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| CVI > SEC Filings for CVI > Form 10-Q on 5-Nov-2009 | All Recent SEC Filings |
5-Nov-2009
Quarterly Report
The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes and with the statistical information and financial data appearing in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2009, as well as our Annual Report on Form 10-K for the year ended December 31, 2008. Results of operations for the three and nine months ended September 30, 2009 are not necessarily indicative of results to be attained for any other period.
This Form 10-Q, including this Management's Discussion and Analysis of Financial Condition and Results of Operations, contains "forward-looking statements" as defined by the Securities and Exchange Commission (the "SEC"). Such statements are those concerning contemplated transactions and strategic plans, expectations and objectives for future operations. These include, without limitation:
• 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;
• statements relating to future financial performance, future capital sources and other matters; and
• any other statements preceded by, followed by or that include the words "anticipates," "believes," "expects," "plans," "intends," "estimates," "projects," "could," "should," "may," 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 Management'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 "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2008. Such factors include, among others:
• volatile prices for petroleum products resulting in volatile refining margins;
• exposure to the risks associated with volatile crude prices;
• the availability of adequate cash and other sources of liquidity for our capital needs;
• disruption of our ability to obtain an adequate supply of crude oil;
• interruption of the pipelines supplying feedstock and in the distribution of our products;
• competition in the petroleum and nitrogen fertilizer businesses;
• low natural gas prices, which historically has correlated with the market price of nitrogen fertilizer products;
• the cyclical nature of the nitrogen fertilizer business;
• the dependence of the nitrogen fertilizer operations on a few third-party suppliers;
• the hazardous nature of ammonia, potential liability for accidents involving ammonia that cause severe damage to property and/or injury to the environment and human health and potential increased costs relating to transport of ammonia;
• the reliance of the nitrogen fertilizer business on third-party providers of transportation services and equipment;
• operating hazards and interruptions, including unscheduled downtime and maintenance;
• capital expenditures required by environmental laws and regulations for the petroleum and nitrogen fertilizer businesses;
• state and federal environmental, economic, health and safety, energy and other policies and regulations, and changes therein;
• changes in our credit profile;
• our indebtedness;
• severe weather conditions and natural disasters;
• the supply and price levels of essential raw materials;
• the slowdown in the credit markets; and
• changes in global economic conditions.
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 ("CVR", the "Company", "we", "us" or "our") is an independent refiner and marketer of high value transportation fuels. In addition, we currently own all of the interests (other than the managing general partner interest ("managing GP interest") and associated incentive distribution rights (the "IDRs")) in CVR Partners, LP (the "Partnership") a limited partnership which produces nitrogen fertilizers, ammonia and urea ammonium nitrate ("UAN").
Any references to the "Company" as of a date prior to October 16, 2007 and
subsequent to June 24, 2005 are to Coffeyville Acquisition LLC ("CALLC") and its
subsidiaries. CALLC 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 ("CALLC II").
We operate under two business segments: petroleum and nitrogen fertilizer. Throughout the remainder of this document, our business segments are referred to as our "petroleum business" and our "nitrogen fertilizer business," respectively.
Petroleum business. Our petroleum business includes a 115,000 barrels per day ("bpd") complex full coking medium-sour crude refinery in Coffeyville, Kansas. In addition to the refinery, we own and operate supporting businesses that include (1) a crude oil gathering system with a gathering capacity in excess of 30,000 bpd, serving central Kansas, northern Oklahoma, western Missouri, eastern Colorado and southwest Nebraska, (2) storage and terminal facilities for asphalt and refined fuels in Phillipsburg, Kansas, (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) a rack marketing division supplying product through tanker trucks directly to customers located in close geographic proximity to Coffeyville and Phillipsburg and to customers at throughput terminals on Magellan Midstream Partners L.P.'s ("Magellan") refined products distribution systems. We also lease 2.7 million barrels of storage capacity at Cushing, Oklahoma. 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 the Magellan pipeline and into Colorado and other destinations utilizing the product pipeline networks owned by Magellan, Enterprise Products Operating, L.P. and NuStar Energy, L.P. 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.
Crude oil is supplied to our refinery through our owned and leased gathering system and by Plains Pipeline, L.P. pipeline from Cushing, Oklahoma. We also maintain capacity on the Spearhead Pipeline receiving crude oil from Canada and receive foreign and deepwater domestic crude oils via the Seaway Pipeline system. 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 optionality of 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 West Texas Intermediate ("WTI"). Our consumed crude cost discount to WTI for the third quarter of 2009 was $(2.82) per barrel compared to $(0.32) per barrel in the third quarter of 2008.
Nitrogen fertilizer business. The nitrogen fertilizer business consists of a nitrogen fertilizer plant in Coffeyville, Kansas which includes two pet coke gasifiers. The nitrogen fertilizer plant is the only operation in North America utilizing a pet coke gasification process to produce nitrogen fertilizers (based on data provided by Blue Johnson & Associates). Its redundant train gasifier provides good on-stream reliability and with the use of low cost by-product pet coke feed, produces high purity hydrogen. This hydrogen is then converted to ammonia at a related ammonia synthesis plant. Ammonia is further upgraded into UAN solution in a related UAN unit. Pet coke is a low value by-product of the refinery coking process. On average during the last five years, more than 75% of the pet coke consumed by the nitrogen fertilizer plant was produced by our refinery. The nitrogen fertilizer business obtains most of its pet coke via a long-term coke supply agreement with our refinery.
The nitrogen fertilizer manufacturing facility is comprised of (1) an 84 million standard cubic foot per day gasifier complex, which consumes approximately 1,500 tons per day of pet coke to produce hydrogen, (2) a 1,225 ton-per-day ammonia unit and (3) a 2,025 ton-per-day UAN unit. In 2008, the nitrogen fertilizer business produced approximately 359,120 tons of ammonia, of which approximately 69% was upgraded into approximately 599,172 tons of UAN.
General Overview. Due to the continued weakness of the general economy, including the tightness in the credit markets, and short-term tightening in demand of the petroleum and nitrogen fertilizer products, both the petroleum business and nitrogen fertilizer business are focused on controlling operational expenditures and minimizing capital spending while maintaining operational efficiency and safety. Inventory management practices are being employed to respond to the changes in demand levels which impact our production volumes in both businesses.
Major Influences on Results of Operations
Petroleum Business
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. These factors include the supply of, and demand for, crude oil, gasoline and other refined products which in turn depend on 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, or FIFO, 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 competitors' facilities, price volatility, domestic and 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 order to assess our operating performance, we compare our net sales, less cost of product sold against a widely used industry refining margin benchmark. The industry refining margin is calculated by assuming that two barrels of benchmark light sweet crude oil are 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.
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 our margin. Our refinery is able to process a blend of crude oil that includes quantities of heavy and medium sour crude oil that have 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 differential. The consumed crude differential will move directionally with changes in the West Texas Sour crude oil ("WTS") differential to WTI and the West Canadian Select ("WCS") differential to WTI as both these differentials indicate the relative price of heavier, more sour, slate to WTI, directly impacting refinery margin. The correlation between our consumed crude differential and published differentials will vary depending on the volume of medium sour crude and heavy sour crude we purchase as a percent of our total crude volume and will correlate more closely with such published differentials the heavier and more sour the crude oil slate. The WTI less WCS differential was $9.21 and $18.69 per barrel, for the three months ended September 30, 2009 and 2008, respectively. The WTI less WTS differential was $1.81 and $2.31 per barrel for the three months ended September 30, 2009 and 2008, respectively. While the sweet-sour and heavy-sour crude oil markets remained tight during the third quarter of 2009, the related impact of this on our crude differential was offset in part due to the ongoing contango in the WTI crude oil market. Contango markets are characterized by prices for future delivery that are higher than the current or spot price of the commodity. Our quarterly crude oil costs benefited in the third quarter of 2009 from the ongoing contango. Our consumed crude oil less WTI differential was $(2.82) and $(0.32) per barrel for the three months ended September 30, 2009 and 2008, respectively.
We produce a significant 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 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 gasoline and heating oil basis are greater than zero, this would mean that prices in our marketing area exceed those used in the 2-1-1 crack spread. Ultra Low Sulfur Diesel basis for the third quarter 2009 and 2008 averaged $1.97 and $4.68 per barrel, respectively. Gasoline basis for the third quarter 2009 averaged $(1.81) per barrel, compared to an average of $2.62 per barrel in the third quarter of 2008.
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.
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, 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 last refinery turnaround was completed in April 2007, and the next refinery turnaround is scheduled for the fourth quarter of 2011.
Because petroleum feedstocks and products are essentially commodities, we have no control over the changing market. Therefore, the lower target inventory position we are able to maintain significantly reduces the impact of commodity price volatility on our 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 unless the market value of our target inventory is increased above cost.
As the petroleum business continues to maintain high product output, product shipping logistics are beginning to surface as a potential limitation. We are continuing to evaluate and look at alternatives for shipping refined products out of the refinery. We do not expect any outbound transportation constraints to have a material or significant impact to the results of the operations of the petroleum business.
Nitrogen Fertilizer Business
In the nitrogen fertilizer business, earnings and cash flow from operations are primarily affected by the relationship between nitrogen fertilizer product prices and direct operating expenses. Unlike its competitors, our nitrogen fertilizer business uses minimal natural gas and, as a result, is not directly impacted in terms of cost by high or volatile swings in natural gas prices. Instead, our adjacent oil refinery supplies most of the pet coke feedstock needed pursuant to a long-term coke supply agreement we entered into in October 2007. The price paid by the nitrogen fertilizer business pursuant to the coke supply agreement with our refinery is based on the lesser of a coke price derived from the price received by the Partnership for UAN (subject to a UAN based price ceiling and floor) and a coke price index for pet coke.
The price at which nitrogen fertilizer products are ultimately sold depends on numerous factors, including the supply of, and the demand for, nitrogen fertilizer products. These factors depend on the price of natural gas, the cost and availability of fertilizer transportation infrastructure, changes in the world population, weather conditions, grain production levels, the availability of imports, and the extent of government intervention in agriculture markets. While net sales of the nitrogen fertilizer business could fluctuate significantly with movements in natural gas prices during periods when fertilizer markets are weak and nitrogen fertilizer products sell at low prices, high natural gas prices do not force the nitrogen fertilizer business to shut down its operations as is the case with our competitors who rely heavily on natural gas instead of pet coke as a primary feedstock.
Nitrogen fertilizer prices are also affected by other factors, such as local market conditions and the operating levels of competing facilities. Natural gas costs and the price of nitrogen fertilizer products have historically been subject to wide fluctuations. An expansion or upgrade of competitors' facilities, price volatility, domestic and 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.
The demand for nitrogen fertilizers is affected by the aggregate crop planting decisions and nitrogen 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 nitrogen fertilizer they apply depend on factors such as crop prices, their current liquidity, soil conditions, weather patterns and the types of crops planted.
The United States Department of Agriculture reported on June 30, 2009 that growers planted an estimated 87 million acres of corn in 2009. This is the second largest planted acreage since 1946, behind 2007. The agricultural sector of the economy; however, has not remained entirely immune to the overall slowdown in both the domestic and world economies, and, in fact, fertilizer usage declined this year. A factor in this decline was the extremely wet weather experienced in the United States during the spring planting season.
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. Instead of experiencing high variability in the cost of raw materials, the nitrogen fertilizer business utilizes approximately 1% of the natural gas used by natural gas-based fertilizer producers.
Because the nitrogen fertilizer plant has certain logistical advantages relative to end users of ammonia and UAN and demand relative to our production has remained high, the nitrogen fertilizer business primarily targets end users in the U.S. farm belt where it incurs lower freight costs as compared to competitors. The nitrogen fertilizer business does not incur any barge or pipeline freight charges when it sells in these markets, giving us a distribution cost advantage over U.S. Gulf Coast importers. 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 2008, the nitrogen fertilizer business upgraded approximately 69% 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 significantly higher fixed costs than natural gas-based fertilizer plants. Major fixed operating expenses include electrical energy, employee labor, maintenance, including contract labor, outside services, property taxes and insurance. These costs comprise the fixed costs associated with the nitrogen fertilizer plant.
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, 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 business generally undergoes a facility turnaround every two years. The turnaround typically lasts 15-20 days each turnaround year and costs approximately $3-5 million per turnaround. The facility underwent a turnaround in the fourth quarter of 2008, and the next facility turnaround is currently scheduled for the fourth quarter of 2010.
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.
Cash Flow Swap
Until October 8, 2009, Coffeyville Resources, LLC ("CRLLC"), a wholly-owned subsidiary of CVR, had been a party to commodity derivative contracts (referred to as the "Cash Flow Swap") with J. Aron & Company ("J. Aron"), a subsidiary of The Goldman Sachs Group, Inc. and a related party of ours. The derivative took the form of three NYMEX swap agreements whereby if absolute (i.e., in dollar terms, not a percentage of crude oil prices) crack spreads fall below the fixed level, J. Aron agreed to pay the difference to us, and if absolute crack spreads rise above the fixed level, we agreed to pay the difference to J. Aron. Based upon expected crude oil capacity of 115,000 bpd, the Cash Flow Swap represents approximately 14% of crude oil capacity for the period of July 1, 2009 through . . .
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