With oil’s collapse, a lot of investor attention has been given to the financial health of midstream’s customers that produce oil and gas. However, several midstream MLPs have refiner customers and/or refiner parents as shown in the table below. Notably, refiners have distinct profitability drivers, which are not necessarily dependent on the absolute crude price.
Refiners make money by processing oil into usable products like gasoline, diesel, jet fuel, and petrochemicals. The profitability of refiners depends on the difference between the price that they can sell their refined products and the cost of crude (referred to as the crack spread), as well as the costs of running a refinery. Refiners can also benefit from widened crude spreads, which occur when regional crude prices trade at a deeper discount than normal to benchmark crudes. Crack spreads can be volatile since they are based on commodity prices. Because refiners make their money on the spread between product prices and crude prices, they are less sensitive to the absolute price of oil than their upstream counterparts that produce oil. This partially explains why refiners have been the best performing energy subsector (excluding renewables) for five of the last eight years (read more). However, weak demand for gasoline, jet fuel, and to a lesser extent, diesel related to COVID-19 resulted in depressed crack spreads as product supply overwhelmed demand, and refiners were forced to lower their processing rates (read more). Per Bloomberg, the Gulf Coast crack spread, which averaged $15 per barrel in 2019, fell into negative territory on April 3, 2020, but has since recovered to almost $8 per barrel as of May 8, 2020.
Setting aside MLPs with refiner parents, many other MLPs have significant exposure to refiners. MLPs may operate crude pipelines that supply refineries or product pipelines that take refined products away from the refinery and deliver them to end markets. NuStar Energy (NS) went public in 2001 as Shamrock Logistics and was part of Ultramar Diamond Shamrock, which Valero (VLO) acquired. In 2006, the renamed Valero LP separated from VLO and was renamed NuStar, but VLO remains a significant customer of NS given the legacy asset base. VLO accounted for 28% of pipeline segment revenues in 2019 and carries an investment-grade credit rating with a stable outlook. In 2019, MPC and PSX accounted for 12% and 11% of total revenues for Plains All American (PAA), respectively. MPC was also the largest customer of EnLink Midstream (ENLC) last year, accounting for 13.8% of 2019 revenues. While no customer accounts for 10% or more of revenues, Magellan Midstream Partners (MMP) provides service to a number of refiners. Last year, 62% of MMP’s refined product volumes originated from direct pipeline connections to 18 refineries, including facilities owned by HFC, MPC, PSX, and VLO.
While the demand impacts of COVID-19 have harmed refiners given weaker crack spreads, the profitability of refiners is less dependent on an oil price recovery than their upstream counterparts. The differentiated sensitivity of refiners to oil prices may help diversify counterparty risk exposure for those MLPs (read more) that also have customers producing oil and gas. The size and credit quality of some of the larger refiners is an asset for their related MLPs.