Whether energy prices are rising, falling, or stagnant — there are almost always opportunities in the energy sector for investors who know where to look. But one has to understand how the ups and downs in energy prices generally affect the different sectors.   

For example, higher oil prices are clearly good for oil producers, but falling oil prices can benefit refiners (who are paying less for their primary feedstock) and tanker operators (as oil traders hire ships to store oil at sea). Falling natural gas prices can also benefit refiners, for whom gas is an important input, but there is another segment that benefits even more from low natural gas prices.

I discussed fertilizer master limited partnerships in a September 2013 article called The Sweet Smell of Decay. As I pointed out in that article, ammonia-based fertilizers are produced from natural gas via one of our most important industrial reactions, the Haber process. This reaction was discovered by German chemist Fritz Haber more than 100 years ago; he won a Nobel Prize for the discovery in 1918. It has been estimated that the many applications of this process are responsible for sustaining more than 2 billion people on this planet.

The reaction to produce ammonia actually takes place between hydrogen and nitrogen (3 hydrogen molecules are required per nitrogen molecule), but hydrogen is produced almost exclusively from natural gas. Thus, natural gas is to ammonia what crude oil is to gasoline, and hence the ammonia market is heavily influenced by natural gas prices.

There are three MLPs with fertilizer production as a core business: Terra Nitrogen (NYSE: TNH), CVR Partners (NYSE: UAN), and Rentech Nitrogen Partners (NYSE: RNF). The year-to-date gains of these three MLPs are respectively 54%, 48%, and 40% — which happen to be the top three year-to-date performances among MLPs.

The fortunes of these partnerships have swung dramatically over the past couple of years. Last winter, natural gas inventories were depleted by the coldest weather we have had in many years. As a result, natural gas prices spiked and were elevated into the fall. As gas prices spiked, the fertilizer MLPs declined, at one point vying for the dubious distinction as the worst performing MLP sector of 2014 (after all three were among the five worst performing MLPs of 2013).

But after the unusually cold winter came an unusually cool summer. Utilities that rely on natural gas to meet peak summer demand ended up needing less natural gas than in either of the two prior years, and at the same time natural gas production continued to rise. As a result, natural gas inventories began to return to normal and prices softened. When the high-demand winter season started out warmer than normal, natural gas prices fell below $3 per million British thermal units (MMBtu), and have been below that level almost every day this year. The fertilizer MLPs have been big beneficiaries of this decline.

Terra Nitrogen owns and operates a nitrogen fertilizer plant in Oklahoma. The general partner is a wholly owned subsidiary of CF Industries (NYSE: CF), the second-largest nitrogen fertilizer producer in the world.

CVR Partners (NYSE: UAN) actually produces fertilizer from the petroleum coke (the price of which is influenced both by oil and natural gas prices) produced by Coffeyville Resources Refining & Marketing, LLC, a refinery owned by CVR Refining (NYSE: CVRR) and located adjacent to its fertilizer operation. CVR Energy (NYSE: CVI), majority-owned by Carl Icahn via Icahn Enterprises (NYSE: IEP), is the general partner and owner of most limited partner units for both CVR Partners and CVR Refining.

Rentech Nitrogen Partners (NYSE: RNF) was spun off from the small alternative energy company Rentech (NASDAQ: RTK) in 2011. RNF owns two fertilizer production plants and is a pure play on nitrogen fertilizer.

Terra Nitrogen and Rentech Nitrogen are both variable distribution MLPs, although over the years Terra Nitrogen’s distribution has been relatively consistent. CVR Partners does not have a variable distribution policy; the past two years have forced it into a pattern of mostly declining distributions.

But the recent low natural gas prices have resulted in distribution increases for all three.

Last week CVR Partners announced a distribution of $0.41 per unit for Q4 2014, up from $0.27 per unit in the previous quarter.  This represents $1.64/unit on an annualized basis and a dividend yield of 11.4%. Earlier this month TNH announced a cash distribution for the quarter ended Dec. 31 of $2.50 per unit. This was also a sharp increase from the prior-quarter distribution of $1.78 (albeit still lower year-over-year), and represents a 6.9% annualized yield. RNF announced a distribution of $0.30 per unit for the fourth quarter after falling to $0.05 per unit in the immediately prior period. While RNF’s distribution implies a 7.9% annualized yield at the current price, the quarterly distribution over the past three years has swung as high as $1.17 and as low as $0.05.

Beyond the fertilizer MLPs, there are two MLPs involved in chemicals that also benefit from low natural gas prices. I will discuss these in next week’s issue. And do keep in mind before you decide to invest in any of the fertilizer MLPs on the basis of their recent strong performance that what goes up can go down just as quickly should natural gas prices start to strengthen.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Updates

CVR Refining’s Quarter to Forget     

Like fertilizer producers, refiners are at the mercy of their input costs — in their case mostly crude oil, though natural gas also plays a role.

Like the fertilizer producers, the sector has lately responded to its falling costs, albeit in much more muted fashion. That’s because coincidental with the oil crash, refining margins began to contract. Once crude steadied in mid-January, those margins, known in the industry as crack spreads, have recovered sharply.

There’s no mystery as to the catalysts for the recent move. First, the glut of domestically produced crude continues to fill up available storage capacity, threatening to exhaust it sometime this summer. Second, lower fuel prices have stimulated notable growth in U.S. fuel demand, so that gasoline stockpiles, while relatively high, suggest nowhere near the same glut as exists in crude — unsurprising, given that refined fuels aren’t subject to the law banning most crude exports.

Unfortunately for CVR Refining (NYSE: CVRR), last week’s results concerned the last three months of 2014, when conditions were far less benign. Then, crack spreads shrank as crude retreated. The cost of renewable identification numbers certifying compliance with the ethanol blending mandates spiked. And on top of that the fluid catalytic cracking unit at the partnership’s Wynnewood, Oklahoma refinery suffered a 16-day unplanned outage. That not only resulted in significant repair costs but reduced fuel output in general and the production of high-margin distillate in particular.

The downside from this series of unfortunate events was summed up with a quarterly distribution of 37 cents per unit that was the second lowest in the partnership’s two-year public history. Even so, that represents an annualized yield of 8.1%.

So the downside, short of a demand-killing recession, doesn’t look all that scary. But does the upside warrant continued buying now that the unit price has run 32% from its mid-January lows? Yes, it does.

Near-term upside will come from the recently improved crack spreads, which could get wider still if crude were to suffer another decline. Output should be higher as well barring another accident.

Longer-term, CVRR’s plan to spin off a fee-based logistics MLP could have upside as well in the next year or two, and management is on the lookout for acquisitions that might make that IPO more appealing.

For the long run, CVRR remains the #10 Best Buy below $26. Patient speculators might want to wait for more of a pullback after the big run in order to pick up this value play a little cheaper.

— Igor Greenwald