are cost of crude oil and other feedstock costs, refinery complexity, refinery efficiency, refinery product mix and product distribution and transportation costs. The location of our refinery provides us with a reliable supply of crude oil and a transportation cost advantage over our competitors. We primarily compete against seven refineries operated in the mid-continent region. In addition to these refineries, our crude oil refinery in Coffeyville, Kansas competes against trading companies, as well as other refineries located outside the region that are linked to the mid-continent market through an extensive product pipeline system. These competitors include refineries located near the U.S. Gulf Coast and the Texas panhandle region. Our refinery competition also includes branded, integrated and independent oil refining companies, such as BP, Conoco Phillips, Frontier, Gary-Williams, Holly, NCRA, Valero and Shell.
Our petroleum business experiences seasonal effects as demand for gasoline products is generally higher during the summer months than during the winter months due to seasonal increases in highway traffic and road construction work. Demand for diesel fuel during the winter months also decreases due to winter agricultural work declines. As a result, our results of operations for the first and fourth calendar quarters are generally lower than for those for the second and third calendar quarters. In addition, unseasonably cool weather in the summer months and/or unseasonably warm weather in the winter months in the markets in which we sell our petroleum products can impact the demand for gasoline and diesel fuel.
Nitrogen Fertilizer Business
The nitrogen fertilizer business operates the only nitrogen fertilizer plant in North America that utilizes a pet coke gasification process to produce nitrogen fertilizer.
Raw Material Supply
The nitrogen fertilizer facilityâ€™s primary input is pet coke. During the past five years, over 70% of the nitrogen fertilizer businessâ€™ pet coke requirements on average were supplied by our adjacent crude oil refinery. Historically the nitrogen fertilizer business has obtained the remainder of its pet coke requirements from third parties such as other Midwestern refineries or pet coke brokers at spot prices. If necessary, the gasifier can also operate on low grade coal as an alternative, which provides an additional raw material source. There are significant supplies of low grade coal within a 60-mile radius of the nitrogen fertilizer plant.
Pet coke is produced as a by-product of the refineryâ€™s coker unit process. In order to refine heavy or sour crude oils, which are lower in cost and more prevalent than higher quality crude oil, refiners use coker units which enable refiners to further upgrade heavy crude oil.
The nitrogen fertilizer businessâ€™ plant is located in Coffeyville, Kansas, which is part of the Midwest pet coke market. The Midwest pet coke market is not subject to the same level of pet coke price variability as is the Gulf Coast pet coke market. Given the fact that the majority of the nitrogen fertilizer businessâ€™ pet coke suppliers are located in the Midwest, the nitrogen fertilizer businessâ€™ geographic location gives it a significant freight cost advantage over its Gulf Coast pet coke market competitors.
Linde, Inc. (â€śLindeâ€ť) owns, operates, and maintains the air separation plant that provides contract volumes of oxygen, nitrogen, and compressed dry air to the gasifier for a monthly fee. The nitrogen fertilizer business provides and pays for all utilities required for operation of the air separation plant. The agreement with Linde expires in 2020.
The nitrogen fertilizer business imports start-up steam for the nitrogen fertilizer plant from our crude oil refinery, and then exports steam back to the crude oil refinery once all units in the nitrogen fertilizer plant are in service. Monthly charges and credits are recorded with steam valued at the natural gas price for the month.
Nitrogen Production and Plant Reliability
The nitrogen fertilizer plant was completed in 2000 and, based upon data supplied by Blue Johnson, is the newest nitrogen fertilizer plant built in North America. The nitrogen fertilizer plant has two separate gasifiers to provide redundancy and reliability. The plant uses a gasification process to convert pet coke to high purity hydrogen for subsequent conversion to ammonia. The nitrogen fertilizer plant is capable of processing approximately 1,400 tons per day of pet coke from our crude oil refinery and third party sources and converting it into approximately 1,225 tons per day of ammonia. A majority of the ammonia is converted to approximately 2,025 tons per day of UAN. Typically 0.41 tons of ammonia is required to produce one ton of UAN.
The nitrogen fertilizer business schedules and provides routine maintenance to its critical equipment using its own maintenance technicians. Pursuant to a Technical Services Agreement with General Electric, which licenses the gasification technology to the nitrogen fertilizer business, General Electric experts provide technical advice and technological updates from their ongoing research as well as other licenseesâ€™ operating experiences. The pet coke gasification process is licensed from General Electric pursuant to a license agreement that is fully paid. The license grants the nitrogen fertilizer business perpetual rights to use the pet coke gasification process on specified terms and conditions.
Distribution, Sales and Marketing
The primary geographic markets for the nitrogen fertilizer businessâ€™ fertilizer products are Kansas, Missouri, Nebraska, Iowa, Illinois, Colorado and Texas. The nitrogen fertilizer business markets the ammonia products to industrial and agricultural customers and the UAN products to agricultural customers. The demand for nitrogen fertilizers occurs during three key periods. The highest level of ammonia demand is traditionally in the spring pre-plant period, from March through May. The second-highest period of demand occurs during fall pre-plant period in late October and November. The summer wheat pre-plant period occurs in August and September. In addition, smaller quantities of ammonia are sold in the off-season to fill available storage at the dealer level.
Ammonia and UAN are distributed by truck or by railcar. If delivered by truck, products are sold on a freight-on-board basis, and freight is normally arranged by the customer. The nitrogen fertilizer business leases a fleet of railcars for use in product delivery. The nitrogen fertilizer business also negotiates with distributors that have their own leased railcars to utilize these assets to deliver products. The nitrogen fertilizer business owns all of the truck and rail loading equipment at our nitrogen fertilizer facility. The nitrogen fertilizer business operates two truck loading and four rail loading racks for each of ammonia and UAN, with an additional four rail loading racks for UAN.
The nitrogen fertilizer business markets agricultural products to destinations that produce the best margins for the business. The UAN market is primarily located near the Union Pacific Railroad lines or destinations that can be supplied by truck. The ammonia market is primarily located near the Burlington Northern Santa Fe or Kansas City Southern Railroad lines or destinations that can be supplied by truck. By securing this business directly, the nitrogen fertilizer business reduces its dependence on distributors serving the same customer base, which enables the nitrogen fertilizer business to capture a larger margin and allows it to better control its product distribution. Most of the agricultural sales are made on a competitive spot basis. The nitrogen fertilizer business also offers products on a prepay basis for in-season demand. The heavy in-season demand periods are spring and fall in the corn belt and summer in the wheat belt. The wheat belt is the primary wheat producing region of the United States, which includes Kansas, North Dakota, Oklahoma, South Dakota and Texas. Some of the industrial sales are spot sales, but most are on annual or multi-year contracts.
The nitrogen fertilizer business uses forward sales of fertilizer products to optimize its asset utilization, planning process and production scheduling. These sales are made by offering customers the opportunity to purchase product on a forward basis at prices and delivery dates that it proposes. The nitrogen fertilizer business uses this program to varying degrees during the year and between years depending on market conditions and has the flexibility to increase or decrease forward sales depending on managementâ€™s view as to whether price environments will be increasing or decreasing. Fixing the selling prices of nitrogen fertilizer products months in advance of their ultimate delivery to customers typically causes the nitrogen fertilizer business reported selling prices and margins to differ from spot market prices and margins available at the time of shipment. Cash received as a result of prepayments is recognized on the balance sheet upon receipt along with a corresponding liability. Revenue, associated with prepaid sales, is recognized at the time the product is delivered to the customer.
The nitrogen fertilizer business sells ammonia to agricultural and industrial customers. Based upon a three-year average, the nitrogen fertilizer business has sold approximately 87% of the ammonia it produces to agricultural customers primarily located in the mid-continent area between North Texas and Canada, and approximately 13% to industrial customers. Agricultural customers include distributors such as MFA, United Suppliers, Inc., Brandt Consolidated Inc., Gavilon Fertilizers LLC, Transammonia, Inc., Agri Services of Brunswick, LLC, Interchem, and CHS Inc. Industrial customers include Tessenderlo Kerley, Inc., National Cooperative Refinery Association, and Dyno Nobel, Inc. The nitrogen fertilizer business sells UAN products to retailers and distributors. Given the nature of its business, and consistent with industry practice, the nitrogen fertilizer business does not have long-term minimum purchase contracts with any of its customers.
For the years ended December 31, 2010, 2009 and 2008, the top five ammonia customers in the aggregate represented 44.2%, 43.9% and 54.7% of the nitrogen fertilizer businessâ€™ ammonia sales, respectively, and the top five UAN customers in the aggregate represented 43.3%, 44.2% and 37.2% of the nitrogen fertilizer businessâ€™ UAN sales, respectively. Approximately 12%, 15% and 13% of the nitrogen fertilizer businessâ€™ aggregate sales for the years ended December 31, 2010, 2009, and 2008, respectively, were made to Gavilon Fertilizers LLC. Additionally, approximately 10% of the nitrogen fertilizer businessâ€™ aggregate sales for the year ended December 31, 2010 were made to United Suppliers, Inc.
MANAGEMENT DISCUSSION FROM LATEST 10K
Overview and Executive Summary
We are an independent petroleum refiner and marketer of high value transportation fuels. In addition, we currently own all of the interests (other than the managing general partner interest and associated IDRs) in a limited partnership which produces nitrogen fertilizers in the form of ammonia and UAN.
We operate under two business segments: petroleum and nitrogen fertilizer. For the fiscal years ended December 31, 2010, 2009 and 2008, we generated consolidated net sales of $4.1 billion, $3.1 billion and $5.0 billion, respectively, and operating income of $93.1 million, $208.2 million and $148.7 million, respectively. Our petroleum business generated net sales of $3.9 billion, $2.9 billion and $4.8 billion, respectively, over these periods. The nitrogen fertilizer business generated net sales of $180.5 million, $208.4 million and $263.0 million, respectively, over these periods. Our petroleum business generated operating income of $104.6 million, $170.2 million and $31.9 million for the years ended December 31, 2010, 2009 and 2008, respectively. Our nitrogen fertilizer business generated operating income of $20.4 million, $48.9 million and $116.8 million for the years ended December 31, 2010, 2009 and 2008, respectively.
Petroleum business. Our petroleum business includes a 115,000 bpd complex full coking medium-sour crude oil refinery in Coffeyville, Kansas. In addition, supporting businesses include (1) a crude oil gathering system with a gathering capacity of approximately 35,000 bpd serving Kansas, Oklahoma, western Missouri and southwestern Nebraska, (2) a rack marketing division supplying product through tanker trucks directly to customers located in close geographic proximity to Coffeyville and Phillipsburg, Kansas and at throughput terminals on Magellan and NuStarâ€™s refined products distribution systems, (3) a 145,000 bpd pipeline system that transports crude oil to our refinery and associated crude oil storage tanks with a capacity of 1.2 million barrels and (4) storage and terminal facilities for refined fuels and asphalt in Phillipsburg, Kansas. The crude oil gathering system is supported by approximately 300 miles of Company owned and leased pipeline.
Our refinery is situated approximately 100 miles from Cushing, Oklahoma, one of the largest crude oil trading and storage hubs in the United States. Cushing is supplied by numerous pipelines from locations including the U.S. Gulf Coast and Canada, providing us with access to virtually any crude oil variety in the world capable of being transported by pipeline. In addition to rack sales (sales which are made at terminals into third party tanker trucks), we make bulk sales (sales through third party pipelines) into the mid-continent markets via Magellan and into Colorado and other destinations utilizing the product pipeline networks owned by Magellan, Enterprise and NuStar.
Crude oil is supplied to our refinery through our gathering system and by a Plains pipeline from Cushing, Oklahoma. We maintain capacity on the Spearhead and Keystone pipelines (as discussed more fully in Note 15 to the financial statements) from Canada and have access to foreign and deepwater domestic crude oil via the Seaway Pipeline system from the U.S. Gulf Coast to Cushing. We also maintain leased storage in Cushing to facilitate optimal crude oil purchasing and blending. Our refinery blend consists of a combination of crude oil grades, including onshore and offshore domestic grades, various Canadian medium and heavy sours and sweet synthetics and from time-to-time a variety of South American, North Sea, Middle East and West African imported grades. The access to a variety of crude oils coupled with the complexity of our refinery allows us to purchase crude oil at a discount to WTI. Our consumed crude cost discount to WTI for 2010 was $3.39 per barrel compared to $4.65 per barrel in 2009 and $2.12 per barrel in 2008.
Nitrogen fertilizer business. The nitrogen fertilizer business consists of our interest in the Partnership, which is controlled by our affiliates. The nitrogen fertilizer business consists of a nitrogen fertilizer facility that includes a 1,225 ton-per-day ammonia unit, a 2,025 ton-per-day UAN unit and a gasifier complex having a capacity of 84 million standard cubic feet per day. The gasifier is a dual-train facility, with each gasifier able to function independently of the other, thereby providing redundancy and improving reliability. In 2010, the nitrogen fertilizer business produced 392,745 tons of ammonia, of which approximately 60% was upgraded into 578,272 tons of UAN.
The primary raw material feedstock utilized in our nitrogen fertilizer production process is pet coke, which is produced during the crude oil refining process. In contrast, substantially all of the nitrogen fertilizer businessesâ€™ competitors use natural gas as their primary raw material feedstock. Historically, pet coke has been significantly less expensive than natural gas on a per ton of fertilizer produced basis and pet coke prices have been more stable when compared to natural gas prices. By using pet coke as the primary raw material feedstock instead of natural gas, the nitrogen fertilizer business has historically been the lowest cost producer and marketer of ammonia and UAN fertilizers in North America. The nitrogen fertilizer business currently purchases most of its pet coke from CVR pursuant to a long-term agreement having an initial term that ends in 2027, subject to renewal. During the past five years, over 70% of the pet coke utilized by the nitrogen fertilizer plant was produced and supplied by CVRâ€™s crude oil refinery.
CVRâ€™s Shelf Registration Statements
On March 6, 2009, the SEC declared effective our registration statement on Form S-3 (initially filed on June 19, 2008 and amended on February 12, 2009), which enabled (1) the Company to offer and sell from time to time, in one or more public offerings or direct placements, up to $250.0 million of common stock, preferred stock, debt securities, warrants and subscription rights and (2) certain selling stockholders to offer and sell from time to time, in one or more offerings, up to 15,000,000 shares of our common stock. As afforded by the registration statement, a stockholder, CALLC II, sold into the public market 7,376,264 shares on November 12, 2009.
On July 1, 2010, the SEC declared effective a second registration statement on Form S-3 (initially filed on April 12, 2010 and amended on June 24, 2010), which enabled certain selling stockholders to offer and sell from time to time, in one or more offers up to 55,738,127 shares of our common stock. As afforded by the registration statement, 20,700,000 shares were sold into the public market on November 24, 2010, by the following stockholders: CALLC â€” 11,686,158 shares; CALLC II â€” 8,943,842 shares; and John J. Lipinski, our president, chief executive officer and chairman of the Board â€” 70,000 shares.
In February 2011, CALLC and CALLC II sold 11,759,023 shares and 15,113,254 shares, respectively, into the public market. As a result of this sale, CALLC II is no longer a shareholder of the Company. As of the date of this Report, CALLC owns 7,988,179 shares and has additional registration rights with respect to the remainder of their shares.
Major Influences on Results of Operations
Our earnings and cash flows from our petroleum operations are primarily affected by the relationship between refined product prices and the prices for crude oil and other feedstocks. Feedstocks are petroleum products, such as crude oil and natural gas liquids, that are processed and blended into refined products. The cost to acquire feedstocks and the price for which refined products are ultimately sold depend on factors beyond our control, including the supply of and demand for crude oil, as well as gasoline and other refined products which, in turn, depend on, among other factors, changes in domestic and foreign economies, weather conditions, domestic and foreign political affairs, production levels, the availability of imports, the marketing of competitive fuels and the extent of government regulation. Because we apply first-in, first-out (â€śFIFOâ€ť) accounting to value our inventory, crude oil price movements may impact net income in the short term because of changes in the value of our unhedged on-hand inventory. The effect of changes in crude oil prices on our results of operations is influenced by the rate at which the prices of refined products adjust to reflect these changes.
Feedstock and refined product prices are also affected by other factors, such as product pipeline capacity, local market conditions and the operating levels of competing refineries. Crude oil costs and the prices of refined products have historically been subject to wide fluctuations. An expansion or upgrade of our competitorsâ€™ facilities, price volatility, international political and economic developments and other factors beyond our control are likely to continue to play an important role in refining industry economics. These factors can impact, among other things, the level of inventories in the market, resulting in price volatility and a reduction in product margins. Moreover, the refining industry typically experiences seasonal fluctuations in demand for refined products, such as increases in the demand for gasoline during the summer driving season and for home heating oil during the winter, primarily in the Northeast. In addition to current market conditions, there are long-term factors that may impact the demand for refined products. These factors include mandated renewable fuels standards, proposed climate change laws and regulations, and increased mileage standards for vehicles.
In order to assess our operating performance, we compare our net sales, less cost of product sold, or our refining margin, against an industry refining margin benchmark. The industry refining margin is calculated by assuming that two barrels of benchmark light sweet crude oil is converted into one barrel of conventional gasoline and one barrel of distillate. This benchmark is referred to as the 2-1-1 crack spread. Because we calculate the benchmark margin using the market value of NYMEX gasoline and heating oil against the market value of NYMEX WTI, we refer to the benchmark as the NYMEX 2-1-1 crack spread, or simply, the 2-1-1 crack spread. The 2-1-1 crack spread is expressed in dollars per barrel and is a proxy for the per barrel margin that a sweet crude oil refinery would earn assuming it produced and sold the benchmark production of gasoline and distillate.
Although the 2-1-1 crack spread is a benchmark for our refinery margin, because our refinery has certain feedstock costs and logistical advantages as compared to a benchmark refinery and our product yield is less than total refinery throughput, the crack spread does not account for all the factors that affect refinery margin. Our refinery is able to process a blend of crude oil that includes quantities of heavy and medium sour crude oil that has historically cost less than WTI. We measure the cost advantage of our crude oil slate by calculating the spread between the price of our delivered crude oil and the price of WTI. The spread is referred to as our consumed crude oil differential. Our refinery margin can be impacted significantly by the consumed crude oil differential. Our consumed crude oil differential will move directionally with changes in the WTS differential to WTI and the West Canadian Select (â€śWCSâ€ť) differential to WTI as both these differentials indicate the relative price of heavier, more sour, slate to WTI. The correlation between our consumed crude oil differential and published differentials will vary depending on the volume of light medium sour crude oil and heavy sour crude oil we purchase as a percent of our total crude oil volume and will correlate more closely with such published differentials the heavier and more sour the crude oil slate.
We produce a high volume of high value products, such as gasoline and distillates. We benefit from the fact that our marketing region consumes more refined products than it produces so that the market prices in our region include the logistics cost for U.S. Gulf Coast refineries to ship into our region. The result of this logistical advantage and the fact that the actual product specifications used to determine the NYMEX 2-1-1 crack spread are different from the actual production in our refinery is that prices we realize are different than those used in determining the 2-1-1 crack spread. The difference between our price and the price used to calculate the 2-1-1 crack spread is referred to as gasoline PADD II, Group 3 vs. NYMEX basis, or gasoline basis, and Ultra Low Sulfur Diesel PADD II, Group 3 vs. NYMEX basis, or Ultra Low Sulfur Diesel basis. If both gasoline and Ultra Low Sulfur Diesel basis are greater than zero, this means that prices in our marketing area exceed those used in the 2-1-1 crack spread.
Our direct operating expense structure is also important to our profitability. Major direct operating expenses include energy, employee labor, maintenance, contract labor, and environmental compliance. Our predominant variable cost is energy, which is comprised primarily of electrical cost and natural gas. We are therefore sensitive to the movements of natural gas prices. Assuming the same rate of consumption of natural gas for the year ended December 31, 2010, a $1.00 change in natural gas prices would have increased or decreased our natural gas costs by approximately $3.2 million.
Because petroleum feedstocks and products are essentially commodities, we have no control over the changing market. Therefore, the lower target inventory we are able to maintain significantly reduces the impact of commodity price volatility on our petroleum product inventory position relative to other refiners. This target inventory position is generally not hedged. To the extent our inventory position deviates from the target level, we consider risk mitigation activities usually through the purchase or sale of futures contracts on the NYMEX. Our hedging activities carry customary time, location and product grade basis risks generally associated with hedging activities. Because most of our titled inventory is valued under the FIFO costing method, price fluctuations on our target level of titled inventory have a major effect on our financial results.
Consistent, safe, and reliable operations at our refinery are key to our financial performance and results of operations. Unplanned downtime at our refinery may result in lost margin opportunity, increased maintenance expense and a temporary increase in working capital investment and related inventory position. We seek to mitigate the financial impact of planned downtime, such as major turnaround maintenance, through a diligent planning process that takes into account the margin environment, the availability of resources to perform the needed maintenance, feedstock logistics and other factors. The refinery generally undergoes a facility turnaround every four to five years. The length of the turnaround is contingent upon the scope of work to be completed. The next turnaround for our refinery is scheduled to commence in the fourth quarter of 2011 and will be completed in the first quarter of 2012.
Our refinery experienced an equipment malfunction and small fire in connection with its FCCU on December 28, 2010, which led to reduced crude throughput and cost approximately $6.5 million to repair (before any insurance recovery). We used the resulting downtime to perform certain turnaround activities which had otherwise been scheduled for later in 2011, along with opportunistic maintenance, which cost approximately $4 million in total. The refinery returned to full operations on January 26, 2011. This interruption adversely impacted the production of refined products for the petroleum business in the first quarter of 2011. We estimate that approximately 1.9 million barrels of crude oil processing will be lost in the first quarter due to this incident.
Nitrogen Fertilizer Business
In the nitrogen fertilizer business, earnings and cash flows from operations are primarily affected by the relationship between nitrogen fertilizer product prices and direct operating expenses. Unlike its competitors, the nitrogen fertilizer business does not use natural gas as a feedstock and uses a minimal amount of natural gas as an energy source in its operations. As a result, volatile swings in natural gas prices have a minimal impact on its results of operations. Instead, our adjacent refinery supplies the nitrogen fertilizer business with most of the pet coke feedstock it needs pursuant to a long-term pet coke supply agreement entered into in October 2007. The price at which nitrogen fertilizer products are ultimately sold depends on numerous factors, including the global supply and demand for nitrogen fertilizer products which, in turn, depends on, among other factors, world grain demand and production levels, changes in world population, the cost and availability of fertilizer transportation infrastructure, weather conditions, the availability of imports, and the extent of government intervention in agriculture markets. Nitrogen fertilizer prices are also affected by local factors, including local market conditions and the operating levels of competing facilities. An expansion or upgrade of competitorsâ€™ facilities, international political and economic developments and other factors are likely to continue to play an important role in nitrogen fertilizer industry economics. These factors can impact, among other things, the level of inventories in the market, resulting in price volatility and a reduction in product margins. Moreover, the industry typically experiences seasonal fluctuations in demand for nitrogen fertilizer products.
In addition, the demand for fertilizers is affected by the aggregate crop planting decisions and fertilizer application rate decisions of individual farmers. Individual farmers make planting decisions based largely on the prospective profitability of a harvest, while the specific varieties and amounts of fertilizer they apply depend on factors like crop prices, their current liquidity, soil conditions, weather patterns and the types of crops planted.
Natural gas is the most significant raw material required in our competitorsâ€™ production of nitrogen fertilizers. Over the past several years, natural gas prices have experienced high levels of price volatility. This pricing and volatility has a direct impact on our competitorsâ€™ cost of producing nitrogen fertilizer.
In order to assess the operating performance of the nitrogen fertilizer business, we calculate plant gate price to determine our operating margin. Plant gate price refers to the unit price of fertilizer, in dollars per ton, offered on a delivered basis, excluding shipment costs.
We have a significant transportation cost advantage when compared to our out-of-region competitors in serving the attractive U.S. farm belt agricultural market. In 2010, approximately 45% of the corn planted in the United States was grown within a $35/UAN ton freight train rate of the nitrogen fertilizer plant. We are therefore able to cost-effectively sell substantially all of our products in the higher margin agricultural market, whereas a significant portion of our competitorsâ€™ revenues are derived from the lower margin industrial market. Our location on Union Pacificâ€™s main line increases our transportation cost advantage by lowering the costs of bringing our products to customers, assuming freight rates and pipeline tariffs for U.S. Gulf Coast importers as recently in effect. Our products leave the plant either in trucks for direct shipment to customers or in railcars for destinations located principally on the Union Pacific Railroad, and we do not incur any intermediate transfer, storage, barge freight or pipeline freight charges. We estimate that our plant enjoys a transportation cost advantage of approximately $25 per ton over competitors located in the U.S. Gulf Coast. Selling products to customers within economic rail transportation limits of the nitrogen fertilizer plant and keeping transportation costs low are keys to maintaining profitability.
The value of nitrogen fertilizer products is also an important consideration in understanding our results. During 2010, the nitrogen fertilizer business upgraded approximately 60% of its ammonia production into UAN, a product that presently generates a greater value than ammonia. UAN production is a major contributor to our profitability.
The direct operating expense structure of the nitrogen fertilizer business also directly affects its profitability. Using a pet coke gasification process, the nitrogen fertilizer business has a significantly higher percentage of fixed costs than a natural gas-based fertilizer plant. Major fixed operating expenses include electrical energy, employee labor, maintenance, including contract labor, and outside services. These costs comprise the fixed costs associated with the nitrogen fertilizer plant. Variable costs associated with the nitrogen fertilizer plant averaged approximately 14% of direct operating expenses over the 24 months ended December 31, 2010. The average annual operating costs over the 24 months ended December 31, 2010 have approximated $86 million, of which substantially all are fixed in nature.
The nitrogen fertilizer businessâ€™ largest raw material expense is pet coke, which it purchases from the petroleum business and third parties. In December 31, 2010, 2009 and 2008, the nitrogen fertilizer business spent $7.4 million, $12.8 million and $14.1 million, respectively, for pet coke, which equaled an average cost per ton of $17, $27 and $31, respectively.
Consistent, safe, and reliable operations at the nitrogen fertilizer plant are critical to its financial performance and results of operations. Unplanned downtime of the nitrogen fertilizer plant may result in lost margin opportunity, increased maintenance expense and a temporary increase in working capital investment and related inventory position. The financial impact of planned downtime, such as major turnaround maintenance, is mitigated through a diligent planning process that takes into account margin environment, the availability of resources to perform the needed maintenance, feedstock logistics and other factors. The nitrogen fertilizer plant generally undergoes a facility turnaround every two years. The turnaround typically lasts 13-15 days each turnaround year and costs approximately $3 million to $5 million per turnaround. The nitrogen fertilizer plant underwent a turnaround in the fourth quarter of 2010, at a cost of approximately $3.5 million. In connection with the biennial turnaround, the nitrogen fertilizer business also wrote off approximately $1.4 million of fixed assets. The next facility turnaround is currently scheduled for the fourth quarter of 2012.
Agreements Between CVR Energy and the Partnership
In connection with our initial public offering and the transfer of the nitrogen fertilizer business to the Partnership in October 2007, we entered into a number of agreements with the Partnership that govern the business relations between the parties. These include the pet coke supply agreement mentioned above, under which the petroleum business sells pet coke to the nitrogen fertilizer business; a services agreement, in which our management operates the nitrogen fertilizer business; a feedstock and shared services agreement, which governs the provision of feedstocks, including hydrogen, high-pressure steam, nitrogen, instrument air, oxygen and natural gas; a raw water and facilities sharing agreement, which allocates raw water resources between the two businesses; an easement agreement; an environmental agreement; and a lease agreement pursuant to which we lease office space and laboratory space to the Partnership. We expect that certain of these agreements would be amended and/or restated in connection with any offering of the Partnership equity interests in a public offering.
The nitrogen fertilizer business obtains most (over 70% on average during the last five years) of the pet coke it needs from our adjacent crude oil refinery pursuant to the pet coke supply agreement, and procures the remainder on the open market. The price the nitrogen fertilizer business pays pursuant to the pet coke supply agreement is based on the lesser of a pet coke price derived from the price received for UAN, or the UAN-based price, and a pet coke price index. The UAN-based price begins with a pet coke price of $25 per ton based on a price per ton for UAN (exclusive of transportation cost), or netback price, of $205 per ton, and adjusts up or down $0.50 per ton for every $1.00 change in the netback price. The UAN-based price has a ceiling of $40 per ton and a floor of $5 per ton.
For the periods ending December 31, 2010, 2009 and 2008, the nitrogen fertilizer segment was charged $10.6 million, $12.1 million and $13.2 million, respectively, for management services.
Factors Affecting Comparability
Our historical results of operations for the periods presented may not be comparable with prior periods or to our results of operations in the future for the reasons discussed below.
Refinancing and Prior Indebtedness
In January 2010, we made a voluntary unscheduled principal payment of $20.0 million on our tranche D term loans. In addition, we made a second voluntary unscheduled principal payment of $5.0 million in February 2010, reducing our tranche D term loansâ€™ outstanding principal balance to $453.3 million. In connection with these voluntary prepayments, we paid a 2.0% premium totaling $0.5 million to the lenders of our first priority credit facility. In April 2010, we paid off the remaining $453.0 million tranche D term loans. This payoff was made possible by the issuance of $275.0 million aggregate principal amount of 9.0% First Lien Senior Secured Notes due 2015 (the â€śFirst Lien Notesâ€ť) and $225.0 million aggregate principal amount of 10.875% Second Lien Senior Secured Notes due 2017 (the â€śSecond Lien Notesâ€ť and together with the First Lien Notes, the â€śNotesâ€ť). In connection with the payoff, we paid a 2.0% premium totaling approximately $9.1 million. In addition, previously deferred financing costs totaling approximately $5.4 million associated with the first priority credit facility term debt were also written off at that time. The Company also recognized approximately $0.1 million of third party costs at the time the Notes were issued. Other financing and third party costs incurred at the time were deferred and are amortized over the respective terms of the Notes. The premiums paid, previously deferred financing costs subject to write-off and immediately recognized third party expenses are reflected as a loss on extinguishment of debt in our Consolidated Statements of Operations.
In December 2010, we made a voluntary unscheduled payment of $27.5 million on our First Lien Notes, resulting in a premium payment of 3.0% and a partial write-off of previously deferred financing costs and unamortized original issue discount totaling approximately $1.6 million, which was recognized as a loss on extinguishment of debt in our Consolidated Statements of Operations.
On March 12, 2010, CRLLC entered into a fourth amendment to its first priority credit facility. The amendment, among other things, provided CRLLC the opportunity to issue junior lien debt, subject to certain conditions, including, but not limited to, a requirement that 100% of the proceeds be used to prepay the tranche D term loans. The amendment also provided CRLLC the ability to issue up to $350.0 million of first lien debt, subject to certain conditions, including, but not limited to, a requirement that 100% of the proceeds be used to prepay all of the remaining tranche D term loans.
In connection with the fourth amendment, CRLLC incurred lender fees of approximately $4.5 million. These fees were recorded as deferred financing costs in the first quarter of 2010. In addition, CRLLC incurred third party costs of approximately $1.5 million primarily consisting of administrative and legal costs. Of the third party costs incurred we expensed $1.1 million in 2010 and the remaining $0.4 million was recorded as additional deferred financing costs.
On October 2, 2009, CRLLC entered into a third amendment to its first priority credit facility. The amendment was entered into, among other things, to provide financial flexibility to us through modifications to our financial covenants for the remaining term of the credit facility. Additionally, the amendment afforded CVR (which is not a party to the credit agreement) the opportunity to incur indebtedness by allowing subsidiaries of CVR, which are parties to the credit agreement, to distribute dividends to CVR in order to fund interest payments of up to $20.0 million annually, so long as CVR agreed, for the benefit of the lenders to contribute at least 35% of the net proceeds of such indebtedness to CRLLC for the purpose of repaying the tranche D term loans under the credit agreement. In addition, CVR is required to agree for the benefit of the lenders not to use the proceeds of such indebtedness to repurchase its capital stock or pay any dividend or other distributions on its capital stock.
In connection with the third amendment, CRLLC incurred lender fees of approximately $2.6 million. These fees were recorded as deferred financing costs in the fourth quarter of 2009. In addition, CRLLC incurred third party costs of approximately $1.4 million primarily consisting of administrative and legal costs. Of the third party costs incurred, we expensed approximately $0.9 million in 2009. The remaining $0.5 million was recorded as additional deferred financing costs.
During June 2009, CRLLC successfully reduced the first priority funded letter of credit from $150.0 million to $60.0 million. This funded letter of credit was issued in support of our Cash Flow Swap. As a result of the third amendment, CRLLC terminated the Cash Flow Swap in advance of its original expiration of June 30, 2010. As a result of the reduction of the first priority funded letter of credit and eventual termination of the remaining $60.0 million first priority funded letter of credit facility on October 15, 2009, previously deferred financing costs totaling approximately $2.1 million were written off. This amount is reflected in our Consolidated Statements of Operations as a loss on extinguishment of debt.
On December 22, 2008, CRLLC amended its outstanding credit facility for the purpose of modifying certain restrictive covenants and related financial definitions. In connection with this amendment, we paid approximately $8.5 million of lender and third party costs. We immediately expensed $4.7 million of these costs and the remainder was deferred to be amortized to interest expense over the respective term of the first priority term debt, revolver and funded letters of credit, as applicable. Previously deferred financing costs of $5.3 million were also written off at that time. The total amount expensed in 2008 of $10.0 million, is reflected in our Consolidated Statements of Operations as a loss on extinguishment of debt.
Goodwill Impairment Charges
As a result of our annual review of goodwill in 2008, we recorded non-cash charges of $42.8 million during the fourth quarter, to write-off the entire balance of the petroleum segmentâ€™s goodwill. The write-off was associated with lower cash flow forecasts as well as a significant decline in market capitalization in the fourth quarter of 2008 that resulted in large part from severe disruptions in the capital and commodities markets.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
This Form 10-Q, including this Managementâ€™s Discussion and Analysis of Financial Condition and Results of Operations, contains â€śforward-looking statementsâ€ť as defined by the Securities and Exchange Commission (the â€śSECâ€ť). Such statements are those concerning contemplated transactions and strategic plans, expectations and objectives for future operations. These include, without limitation:
â€˘ statements, other than statements of historical fact, that address activities, events or developments that we expect, believe or anticipate will or may occur in the future;
â€˘ statements relating to future financial performance, future capital sources and other matters; and
â€˘ any other statements preceded by, followed by or that include the words â€śanticipates,â€ť â€śbelieves,â€ť â€śexpects,â€ť â€śplans,â€ť â€śintends,â€ť â€śestimates,â€ť â€śprojects,â€ť â€ścould,â€ť â€śshould,â€ť â€śmay,â€ť or similar expressions.
Although we believe that our plans, intentions and expectations reflected in or suggested by the forward-looking statements we make in this Form 10-Q, including this Managementâ€™s Discussion and Analysis of Financial Condition and Results of Operations, are reasonable, we can give no assurance that such plans, intentions or expectations will be achieved. These statements are based on assumptions made by us based on our experience and perception of historical trends, current conditions, expected future developments and other factors that we believe are appropriate in the circumstances. Such statements are subject to a number of risks and uncertainties, many of which are beyond our control. You are cautioned that any such statements are not guarantees of future performance and actual results or developments may differ materially from those projected in the forward-looking statements as a result of various factors, including but not limited to those set forth under â€śRisk Factorsâ€ť in our Annual Report on Form 10-K for the year ended December 31, 2010 and in our Form 10-Q for the quarter ended March 31, 2011. Such factors include, among others:
â€˘ volatile margins in the refining industry;
â€˘ exposure to the risks associated with volatile crude oil prices;
â€˘ the availability of adequate cash and other sources of liquidity for our capital needs;
â€˘ our ability to forecast our future financial condition or results of operations and our future revenues and expenses;
â€˘ disruption of our ability to obtain an adequate supply of crude oil;
â€˘ interruption of the pipelines supplying feedstock and in the distribution of our products;
â€˘ competition in the petroleum and nitrogen fertilizer businesses;
â€˘ capital expenditures and potential liabilities arising from environmental laws and regulations;
â€˘ changes in our credit profile;
â€˘ the cyclical nature of the nitrogen fertilizer business;
â€˘ the seasonal nature of our business;
â€˘ the supply and price levels of essential raw materials;
â€˘ the risk of a material decline in production at our refinery and nitrogen fertilizer plant;
â€˘ potential operating hazards from accidents, fire, severe weather, floods or other natural disasters;
â€˘ the risk associated with governmental policies affecting the agricultural industry;
â€˘ the volatile nature of ammonia, potential liability for accidents involving ammonia that cause interruption to our businesses, severe damage to property and/or injury to the environment and human health and potential increased costs relating to the transport of ammonia;
â€˘ the dependence of the nitrogen fertilizer operations on a few third-party suppliers, including providers of transportation services and equipment;
â€˘ new regulations concerning the transportation of hazardous chemicals, risks of terrorism and the security of chemical manufacturing facilities;
â€˘ our dependence on significant customers;
â€˘ the potential loss of the nitrogen fertilizer businessâ€™ transportation cost advantage over its competitors;
â€˘ our potential inability to successfully implement our business strategies, including the completion of significant capital programs;
â€˘ our ability to continue to license the technology used in our operations;
â€˘ existing and proposed environmental laws and regulations, including those relating to climate change, alternative energy or fuel sources, and the end-use and application of fertilizers;
â€˘ refinery and nitrogen fertilizer facility operating hazards and interruptions, including unscheduled maintenance or downtime, and the availability of adequate insurance coverage;
â€˘ our significant indebtedness, including restrictions in our debt agreements;
â€˘ our ability to consummate the Gary-Williams Energy Company (Wynnewood refinery) acquisition and the timing for the closing of such acquisition;
â€˘ our ability to complete the successful integration of the Gary-Williams Energy Company (Wynnewood refinery) into our business and to realize the synergies from such acquisition;
â€˘ unforeseen liabilities associated with the acquisition of Gary-Williams Energy Corporation; and
â€˘ instability and volatility in the capital and credit markets.
All forward-looking statements contained in this Form 10-Q speak only as of the date of this document. We undertake no obligation to update or revise publicly any forward-looking statements to reflect events or circumstances that occur after the date of this Form 10-Q, or to reflect the occurrence of unanticipated events.
CVR Energy, Inc. and, unless the context requires otherwise, its subsidiaries (â€śCVRâ€ť, the â€śCompanyâ€ť, â€śweâ€ť, â€śusâ€ť or â€śourâ€ť) is an independent refiner and marketer of high value transportation fuels. In addition, we own the general partner and approximately 70% of the common units of CVR Partners, LP (the â€śPartnershipâ€ť), a limited partnership which produces nitrogen fertilizers, ammonia and UAN.
Coffeyville Acquisition LLC (â€śCALLCâ€ť) formed CVR Energy, Inc. as a wholly-owned subsidiary, incorporated in Delaware in September 2006, in order to effect an initial public offering, which was consummated on October 26, 2007. In conjunction with the initial public offering, a restructuring occurred in which CVR became a direct or indirect owner of all of the subsidiaries of CALLC. Additionally, in connection with the initial public offering, CALLC was split into two entities: CALLC and Coffeyville Acquisition II LLC (â€śCALLC IIâ€ť).
As of December 31, 2010, approximately 40% of our outstanding shares were owned by certain funds affiliated with Goldman Sachs & Co. and Kelso & Company, L.P. (â€śGSâ€ť and â€śKelsoâ€ť, respectively), through their respective ownership of CALLC II and CALLC. On February 8, 2011, CALLC and CALLC II completed a sale of our common stock into the public market pursuant to a registered public offering. As a result of this offering, GS sold into the public market its remaining ownership interests in CVR Energy and Kelso substantially reduced its interest in the Company. On May 26, 2011, Kelso completed a registered public offering, whereby Kelso sold into the public market its remaining ownership interests in CVR Energy.
On April 13, 2011, the Partnership completed its initial public offering of its common units representing limited partner interests (the â€śOfferingâ€ť). The Partnership sold 22,080,000 common units (such amount includes common units issued pursuant to the exercise of the underwritersâ€™ over-allotment option) at a price of $16.00 per common unit, resulting in gross proceeds (including the gross proceeds from the exercise of the underwritersâ€™ over-allotment option) of $353.3 million before giving effect to underwriting discounts and other offering costs. The Partnershipâ€™s units are listed on the New York Stock Exchange and are traded under the symbol â€śUAN.â€ť In connection with the Offering, the Partnership paid approximately $24.7 million in underwriting fees and incurred approximately $4.4 million of other offering costs. Approximately $5.7 million was paid to an affiliate of GS which was acting as a joint book-running manager. Until the completion of the February 2011 secondary offering (described above), an affiliate of GS was a stockholder and a related party of the Company. As a result of the Offering, CVR indirectly owns approximately 70% of the Partnershipâ€™s outstanding common units and 100% of the Partnershipâ€™s general partner with its non-economic general partner interest.
We operate under two business segments: petroleum and nitrogen fertilizer. Throughout the remainder of this document, our business segments are referred to as our â€śpetroleum businessâ€ť and our â€śnitrogen fertilizer business,â€ť respectively.
Petroleum business. Our petroleum business includes a 115,000 bpd complex full coking medium-sour crude oil refinery in Coffeyville, Kansas. In addition, supporting businesses include (1) a crude oil gathering system with a gathering capacity of approximately 35,000 bpd serving Kansas, Oklahoma, western Missouri and southwestern Nebraska, (2) a rack marketing division supplying product through tanker trucks directly to customers located in close geographic proximity to Coffeyville, Kansas and at throughput terminals on Magellan and NuStar Energy, LPâ€™s (â€śNuStarâ€ť) refined products distribution systems and (3) a 145,000 bpd pipeline system that transports crude oil to our refinery with 1.2 million barrels of associated company-owned storage tanks and an additional 2.7 million barrels of leased storage capacity located at Cushing, Oklahoma. The crude oil gathering system is supported by approximately 300 miles of Company owned and leased pipeline.
Our refinery is situated approximately 100 miles from Cushing, Oklahoma, one of the largest crude oil trading and storage hubs in the United States. Cushing is supplied by numerous pipelines from locations including the U.S. Gulf Coast and Canada, providing us with access to virtually any crude oil variety in the world capable of being transported by pipeline. In addition to rack sales (sales which are made at terminals into third party tanker trucks), we make bulk sales (sales through third party pipelines) into the mid-continent markets via Magellan and into Colorado and other destinations utilizing the product pipeline networks owned by Magellan, Enterprise Products Operating, L.P. and NuStar.
Crude oil is supplied to our refinery through our gathering system and by a Plains pipeline from Cushing, Oklahoma. We maintain capacity on the Spearhead and Keystone pipelines (as discussed more fully in Note 11 to the financial statements) from Canada and have access to foreign and deepwater domestic crude oil via the Seaway Pipeline system from the U.S. Gulf Coast to Cushing. We also maintain leased storage in Cushing to facilitate optimal crude oil purchasing and blending. Our refinery blend consists of a combination of crude oil grades, including onshore and offshore domestic grades, various Canadian medium and heavy sours and sweet synthetics and from time to time a variety of South American, North Sea, Middle East and West African imported grades. The access to a variety of crude oils coupled with the complexity of our refinery allows us to purchase crude oil at a discount to WTI. Our consumed crude cost discount to WTI for the third quarter of 2011 was $(2.57) per barrel compared to $(3.70) per barrel in the third quarter of 2010.
Nitrogen fertilizer business. The nitrogen fertilizer business consists of our interest in the Partnership. We own the general partner and approximately 70% of the common units of the Partnership. The nitrogen fertilizer business consists of a nitrogen fertilizer manufacturing facility that is the only operation in North America that utilizes a petroleum coke, or pet coke, gasification process to produce nitrogen fertilizer. The facility includes a 1,225 ton-per-day ammonia unit, a 2,025 ton-per-day UAN unit and a gasifier complex having a capacity of 84 million standard cubic feet per day. The gasifier is a dual-train facility, with each gasifier able to function independently of the other, thereby providing redundancy and improving reliability. The nitrogen fertilizer business upgrades a majority of the ammonia it produces to higher margin UAN fertilizer, an aqueous solution of urea and ammonium nitrate which has historically commanded a premium price over ammonia. In 2010, the nitrogen fertilizer business produced 392,745 tons of ammonia, of which approximately 60% was upgraded into 578,272 tons of UAN. For the nine months ended September 30, 2011, the nitrogen fertilizer business upgraded approximately 71% of our ammonia production into UAN, a product that presently generates a greater profitability than ammonia.
The primary raw material feedstock utilized in our nitrogen fertilizer production process is pet coke, which is produced during the crude oil refining process. In contrast, substantially all of the nitrogen fertilizer businessâ€™ competitors use natural gas as their primary raw material feedstock. Historically, pet coke has been significantly less expensive than natural gas on a per ton of fertilizer produced basis and pet coke prices have been more stable when compared to natural gas prices. By using pet coke as the primary raw material feedstock instead of natural gas, the nitrogen fertilizer business has historically been the lowest cost producer and marketer of ammonia and UAN fertilizers in North America. The nitrogen fertilizer business currently purchases most of its pet coke from CVR pursuant to a long-term agreement having an initial term that ends in 2027, subject to renewal. During the past five years, over 70% of the pet coke utilized by the nitrogen fertilizer plant was produced and supplied by CVRâ€™s crude oil refinery. Recent Developments
On November 2, 2011, the Company announced that it and CRLLC entered into a Stock Purchase and Sale Agreement (the â€śPurchase Agreementâ€ť) to acquire (the â€śAcquisitionâ€ť) all of the issued and outstanding shares of the Gary-Williams Energy Company (â€śGWECâ€ť). The associated assets include a 70,000 bpd refinery located in Wynnewood, Oklahoma. Under the terms of the Purchase Agreement, at the closing of the Acquisition, CRLLC will pay a purchase price of $525.0 million in cash (less the deposit of approximately $26.3 million CRLLC paid on November 2, 2011 upon the signing of the Purchase Agreement), subject to certain adjustments based on the working capital of GWEC at the closing, estimated to be $100.0 million as of the date of this Quarterly Report on Form 10-Q.
The closing of the Acquisition is subject to the satisfaction or waiver of certain customary closing conditions including, among others, expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 and the absence of any law, regulation, order or injunction prohibiting the Acquisition. Each partyâ€™s obligation to consummate the Acquisition is subject to certain other conditions, including the material accuracy of the representations and warranties of the other party (generally subject to a material adverse change standard); and in the case of CRLLCâ€™s obligations, there being no material adverse change to GWEC after the signing of the Purchase Agreement; and material compliance by the other party with its obligations under the Purchase Agreement. The Purchase Agreement contains certain customary termination rights for both CRLLC and the seller, including right of either party to terminate in the event that the Acquisition has not been completed by March 31, 2012.
On November 2, 2011, CRLLC entered into a commitment letter with a syndicate of banks for a senior secured one year bridge loan facility of up to $275.0 million to fund the Acquisition. Funding of the bridge loans will be subject to certain customary conditions. On November 2, 2011, CRLLC also entered into a commitment letter with a syndicate of banks who have committed to provide $150.0 million in aggregate incremental commitments under the ABL credit facility, in accordance with and subject to the terms of the ABL credit facility. The incremental ABL commitments are subject to the satisfaction of certain customary conditions.
After completing the transaction, the Company will have a total crude oil throughput capacity of approximately 185,000 barrels per day.
Good morning, everyone. We very much appreciate you being here for our CVR Energy conference call this morning. With me today are Jack Lipinski, our Chief Executive Officer; Ed Morgan, our Chief Financial Officer; and Stan Riemann, our Chief Operating Officer.
Prior to discussing of our 2011 third quarter results, weâ€™re required to make the following Safe Harbor statement. In accordance with Federal Securities laws, the statements in this earnings call relating to matters that are not historical facts are forward-looking statements based on managementâ€™s belief and assumptions, using currently available information and expectations as of this date and are not guarantees of future performance and do involve certain risks and uncertainties, including those noted in our filings with the Securities and Exchange Commission.
This presentation includes various non-GAAP financial measures. The disclosures related to such non-GAAP measures including reconciliation to the most directly comparable GAAP financial measures are included in our 2011 third quarter earnings release that we filed with the SEC yesterday after closing the market.
With that said, Iâ€™ll turn back over to Jack Lipinski, our Chief Executive Officer. Jack?
Thank you, Jay. Good morning all. Thanks for joining us. As you know from our filings and new releases yesterday, we have a lot to talk about. First â€“ and I will review the earnings we reported after market close yesterday, then Iâ€™ll talk about the turnaround that weâ€™re just completing, and then weâ€™ll spend some time putting some color on the acquisition of the Gary-Williams Energy Corporation and its Wynnewood refinery in Wynnewood, Oklahoma.
Let me start with our third quarter earnings. Obviously, weâ€™re pleased with these numbers. These were produced even as we answered a major turnaround at refinery at the end of September. Our consolidated net income was $109.3 million, or a $1.25 for fully diluted share on net sales of $1.35 billion. Adjusted net income was 137.4 million or $1.57 for fully diluted share. Typically, adjustments include FIFO, major turnaround expense, and other items. Ed will provide you more details on the numbers during his remarks.
Today our consolidated businesses had approximately 898 million in cash and cash equivalents and cash invested in excess working inventories added an additional $37 million at the end of the third quarter. Cash on balance sheet has increased nearly $110 million since our last investor call.
Let me start by talking about our petroleum business, which is our largest segment. We had operating income of $179.8 million of net sales of just under $1.3 billion. Adjusted EBITDA for the petroleum segment was $232 million and comparatively, that was $62 million a year ago. For the third quarter, we processed 112,880 barrels a day of crude and total throughput was just a little over 116,000 barrels a day. These numbers are a little bit lower than what we produced last year, and there are a number of reasons.
During the quarter, as you heard on our last investor call, we had operational issues with our CCR, which hampered our crude throughput in the quarter. And more importantly, we reduced crude rate at the end of September to manage inventories as we began shutting down some preparation for our turnaround.
Again, overall, weâ€™re pretty pleased with the way the quarter turned out. We continue to see the NYMEX 2-1-1 crack spreads significantly above historical levels. During the quarter, they averaged $3.92 a barrel and that compares to a little over $9 a barrel a year ago.
Today the NYMEX 2-1-1 cracks stands a little over $25 a barrels and on top of that, we enjoy a positive product basis of almost $3 a barrel. In the third quarter, we realized an average refining margin of $25.3 per throughput barrel and again, just put some color against last year, that was $9.84 last year same quarter.
As you know, weâ€™re a 100% WTI-based refiner and we continue to capture the difference in price between Brandt and WTI crude in our margins. The Brandt-TI relationship will continue to define our market.
Today â€“ or actually at the close business yesterday, the spread was just under $17 a barrel. This year, weâ€™ve seen it range from a low of $3.29 to a high of $27.88.
During the quarter, we did see heavy crude differentials tighten and as a result, we processed heavy barrels during the period. Early in the year, heavy differentials were against $20 a barrels and thatâ€™s against WTI. They averaged $14.09 during the second quarter, and today they are slightly above $11.
We have seen the â€“ also â€“ we have also seen the tightening of the sweet hour spreads, and thatâ€™s the difference between WTI and WTS. And also, we ran heavy barrels not because of the price differential, but as we have to turnaround we wanted the minimize inventories of heavy and intermediate stocks.
Iâ€™d like to mention our expanding gathering business. In the third quarter, we set another quarter with total leased crude volumes averaging 36,700 barrels a day. These early price locally gathered barrels on important turnover refinery economics and costly though and become even more important as we expand our refining footprint with the pending acquisition of Wynnewood refinery, and Iâ€™ll talk more about that in a minute.
About turnaround, toward the end of September, again, we began lowering crude rates and preparation for turnaround. Actual maintenance work began in the first week of October as scheduled. Remember from our prior calls, this is a bifurcated turnaround with about two-thirds of all of the work being accomplished this fall and the remainder will be accomplished in the first quarter of 2012.
The turnaround proceeded well. All units have been turned over as of this morning for operations for restart. But during a restart on our CCR, we experienced major mechanical problem with our recycle compressor which is going to delay us recovering to full crude rates for 10 to 12 more days. This was completely unexpected, especially following maintenance. And previously indicated that we would run between 90,000 and 95,000 barrels a day for the fourth quarter. We expect that now to be more in the range of 80,000 to 85,000 barrels a day. We should have the compressor repair. Itâ€™s in the shop right now, and the refinery back at full rate by â€“ hopefully by the end of next week.
There are always a few surprises in turnaround. We did expect to find work and we did. As a result, the first phase of the turnaround will cost about $62 million as opposed to our original forecast of about 54 million. Donâ€™t forget that we do expense our turnaround costs as they are incurred, so when you look forward to our next two quarters, we will running not only fewer barrels, but have increased expenses as well.
Talking about nitrogen fertilizers, Iâ€™ll be brief because CVR Partners, CEO, Byron Kelley has already given you the details during his conference call earlier this week I hope you listened in.
The Fertilizer segment had a net income of 37.5 million. Our net sales of 77.2 million. And Ed will give you further details on these numbers as well. Last week, our CVR Partners announced their third quarter distribution of $0.0572 per common unit payable on November 14 to unit holders as of record of November the 7th.
Those of you who listened to Byronâ€™s call heard that these results give us confidence in our original IPO guidance of $1.92 per unit, which we have reaffirmed. And also recall that we own approximately 70% of the common units in CVR Partners. So therefore we will receive a proportional amount of distributions when they occur.
We continue to see stability in the ad markets. Weâ€™re sold out UAN in Q4 at an average net back of about $330 a ton. Our booked first quarter 2012 sales are above $350 a ton and again thatâ€™s on net back basis.
Ed, Iâ€™ll turn the call over to you and then weâ€™ll talk about the Wynnewood acquisition we announced last night.
Thank you, Jack and good morning everybody. Just to recap some of the financial results. At the consolidated level, our net income was 109.3 million or $1.25 per diluted share versus 23.2 or $0.27 per diluted share in the third quarter of last year.
Adjusted earnings per share were $1.57 versus $0.29 per diluted share last year. We do believe and feel that the adjusted earnings is a meaningful metric for analyzing the performance in our business and will provide a better comparison to the market expectation.
In the third quarter, these adjustments and calculating adjusted earnings included FICO inventory accounting, unrealized gains or losses on the derivatives, turnaround expenses and share based compensation.
I give brief in each, the first being related to the increase â€“ decrease in inventory values realized under first in, first out or FICO inventory accounting. In the third quarter of 2011 we released unfavorable FICO impact of 15.8 million after tax or $0.18 per share.
Secondly, we had an adjustment to net income on an unrealized derivative loss of $6 million after tax or $0.07 per diluted share. In the quarter, the company had 2,000 contracts in place that we originated in the second quarter in support of our turnaround activities.
The third after tax adjustment to net income was turnaround expenses of 4.8 million or $0.07 per share. We have previously guided the market to expect after tax turnaround cost of 1.8 million. But due to the advance turnaround preparation at the end of September, these additional costs fell into the third quarter.
Our final adjustment relates to stock-based compensation, of which 1.5 million after tax or $0.02 per share was the impact in the third quarter.
In addition to the adjustments, our quarterly results were also impacted by our turnaround event and related inventory management. In the quarter, we decided to limit sales of our current production over the last two weeks of September to support our rack business in the turnaround in October. The deferment of the sales had a negative impact to our third quarter refining contribution margin equaled $8 million.
Having realized these sales, our adjusted earnings per share would have increased by $0.09 per share on a pre-tax business. In support of what Jack said about the fertilizer business, we reported in the third quarter adjusted EBITDA of 43.3 million, a net income of 36.3 million or $0.50 per common unit.
We also announced the distribution of $57.2 per common unit payable on November 14th to unit holders on record as of November 7th.
Moving to capital expenditures, the third quarter 2011 totaled 25.7 million versus for 6.2 million for the same period in 2010. The majority of the increase year-over-year is related to our UEA expansion at the Nitrogen Fertilizers plant in Cushing tank farm project.
Our total 2011 capital spending forecast is expected to be 156 million of which 36 million is related to the UEA expansion.
Of the total, 108 million is budgeted for the petroleum business, which does include for the Cushing Oklahoma tank farm. We do expect to placing crude oil to the new Cushing tanks at the end of the first quarter in 2012.
The UEA expansion project continues on schedule to be completed in the fourth quarter of 2012, and we have initiated construction of 10,000 ton storage tank in (inaudible), Kansas to expand our fertilizer distribution logistics.
We also expect to expend in 2011 approximately 60.2 million at the refinery in connection with the turnaround that are taken last month. The overall cost for turnaround is up slightly versus our previous guidance, primarily as a result necessary repairs identifiable only throughout in the turnaround process.
With that, Jack, Iâ€™d like to turn the call back over to you.
Thank you, Ed. and now letâ€™s talk about Wynnewood. At the time we announced earnings last night, we also announced the acquisition of Gary-Williams Energy Corporation and it refinery in Wynnewood, Oklahoma and that was for a purchase price of $525 million plus working capital. We intend to close on this deal by year end.
Posted on our website, you can find a presentation in the Investor Relation section giving additional information about this acquisition. These are quality refining assets that represent a highly complementary acquisition for CVR energy.
The strategic financial and operational attributes of the transaction are compelling and will drive shareholder value, both in the near-term and for years to come. With $70,000 a day of crude throughput capacity, the Wynnewood refinery provides an immediate and meaningful increase in the scale and stability of our operations.
Once completed, CVR Energy will have more than 185,000 barrels a day of refining capacity in two major locations serving group. It will let us take even greater advantage of our growing crude oil gathering business in the region as well as our crude storage position in Cushing.
And we will be able to benefit from continuing production from domestic share oils â€“ sorry, weâ€™re getting a little bit of feedback here â€“ and weâ€™ll be able to benefit from the production from domestic share oils in Canadian crudes, which are forecasted to be produced in ever larger volume.
Weâ€™ll immediately realize increased operating cash flow which is added any impressive cash flow being generated at Coffeyville refinery. The transaction is expected to be accretive to analystsâ€™ estimates for EPS by more than 25% in 2012.
Diversification of our asset and customer basis should reduce any tendency to a single location discount that some investors have factored into their evaluation CVR Energy stock to date.
Weâ€™ll accomplish this transaction through a combination of existing cash and approximately 250 million in additional debt financing. This acquisition makes operational sense. We will capitalize on CVR Energyâ€™s operational expertise, and the bench strength of our employee team.
We believe there are opportunities of Wynnewood for a number of operational improvements, much as we saw when we acquired the Coffeyville refinery six years ago. We expect the combination of the businesses to result in expanded opportunities for our employees as well to grow their careers, and result in greater retention of both Coffeyville and Wynnewoodâ€™s best employees.
In short, Iâ€™m excited about this acquisition and hope most shareholders will be as well. Acquiring Wynnewood represents exactly what weâ€™ve been saying weâ€™ve been looking for.
Itâ€™s accretive to earnings and built shareholder value. Itâ€™s located in group three where the Brandt-TI spread is an advantage, and itâ€™s a quality asset that complements our existing business. We look forward to integrating Gary-Williams into our family of companies.
Okay. With that, operator, weâ€™ll take questions.