CVR Energy Stock: Refinery Margins May Be Peaking (NYSE:CVI)

As presented in my prior article, CVR Energy: Supported By Oil Prices, CVR Energy, Inc. (NYSE:CVI) is a diversified holding company primarily engaged in the petroleum refining and nitrogen fertilizer manufacturing industries through its holdings in CVR Refining, LP and CVR Partners, LP. Its mission is to…

be a top tier North American renewable fuels, petroleum refining, and nitrogen-based fertilizer company as measured by safe and reliable operations, superior performance and profitable growth.

Over the past 10 years, CVI returned 232%, as compared to 230% by the SP500TR.

Over the past year, CVI’s shares returned 102.2%, as compared to -14.84% for the SP500TR.

The oil market has been highly volatile in 2022. And it’s easy to be biased by the latest price moves.

But Stanley Druckenmiller, the legendary hedge fund manager, recently said about stocks, “Do not invest in the present. The present is not what moves stock prices.”

In a September 22nd episode of the “How Leaders Lead” podcast, Druckenmiller stated (via The Transcript):

I learned this way back in the 70s from my mentor [Speros] Drelles. I was a chemical analyst. When should you buy chemical companies? Traditional Wall Street is when earnings are great. Well, you don’t want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there’s overcapacity and they’re losing money. What about when they’re losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it’s going to be in 18 to 24 months as opposed to now. If you buy it now, you’re buying into every single fad every single moment. Whereas if you envision the future, you’re trying to imagine how that might be reflected differently in security prices.

In today’s oil market, investors need to factor-in what high oil prices and a likely recession will do to oil demand in the months ahead.

Sticker Shock

In a recent article, Connecticut residents grapple with sticker shock of home heating oil prices, anecdotal evidence of the impact of high heating oil prices was presented. In one case,

for the past 25 years, he has pre-bought all his estimated oil for the season. He was shocked in mid-June to see his oil company’s offer of $4.90 per gallon, considering the prebuy price the previous year was $2.90.

Another couple in their 80s,

managed to make ends meet until the increased price of heating oil changed it all. He said in an email they shop at Walmart to save money on groceries, started canceling magazine subscriptions, and stopped visiting family members elsewhere in the state.

Fuel Switching and Conservation

According to the EIA,

Customers in the Northeast rely on heating oil more than in any other region. About 18% of households in this region use heating oil as a primary space heating fuel, down from 25% a decade ago. An increasing number of homes in the Northeast have switched to natural gas or electricity for primary space heating needs.

Do not underestimate the frugality of the Yankees in New England.

“Some people are opting to burn more wood – or just sit in a red Polartec jacket under a blanket in a 58-degree house,” as one woman said she was doing.

According to one estimate,

The rule of thumb is that you can save about 3% on your heating bill for every degree that you set back your thermostat. Turn down the thermostat 10 degrees when you go to work, and again when you go to bed — a total of 16 hours a day — and you can save about 14% on your heating bill.

The EIA estimates:

that more than 1.7 million U.S. households, or 1.3%, will use cord wood or wood pellets as the primary fuel for residential space heating this winter. As of 2020, we estimate another 7% of households will use wood as a secondary source of heat, second to electricity as a supplemental heating fuel for U.S. households. Wood is more widely used in rural homes, with 22% of rural U.S. households using wood for primary or secondary space heating, compared with 6% of urban households, according to RECS. Wood use was most common in New England, where 16% of households used wood as either a primary or secondary source of heat.

Petroleum Industry Will ‘Oversolve’ The Problem

The oil and gas industry has a history of ‘oversolving’ supply problems by producing excess supplies. For example, in a recent article, Wave of LNG tankers is overwhelming Europe in energy crisis and hitting natural gas prices,

Sixty liquified natural gas vessels are slow sailing or anchored around Northwest Europe, the Mediterranean, and the Iberian Peninsula, according to MarineTraffic. The vessels are considered floating LNG storage since they cannot unload and the situation is impacting the price of natural gas and freight rates. Natural gas is critical for European energy needs into the winter and Russia has reduced its supply of gas as a result of the war in Ukraine, but existing storage capacity is at 93%.

In its October 2022, the Short-Term Energy Outlook, the EIA projects that total U.S. distillate stocks, including diesel fuel and home heating oil, will remain low but adequate in the up-coming months. And that is based upon distillate demand during the heating season (Nov-March) averaging just 2.8% below the year-earlier season. High prices are likely to cause more demand destruction, in my opinion.

NYMEX Heating Oil Futures Prices (“HO”) are predicted to drop substantially by the oil futures market (October 24, 2022 close). The April futures price of $3.15/gal is $0.77/gal lower than the November contract.

The Conference Board predicts:

96 percent likelihood of a recession in the US within the next 12 months, based on our probability model. This supports our expectation of a recession before the end of 2022 caused by the Federal Reserve’s interest rate hikes. The last quarter of 2022 and the first quarter of 2023 are likely to see negative real GDP growth rates.

Published: October 5, 2022

Winter Fuels Outlook, October 2022

In its Winter Fuels Outlook, the EIA projects,

We expect that the 4% of U.S. households that use heating oil as the primary space heating fuel will spend about $2,350 on average this winter, up 27% from last winter.”

Distillate fuel inventories (which include heating oil and diesel fuel) on the East Coast (PADD 1) at the end of September were 25.5 million barrels, 45% below the five-year average,” according to the EIA.

Boslego Risk Services Trading Signal

Robert J. Shiller, Nobel economics laureate (2013), published a paper in 2003, “From Efficient Markets Theory to Behavioral Finance,” in which he discusses the failure of the efficient market theory to explain stock market prices and the “blooming of behavioral finance.” He proved that stock market prices exhibited “excessive volatility” from what would be expected, if market prices behaved according to the efficient market theory.

I developed and tested hypotheses to try to quantify conditions that might make investors feel greedy or fearful. And it turns out that the size of market gains and losses, combined with the speed of them, does a pretty good job in determining when to be long (bullish), when to be short (bearish), and when to be out (neutral). There are other unique positioning techniques built into my model, such as a position adjustment based on market price volatility for risk control.

My approach was to separate emotions from investment decisions by running an algorithmic trading (AT) strategy that provides systematic, quantitative signals. The benefit of an AT strategy is that it can be back-tested under many different market conditions to determine the potential risks and returns of its future use. While such a strategy cannot guarantee future results, it can show how it would have performed in the past, unlike discretionary strategies, dependent on the skills of a trader. And at the least, it can eliminate strategies that would have performed poorly in the past.

My simulation results are presented in this article. Every day, I update the AT strategy for NYMEX WTI crude oil (“CL”), RBOB Gasoline (“RB”), Heating Oil (“HO”) and Natural Gas (“NG”). The outputs provide to me a signal of whether to be long, short, or neutral, and the relative strength (i.e., -100%, -50%, 0%, 50% or +100%).

As of the close of October 24, 2022, the signal was Red.

Red means Short. The Strength (percentage) is intended to reflect what percentage of a maximum position I would take based on the outputs of the algorithm.
Green means Long. The Strength (percentage) is intended to reflect what percentage of a maximum position I would take based on the outputs of the algorithm.
Yellow means No Position. The Strength (percentage) is intended to reflect what percentage of a maximum position I would take based on the outputs of the algorithm.

Click to enlarge

Gasoline Market

CVR’s refineries produce a product mix of about 53% gasoline and 41% distillates (diesel fuel and heating oil). Therefore, the gasoline market is very important to CVR’s earnings’ prospects.

High U.S. retail gasoline prices have caused gasoline demand to sink to pandemic levels (2020) for this time of year.

Therefore, the EIA is projecting a large recovery in gasoline stocks beginning in November.

For more perspective, the graph below shows the history and full outlook.

NYMEX Gasoline Futures Prices (“RB”) as of the October 24, 2022 close, implied a significant downward trend.

The Boslego Risk Services Trading Signal for RB is Red.

Conclusions

“Do not invest in the present. The present is not what moves stock prices,” is very good advice, in my opinion. However, it is easier said than done.

At present, there are major worries about whether Russian oil output will drop in December and whether heating oil supplies will be adequate this winter.

But you can always count on the oil & gas industry to ‘oversolve’ supply problems. In this case, they will get help from consumers who balk at paying such high prices to heat their homes and drive their cars.

And so, I now believe that CVR’s earnings’ prospects will diminish in the months ahead and rate the stock as a “Sell.”