shhughes1116

I sent you a PM but I am curious about this as well. I presume the thesis is that higher margin specialty chemicals won't experience the price-drop that feedstock has? Thanks for the idea. Specialty chemicals will be subject to the same margin compression and margin expansion as fuel when the price of crude changes. The important difference are the margins. CLMT's fuel segment had gross margins of ~$3/bbl in Q32014 (July, Aug, and Sept). During this time, WTI declined from ~$102/bbl to ~$92/bbl. CLMT's specialty chemicals segment had gross margins of ~$43/bbl, which comprised ~80% of CLMT's EBITDA for the quarter. Generally speaking, I expect the margins for specialty chemicals to fluctuate as crude pricing fluctuates. This doesn't impact my thesis. My long-term thesis for CLMT could be summed up by a couple of key points: 1. Specialty chemical business (production and distribution) is pretty segmented in the United States. There is a lot of room for consolidation. CLMT has been quite active doing this, and appears to have been pretty successful in integrating new production lines as well as new distribution teams. 2. Specialty chemicals tend to be pretty sticky, and the demand tends to be pretty inelastic. There are a lot of examples that come to mind... 3. CLMT sells about 90% into domestic market, and 10% into foreign market. Recent acquisition gives them toehold in foreign distribution. Once the price of crude stabilizes, I expect them to start pushing more into foreign markets. Given that I expect the Brent-WTI differential to persist for quite some time, CLMT will have a pricing advantage even when selling into foreign markets. 4. CLMT established an agreement with Wal-Mart, and now Wal-Mart is carrying their Royal Purple line of lubricating oil. This provides a pretty substantial step-up in retail distribution for CLMT. 5. Controlling family owns about 26% of the limited partner units, plus the general partner interest. This gives me a little bit of confidence that they are not going to dilute their limited partner units willy-nilly. This belief has been confirmed by their limited use of an ATM program.

When you say small...are you saying ~1% positions? Just curious...I have been looking at CTCM for quite some time and held off because of the price. It is starting to get interesting for me.

Isn't that a good thing for the refiners? That's not entirely accurate. Capacity expansion can occur via two mechanisms: (1) Brownfield expansions (i.e. the expansion and improvement of BP's Whiting Refinery a few years back, primarily via addition of massive coking units; the expansion of CLMT's Montana Refinery by way of new distillation towers and a new mild-hydrocracking unit); and (2) Greenfield expansions (i.e. new MDU/CLMT refinery in the Bakken which is first new refinery in the United States in 30 years). Capacity is growing in the United States, primarily because of the opportunity to export refined products to Europe and Asia. In addition to the new MDU/CLMT refinery in the Bakken, another topping refinery is far along in the planning stages for the Bakken, and a third MDU/CLMT topping refinery is being considered for the Bakken. These are relatively small 20k/day refineries. On top of this, folks like KMI and EPD have also been planning new "refineries" where they will minimally process crude distillates for export. If you are going to play the refinery business, I see two ways to do it profitably: 1. Figure out where there are going to be structural changes in feedstock that have not been priced into the shares (i.e. PFB on the east coast transitioning from expensive seaborne Brent to cheaper inland crude). 2. Look for the niche players that are using their refinery business as a means to provide cheap feedstock to their higher margin specialty chemical business. CLMT is one; there are a few others if you look closely. 3. Play ALDW. They are a variable distribution refinery, essentially paying out all of their cash flow. If you are willing to track the spread between WTI and their feedstock on a daily basis, you can pretty closely estimate their payout for the upcoming quarter given they have one refinery with access to a limited slate of feedstocks. This should be pretty obvious to all market participants, but for the most part, the share price generally reflects the previous quarter distribution rather than expectations for the upcoming quarter. Pretty easy to arbitrage this for some capital appreciation and the dividend if you are willing to spend some time tracking this information.

Do tanks really run on gasoline? I've always assumed they ran on diesel, like large industrial engines. It would certainly be more efficient... The gas turbine engine is quiet. You are correct, historically most tanks have run on diesel engines. However, M1A2 uses a gas turbine rather than a diesel engine...can run on Diesel #1, Diesel #2, JP-4, JP-8, kerosene, and even marine diesel if you are in a pinch. United States has typically fueled their Abrams with JP-8...gets a whopping 0.6 miles to the gallon, so a typical armored division uses ~600,000 gallons of JP-8 per day when deployed to the field for combat. Imagine what that does to the market for refined products! ERICOPOLY is right on the money about the noise level...M1A1 was known as Whispering Death when they ran it through trials. Sorry to hijack this thread with irrelevant chatter...I'll stop now.

It is funny that you mention that...we American's are pretty good at starting wars and blowing s**t up when we need a positive jumpstart for our military-industrial complex or a quick way to boost world-wide oil demand (you would not believe the amount of gasoline that an M1A2 tank guzzles on a daily basis when driving around the desert). Sorry for the sarcasm, but, in general, I find it a bit silly how much Americans berate the Russians for what they do, yet we Americans have a pretty rich history of nation-building and war-mongering. For what it is worth, I am a conservative and come from a family where there has been a substantial amount of service to our Armed Forces, both in the past and in the current period.

I think that is a bit of an oversimplification. In looking at the economics of refining, you need to ask yourself whether we are in an extended cyclical upswing, or whether there has been a structural change in refining. I would argue that we are in the middle of a cyclical upswing, which will ultimately be ended when the midstream folks finish building out a pipeline network that provides east coast and west coast refiners with access to inland crude. At that point, we will probably see more of a convergence in Brent-WTI, as well as a narrowijg in the spreads currently enjoyed by the inland and gulf coast PADDs relative to the east coast and west coast PADDs. At that point, profitable refining will simply depend on what the crack spreads are, and the ability of the refiner to produce higher margin specialty products such as base oils, lubricants, solvents, etc. profitability of the larger refiners will also to some degree depend on their midstream assets and logistics assets. Both Tesoro and PSX have decent midstream and logistics assets, while PBF has been building out logistics assets on the east coast (primarily rail terminals). I personally don't think there is much opportunity in the larger refiners. I think the current share prices are reflective of my expectation to future performance. However you might consider looking at some of the niche companies in the business that produce specialty chemicals. I have a fairly large position in Calumet Refining (CLMT). They are a refiner in the sense that they own about half a dozen small refineries. However, the primary purpose of their refineries is to supply their specialty chemical operations with base oils and other important feedstocks. Thus about 80% of their EBITDA is based on the production and distribution of specialty chemicals. I also find them to be attractive because they have been rolling up small mom-and-pop specialty chemical companies and distributors. Their share price has been whacked along with the sell-off in crude...I suspect we have been seeing a capitulation if retail yield seekers. Anyways, CLMT seems to be priced as a specialty chemical producer, based on current EBITDA and a substantial amount of debt. However, the debt is the result of a fairly large organic growth program that should yield an incremental 200million EBITDA per year, with the first project coming online now, two more projects coming online in mid 2015, and the final project coming online in q12016.

Mainly by vomiting in a trash can. :) That about describes me today. A substantial portion of my portfolio is in refining (CLMT) and midstream (ETP, USAC, EPD, and WMB). It has been a nauseous few months...

I am, thanks for the suggestion. I am in need of a few, less-than-exciting positions to complement my roller-coaster ride in midstream oil/gas. The death industry looks interesting to me...

It's my personal belief that Saudi Arabia orchestrated the lower oil prices for the following reasons: 1) It's a shot at Iran. Maybe putting pressure on Iran will entice them to give up their nuclear program. 2) ISIS has been selling oil. I believe that is where they have been getting the majority of their profits. Lower oil profits means less money for them and may weaken their base. SA is certainly no friend of ISIS and it must scare the shit out of them to think that Iran is on one side and ISIS is on the other. 3) To a lesser degree, this hurts Russia and shale producers. If this takes out some of the supply then it's icing on the cake. I would be interested in hearing other's thoughts about the above? Does anyone get anything from Stratfor? I would be curious their take on this whole thing. Thanks, AtlCDore I initially thought there was a strong geo-political aspect to the Saudi's decision to maintain production even in the face of falling crude prices. However, the more I read about the Saudi's experience and thought process in the 70's and 80's, the more I think that this is entirely an economic decision on the part of the Saudi's. This is illustrated by the Saudi's experience over the previous three decades. In the past, in the face of falling crude, they cut production to maintain crude pricing. A couple of things happened that negatively impacted Saudi Arabia. First, Certain OPEC members have historically always exceeded their quotas, so the Saudis bear the brunt of the production cuts. Second, by cutting production and maintaining higher crude prices, this has stimulated a higher rate of growth in non-OPEC production. And third, as non -OPEC production has increased, the share of oil supplied by OPEC has declined substantially. Fourth, higher crude prices reduce future crude demand substantially given that higher crude prices stimulate investments in alternative energy sources. Fifth, the Middle East ships a substantial amount of crude to Asia, particularly China. The Chinese have the largest shale deposits in the world, and they are getting ready to exploit them given their reliance on imported crude and imported gas. Lower crude prices make it much less economic to pursue development of Chinese shale, thereby ensuring continued reliance on Middle East crude. (Ultimately I think the Chinese will fail to exploit their vast shale deposits given their severe water issues, but that is a discussion for another day) So I am led to believe that the Saudi's actions are entirely to maintain market share, and by doing so, the low prices will encourage an increase in demand while cutting the legs out from under development of certain crude alternatives.

How will potential bankruptcies and lack of future drilling affect midstream? I know nothing but I thought I heard that midstream enters into long term contracts. What if the counterparty defaults? I am intrigued but not interested so I am waiting. It looks like the bad companies sold off and I will wait until they go bankrupt or quality sells off before I start to get very interested. As I stated in my original post, I think the slow down in drilling activity will negatively impact midstream companies that focus on building out collection/gathering systems. That is simply my assessment based on how they seem to plan and build out those systems, relative to the larger interstate pipelines. With respect to counterparty risk, that is certainly a concern with any company engaging in long-term contracts. However, my belief is that if/when some of the marginal companies default (and I think there will be a few that do) their trustees will continue to honor the contracted terms in order to get their hydrocarbon product to the market. How else would they maximize cash flow from the distressed asset if they can't get their hydrocarbons to the market? I think the great recession is instructive in this case. Not only did demand drop off, but the credit markets froze up as well. Yet many of the stronger midstream companies maintained their distribution or even increased it, with few counterparty issues. I think it is also useful to point out that the marginal companies most likely to default, for the most part, are smaller operators that make up a small portion of contracted volumes on the bigger pipelines. I don't have any numerical data to substantiate this claim...this is just something I have gleaned from reading a number of 10k's. In my case, I have focused on midstream operators where demand seems to be driving the construction and/or expansion of pipelines. Williams Company is a good example with their transco pipeline. Upstream companies seem to be falling all over themselves to get space on this pipeline because it serves some of the biggest natural gas markets in the country. EPD is another good example, especially given their distribution coverage of almost 1.5:1 and their assets in the Gulf Coast Region. and SHLX is another good example...although the valuation is a bit rich right now, shell has some premier midstream sssets that will likely be dropped down to SHLX....their stake in the colonial pipeline is a great example.

You get into USAC at sub-17.00? I was traveling yesterday and it looks like I missed my opportunity to expand my position at a better price. 12% yield for USAC is a bit ridiculous, unless one thinks that we are no longer going to need oil and gas compression equipment. Yep, thank you for the idea! I think it's priced for a 50% dividend cut. Remember that the subordination period hasn't ended. If they cut the distribution, the subordinated units will get their distributions whacked first.

Look at midstream and compression. While growth in production will slow, midstream and compression plays are more dependent on volume than price, and I would expect volume to increase as the price decreases. Can't move liquid and gas through a pipe without compression. One caveat...although I like midstream, I would avoid the smaller plays that depend on collection/gathering systems for a substantial Amount of their cash flow. I can only speak from my personal research, but it seems that mAny of the pipelines are built to address existing volume, while many of the collection/gathering systems are built based on projections for new well completions and projected oil/gas volumes. Thus they may be more impacted by the slowdown in drilling new wells.

You get into USAC at sub-17.00? I was traveling yesterday and it looks like I missed my opportunity to expand my position at a better price. 12% yield for USAC is a bit ridiculous, unless one thinks that we are no longer going to need oil and gas compression equipment.

Remember that the inventory number is a bit misleading. Because of the sharp drop in oil prices over the last fee months, many refiners delayed their turnarounds, and most refiners are literally running at 110% to produce as much finished product as possible while crude prices are so low. Hard to tell what happens next though...if I had to guess, folks will run out of storage for their finished refined products, and so they will implement their turnaround schedule. Unless crude supply drops off, we will likely see some more weakness in North American crude prices at that time.

For more information about compression, including a good overview of USAC's primary competitor. http://finance.yahoo.com/news/overview-natural-gas-compression-companies-181903522.html

In full disclosure, I should also note that my weighting may be a bit misleading. For reasons I won't expand upon, I am unable to invest in companies that derive more than 10% of their revenues from food, drugs, biologics, medical devices, or tobacco. Therefore my weighting in oil, oil services, and pipeline companies is likely to be higher than others may find prudent.

It is just under 6% of my portfolio. I generally carry about 20-30 positions, so it is currently weighted a bit on the higher end than normal. I guess here is the 10-cent version of my thesis: 1. 85% of revenue is fee-based and generated from compression equipment installed in natural gas midstream applications. This is pretty sticky, and the company states this in their most recent filings. Think of it this way, you can't move natural gas through a gathering system or through a large natural gas trunk line (i.e. WMB's Transco pipeline) without compression. These systems are long lasting, and they need compression for the life of the pipeline. 2. 15% of revenue is fee-based and generated from gas-lift applications for crude wells. After a well is drilled and completed, the crude output declines over time. Producers employ secondary techniques (i.e. gas-lift) and tertiary techniques (water flooding) to improve the output of a well. Assuming oil prices remain low for an extended period of time, the drilling of new wells will likely slow. However, producers will desire to maintain/enhance output from existing wells by using secondary and tertiary recovery techniques. Thus I suspect the use of compression units for gas-lift applications in crude wells will not collapse. 3. Their recent quarter was the first where they achieved a 1.0x distribution coverage. During the previous quarters, the distribution coverage has been under 1.0x, but the controlling shareholders agreed to participate in the DRIP program rather than take distributions. 4. Their cash flow during the recent quarter was a substantial improvement from the previous quarter. However it underestimates their true earning power because a substantial amount of new compression equipment had not been deployed for the entire quarter. 5. They are ordering ~200k in new compression equipment for 2015, all for midstream applications. The drop in crude should not impact new natural gas pipelines current under construction, thus the market will likely be able to absorb the new compression units. 6. Large, addressable market. Compression can be provided by the producer or midstream operator. However, many choose to outsource this work, so there is a large market with more opportunity to expand if desired. 7. Although USAC could operate profitably by itself, I suspect it would make a good acquisition target for one of the major oil service companies.

Added to existing positions in EPD, USAC, and CLMT. 1. In general, I view EPD as fairly protected against the recent collapse in oil prices (with respect to their focus on all hydrocarbons and their very high distribution coverage); 2. I think USAC has been unfairly pummeled by the market given that it derives 85% of their fees from placing their compression units with midstream natural gas projects (and 15% of their fees are associated with compression units on already-producing crude wells); 3. CLMT is a specialty refiner that derives most of their EBITDA from Specialty products (lubricants, waxes, solvents). They have a fairly small business (5%-10%) that sells drilling fluids...that will certainly be impacted, but I think a ~17% share price drop is a bit extreme. More importantly, they are getting ready to ramp up their refinery in ND, and the lower oil/gas prices should encourage more driving, which will result in a higher demand for their specialty lubricants. I have been picking over the carnage in upstream companies, but so far I've avoided putting any money to work in that area. Maybe I am being overly cautious, but I don't think the bottom is in for those companies yet. Moreover, if experiences from the late 80's are any indication, it is likely that there will be a fairly long window in which to pick up beaten-down upstream companies before the crude cycle turns up.

Great opportunity to buy some of the US-based midstream plays (EPD, WMB/WPZ, MMP, NGLS, PAGP/PAA, KMI, SE, to name a few). These guys operate under relatively long-term fee-based contracts that should insulate them from the move down in oil prices, and much of their business is oriented towards natural gas which seems to be relatively unimpacted by the carnage in the oil sector. I also like USA Compression Partners (USAC). They generate income by leasing compression units. ~85% of their compression units are leased to midstream folks over 2-5 year contracts. I see their midstream business as pretty sticky given that most of the newer dry gas and wet gas plays come out of the ground at relatively low pressure...thus compression is necessary to move the gas volumes into the gathering systems and through the midstream system. The other ~15% of their compression units are exposed to crude prices via short-term leases (6 - 12 months) to operators to improve crude recovery rates in existing wells via gas-lift. On the surface, the exposure to crude appears problematic. However, if you dig a bit deeper, you will note that most of this equipment is fungible (i.e. can be removed and installed in other locations), and in most cases it probably makes sense for a driller to continue using gas-lift to extract more oil from an existing well than it does to drill a new well. Current yield is ~11% which probably reflects the fact that this is the first year where they will achieve a 1.0x distribution coverage, along with a fear that the current decline in oil prices will cause operators to discontinue use of gas-lift equipment for existing wells.

I think your last statement is so important. Think of all the young bucks who started their investment careers in late 2008 or early 2009. Although there have been some hiccups along the way, the broadly rising tide following the Great Recession has lifted everyone's boats. Now it seems that everyone thinks they are a great stock picker, although in reality the rising market had more to do with most folks' success. It should be interesting to see what happens when we have a real correction... For what its worth, I also agree with a 5-7 year market cycle for evaluating performance.

Why do you think CFG is significantly better than mediocrity for it to be the best long-term idea today? Something about the management? Business mix? Just curious. Thanks The ten cent version of my thesis is as follows: 1. Around the time of their IPO, CFG was priced at ~0.65 P/B, and ~1.0 P/TB, with a ROE of ~3%. I think the IPO price reflected that the divested entity has a pretty marginal ROE, and had been undermanaged by RBS due to the financial crisis. 2. Royal Bank of Scotland divested only a portion of their stake. They are a forced seller, and the UK government is requiring RBS to divest the remainder of their stake in the next couple of years. Sucks to be a forced seller, but great to be on the other side of the transaction (think the forced divestiture of Voya by ING). 3. As oddballstocks noted, this "production" will take a couple of years to play out, keeping many short-term focused folks out of this equity. 4. I like regional banks. Big enough to achieve some economies of scale, but small enough to enable effective management/oversight. (Value and Opportunity did a pretty good job laying out the bull case for CFG - http://valueandopportunity.com/page/2/) So I look at it this way. The bank is priced for a mediocre ROE. If the divested entity is unable to improve the ROE, then there probably is not much downside. If they are able to improve the ROE to what we would expect from an average regional bank, then they are deserving of a higher valuation. The forced selling over the next couple of years means that end game for this stock (i.e. higher valuation reflective of improved ROE) will take a couple of years to play out. I have a few other ideas which will probably yield higher annualized returns. However, my concept of a "best long-term idea" is not necessarily the idea with the highest annualized return, but instead the idea where the upside is skewed substantially in my favor, and downside is pretty limited, and the risk of substantial permanent capital impairment is very unlikely. I think CFG satisfies these three criteria, and similarly to oddball stocks, my position sizing is a bit larger than some other positions I hold.

CFG. Being divested by Royal Bank of Scotland right now, and currently priced for mediocrity.