HollyFrontier Produces Sweet Results Thanks To WTI Crude

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To most people, all crude oil looks pretty much the same. It's dark, thick and, yes, oily.

But there are important differences between types of crude. An example is West Texas Intermediate crude, or WTI. It is lighter and sweeter than other types of oil, such as Brent crude.

WTI is produced mainly in North America. Its sweetness comes from its low sulfur content. Its lightness is due to a high API (American Petroleum Institute) gravity. The combination makes it of higher quality than other crudes, experts say.

For oil refiners with easy access to WTI, such asHollyFrontier ( HFC ), the superior quality of WTI is only one of its benefits.

The other benefit -- the one that has helped send HollyFrontier's financial returns and stock price soaring over the last few months -- is the cheap price of WTI.

"HollyFrontier has definitely benefited from the WTI discount to Brent," said Sam Margolin, an analyst at Dahlman Rose.

HollyFrontier is one of the biggest independent petroleum refiners in the U.S., with operations in the Midwest, Southwest and Rocky Mountain regions.

Five Refineries

It operates five refineries with 443,000 barrels per day of crude oil processing capacity. In addition to WTI crude, certain of these refineries can also refine heavy, sour crude.

The company's subsidiaries produce and sell gasoline, diesel, jet fuel, asphalt, heavy products and specialty lubricant products.

HollyFrontier was formed last year following the merger of Houston-based Frontier Oil and Dallas-based Holly Corp. That deal, which closed in early July 2011, created the country's fourth-largest independent oil refiner.

The company's holdings include a 44% interest inHolly Energy Partners ( HEP ), a master limited partnership that owns and operates petroleum logistics assets, such as pipelines, terminals and tanks.

Among Holly Energy's assets are ownership or lease stakes in about 2,500 miles of petroleum product and crude oil gathering pipelines in Texas, New Mexico, Oklahoma and Utah.

Holly Energy Partners also has a 75% stake in the UNEV pipeline, a joint venture with Sinclair Transportation to build and operate a refined products pipeline from Salt Lake City to Las Vegas, along with terminals in Cedar City, Utah, and North Las Vegas.

WTI is produced in many of the regions where HollyFrontier operates. And there's plenty of it, thanks to the emergence of new and better production techniques.

As the supply of WTI has increased, its price has dropped. WTI sells for anywhere from $10 to $20 cheaper than other types of crude.

Refiners can buy WTI at a discount, then sell their refined products at a considerable profit thanks to the favorable spreads. That discount won't last forever, though it still has plenty of room to run, analyst Margolin says.

"When the discount for WTI first started last year, the expectation was that it would be relatively short-lived," he said. "But since then, the expectations have changed, and it looks like the discount will extend longer."

Windfall Year

The WTI discount was a major driver of HollyFrontier's strong financial performance in 2011, when the company posted earnings of $6.42 a share and revenue of $15.4 billion.

"Last year was a windfall year for (HollyFrontier)," Margolin said. "They built up a large net cash position and were able to establish a dividend yield that's very strong."

The windfall has continued into 2012. HollyFrontier reported first-quarter net income of $241.7 million, up 185% from the prior year.

"Our first-quarter results benefited from strong product margins, improved heavy crude oil differentials and robust differentials between inland and coastal crude oils," Chief Executive Mike Jennings said in a statement.

The company produced 433,000 barrels a day during the quarter. That was a big improvement from the prior year when Holly and Frontier combined to produce 408,000 barrels a day.

Earnings Growth

Earnings per share for the first quarter came in at $1.16. Revenue rose 112% to $4.9 billion.

HollyFrontier's margins on mid-continent refineries were $17.79 a barrel. That was well above the $16.07-per-barrel margin expected by Citigroup analyst Faisel Khan.

"Mid-continent margins exceeded our estimates on high lubes production," Khan noted in a report. "This more than made up for lower gasoline prices in the region as a result of higher gasoline inventories on the Magellan pipeline system."

The biggest risk facing the company in the near term is the spread between WTI and Brent crude. Just about everyone expects the spread to get smaller over time, which means refiners like HollyFrontier face compressed margins.

For now, however, the company is still in a strong financial position. Analysts polled by Thomson Reuters expect HollyFrontier to post second-quarter earnings of $2.23 a share. Full-year profit should come in at $6 a share.

Meanwhile, HollyFrontier's stock price touched an 11-month high of 38.40 on July 17. Its all-time high of 38.89 was set last August.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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