BEHIND THE NEWS: Locally based oil refiner sees boom times vanish

May 5, 2008

Calumet Specialty Products Partners LP, the low-profile Indianapolis-based oil refiner, has been confronting challenges lately that would fray the nerves of even the most seasoned executive.

First, the business is grappling with a huge spike in crude oil prices-the main input for its three Louisiana refineries, which churn out vehicle and jet fuel, along with solvents, waxes and other specialty petroleum products.

Then there's the delay-plagued expansion of its Shreveport refinery, which began in late 2006. The project was supposed to cost $110 million but the tab keeps soaring higher and higher-escalations Calumet blames on rising costs for labor and construction materials, as well as a revision to the plan that will boost output.

The expansion was supposed to be finished in the third quarter of last year. In February, the company revealed the cost had climbed from its most recent estimate of $220 million to $300 million-in part because of overtime pay aimed at averting further delays-and predicted production would ramp up in the second quarter.

In a conference call with analysts on Feb. 20, CEO William Grube provided this chilling fact: Every day of delay was costing Calumet $700,000.

You know a business is operating in a tough environment when setbacks like that aren't even its biggest obstacle.

Indeed, the bigger threat these days is crude oil prices, which have nearly doubled in the last 12 months. The price per barrel surged past $100 in February and now is flirting with $120.

Calumet uses hedging strategies to blunt the impact of price swings. But they don't wipe them out entirely. And while the company can pass on higher costs to customers-which include the makers of such products as Duraflame fireplace logs and Turtle Wax car polish-there's typically a four- to sixweek lag in doing so.

It all adds up to bleak times for the company, which operates quietly from headquarters on the west side near interstates 74 and 465. The publicly traded company is part of the sprawling empire of the Fehsenfeld family, whose holdings also include Heritage Environmental Services and the Crystal Flash convenience store chain.

"A perfect storm of negative events has impacted our outlook," Goldman Sachs analyst David Chiaro wrote in a recent report on Calumet.

The company on May 6 is scheduled to release first-quarter results, which some analysts fear will include more bad news. Calumet officials declined to comment in detail to IBJ, citing the upcoming release.

Even in a friendlier climate for oil refiners, Calumet would have had plenty on its plate for this year. In January, it closed on the $267 million purchase of Penreco, a Texas-based partnership that owns manufacturing plants in Texas and Pennsylvania and has longterm supply agreements with Houstonbased ConocoPhillips Co.

It's a substantial business to swallow and integrate for Calumet, which reported profit of $83 million on revenue of $1.637 billion in 2007. That compares with profit of $96 million on revenue of $1.641 billion a year earlier.

Calumet is one of about 80 U.S. companies organized as a publicly traded partnership-a structure that allows firms in some industries, primarily energy, to avoid paying income taxes. In return, the partnerships must pass on income to their investors, known as unit holders, in the form of quarterly distributions. Such firms are attractive to income-oriented investors because of their lofty dividends.

But Calumet just took a drastic step back on the dividend front. To conserve cash, the company announced April 23 that it was reducing its quarterly distribution from 63 cents a unit to 45 cents a unit-a 27-percent decline.

Even with that move, "we believe [Calumet] will need to take additional steps to ensure it does not break" the terms of its lending agreements, Goldman Sachs' Chiaro said in a report.

Not surprisingly, the woes have decimated the price of Calumet units. After going public at $21.50 in January 2006, the units shot higher like a newfound gusher, and by last spring they were flirting with $55. But they've been on a long decline since and now fetch only about $14.

The good news: If the company can avoid further cuts to its dividend, income investors now can make a bundle. At its current price, Calumet shares have an annual yield of nearly 13 percent.

That's a big "if." Raymond James' Darren Horowitz recently downgraded Calumet units from "market perform" to "underperform," citing his need to regain confidence in the company's operational and financial health.

Goldman Sachs' Chiaro is more optimistic and recently maintained his "buy" recommendation. He thinks the price has fallen so far that units now trade for less than the value of the underlying assets, "providing investors with a high-risk, high-return opportunity."
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