BULLETIN #113 UPDATED JULY 14, 2015 COMPANY ANALYSIS NORTHERN TIER ENERGY NTI:NYSE

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1 BULLETIN #113 UPDATED JULY 14, 2015 COMPANY ANALYSIS NORTHERN TIER ENERGY NTI:NYSE NTI is a pure-play, mid-continent refinery. It s a variable rate MLP (Master Limited Partnership) which pays out a big yield dividend. The dividend changes quarter to quarter, hence the larger yield. The investment thesis here is this simple: Canadian and Bakken crude are the cheapest in the world. They trade at a discount sometimes a BIG discount to WTI, which trades at a discount to the international Brent price for oil set in London England. Canadian and Bakken oil account for almost 100% of NTI s oil so cheap input costs. The US now exports huge amounts of refined oil products diesel, jet fuel, home heating fuel. All these products get sold at Brent pricing as North Americans are competing against export buyers for them. That difference between Bakken or Canadian oil prices and Brent oil prices is the main profit driver for this company. And until there is a lot more refining capacity in North America, or the US allows export of raw crude or US crude production finally falls off a cliff--this profit play is here to stay in a bigger way than The Street thinks.

2 QUICK FACTS Trading Symbol: NTI-NYSE Share Price: $25.50 Shares Outstanding million 2014 Revenue $5.5 billion 2014 EBITDA $431.1 million Cash $118.3 million Debt $354.0 million First Quarter 15 Dividend $1.08 POSITIVES - close to both discounted Bakken and Canadian oil production - low WTI prices increase NTI profitability, so an excellent hedge if you own oil producers - a natural acquirer exists with controlling shareholder Western Refining (WNR- NYSE) - double digit dividend yield - management of WNR now run NTI they have proven to be excellent operators NEGATIVES -single asset company St. Paul Park refinery in Minnesota any operational issues or plant shutdown and stock gets hit -refining is volatile and that works both ways. The bullish case for crack spreads is strong now, but if it is wrong (say U.S. shale production really collapses) profitability here will collapse along with it -the dividend fluctuates quarter to quarter along with available cash flow this uncertainty creates the big dividend yield

3 HISTORY/BACKGROUND The original management team of NTI bought the St. Paul Park refinery in October 2010, from Marathon Oil (MRO-NYSE). The sale included a 17% interest in the Minnesota Pipeline (which runs from the town of Clearbrook in northern Minnesota down to the twin cities of Minneapolis/St. Paul), and 233 retail stores (under the SuperAmerica brand name). The deal cost US$605 million, which included working capital of US$300 million. Refining is traditionally a very up and down business; boom or bust. So management put on some hedges. Management hedged their crack spreads at US$20 for a couple years. That was a mistake. Just after they did that, the glut of Bakken oil lowered prices and crack spreads (which is their profitability measure) soared and for the first time in years, refining became VERY profitable. So that hedge was under water. They literally had to go public to raise the money to pay off the hedge, and clean up their balance sheet. That management team is now gone. A larger refiner, Western Refining (WNR) acquired control of NTI in November 2013 and replaced the entire management group with their own hand-picked individuals. To me, this is a big deal. The previous management team underperformed the PADD II refining margins, and the WNR now team is now beating it by $1-$2/barrel. On 90,000 + bopd, that s a lot of extra cash flow being generated. Western Refining only acquired 38% of the units of NTI, but it also acquired NTI s general partner which effectively gives it control (and four of the seven board seats). Operationally, the company is now doing extremely well, running at top capacity and being in the Top 2 or Top 5 most profitable refineries in the US, depending on which analyst you want to believe.

4 INVESTING IN REFINERIES 101 There has been no group of businesses that have benefited from the Shale Revolution more than American refineries. The reason is simple: over the past several years the huge surge in U.S. oil production has blown out profit margins for refiners especially for midcontinent ones like the St. Paul Park NTI owns and operates in Minnesota. They buy cheap crude based on WTI pricing (less the Bakken and Canadian discount), which has traded well below Brent, and sell their refined products like gasoline for cars, diesel, jet fuel, kerosene and other products based on the more expensive Brent pricing. The chart below shows the historical WTI-Brent spread. From 1990 through 2010 there was little difference between WTI and Brent oil prices. In fact, WTI historically traded at a slight premium to Brent because it is a higher quality light oil.

5 Jan-90 Jul-90 Jan-91 Jul-91 Jan-92 Jul-92 Jan-93 Jul-93 Jan-94 Jul-94 Jan-95 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 WTI / Brent - Differential $30 $20 $10 $0 ($10) ($20) ($30) Then towards the end of 2010 the surge in U.S. shale oil production disrupted the status quo. Differentials have been as wide as $30 at one point. The measure of profitability for a refiner is called a crack spread; it is the difference in value between the crude going in and the value of the refined products going out. The crack spread has gone WAY UP in recent years; it s being turbocharged because of this Brent-WTI spread. The higher this spread the better for NTI. NTI has an additional benefit in that on top of WTI-Brent spread both Bakken oil and Canadian oil (which represent NTI s input costs) trade at a further discount to WTI. NTI is able to source the two cheapest crudes in the world Canadian oil and Bakken oil.

6 I think that NTI, with the Bakken and Canada as its primary inputs, is in the sweet spot for low costs for at least the medium term and especially the short term (as of July 2015). There are currently 600,000 barrels of Canadian oil production that are going to be coming back on-line in the coming weeks and months which should have a significant impact on pricing (to the benefit of NTI). And I think the good times are going to keep rolling for NTI for quite a while to come.

7 Oil inventory levels are still beyond bloated in the U.S. which is going to keep pressure on pricing. The big surge in Canadian production will worsen that. NORTHERN TIER REFINERY ECONOMICS SUPPLY SIDE St. Paul Park which has 97,800 bopd output capacity can refine the two cheapest crudes in the western world Canadian heavy oil, and Bakken light oil. Like I said, refineries want low cost crude that s their input costs. Long term projections for both Bakken and Canadian oil production still show that the amount of oil produced will increase, with the rate of growth levelling off in the near term before accelerating again. Sixty percent of Northern Tier s crude comes from the Bakken.

8 The other 40% comes from a mixture of Canadian heavy oil and Syncrude. Both of these sources of oil meet at Clearbrook in northern Minnesota which is in close proximity to all of the action. That puts the company at the front of the line of buyers for this discounted oil. This is a long term differentiating factor.

9 Clearbrook is the clearing station for Bakken oil, and where Canadian oil comes down to the US via pipeline. Here is where the two sources of crude compete against each other for pipeline space. The closer any refinery is to Clearbrook, the cheaper their oil because of lower transport costs from this clearing station. And St. Paul Park is the closest. That s why their input costs are one of, if not the, lowest cost in the US and their margins near the widest of all refiners.

10 Source of image: NTI corporate presentation The differentials between Bakken and Canadian oil and Brent have actually been quite narrow of late, but I believe that is temporary (and why I m jumping on the stock now). In 2014 the Bakken discount to Brent crude averaged $11/bbl of late, and that has shrunk to $5/bbl of late. Over time I would expect that differential to blow back out back to $11/bbl which matches the cost to transport Bakken crude by rail to the East and West Coast. Differentials on Canadian oil prices have also come in of late thanks to the temporary shut-ins for upgrading and wildfires that I mentioned earlier. That will reverse course when that production comes back on-line in the coming weeks.

11 NORTHERN TIER REFINERY ECONOMICS DEMAND SIDE The US divides up its country into energy areas called PADDs Petroleum Administration for Defence Districts (that s another story). As you can see, Minnesota is in PADD 2. There are 25 operating refineries in PADD 2, but only six in the Upper Midwest. Transportation fuels demand in the Upper Great Plains where Minneapolis-St. Paul is in PADD II exceeds supply from local refineries. This is called being structurally short product. They have to import gasoline and other products so prices are higher than in other areas of the US. That makes PADD II crack spreads among the highest in the land (often the highest). Northern Tier, due to their area being structurally short and just how efficient they are, usually have crack spreads $2 above the normal PADD II average. The end result is that St. Paul Park is usually #1 or #2 most profitable refinery in all the United States (see the earlier image with gross margin by U.S. independent refiner). By the way, you don t need to wait for quarterlies to guess on profitability on this stock. The Gulf Coast crack spread is free to see every day

12 Then add $3 and that will be close to the mid-continent crack spread where NTI has its refinery. As I said, St. Paul Park actually gets about $2 more than midcontinent crack spreads, but you know me, I want to be conservative ;-). The point is, every day you can tell roughly what the profitability is of this company. It takes about 30 days for today s crack spread to get into the refinery; so today s crack spread tells you (very roughly) what the profitability of Northern Tier will be one month from now. ST. PAUL PARK REFINERY OTHER FACTS YOU MAY WANT TO KNOW 1. It has dual processing streams, so if one goes down (industrial accident) another one can still produce 2. It has a Nelson Complexity of 11.5 that s high. Nelson complexity is a measure of a refinery s ability to process lower quality (cheap) crudes in an economic way. St. Paul Park processes both light Bakken oil and heavy Canadian crude. 3. It has a finished product mix that is 48% gasoline, 35% distillates, 11% asphalt and 6% other.

13 INTEGRATED MARKETING CHANNEL SUPERAMERICA Forty to fifty percent of the gasoline produced by the St. Paul Park Refinery is sold through North Tier s own network of SuperAmerica convenience stores. There are 260 SuperAmerica stores in total, 165 of them are company-operated and the other 95 are operated by franchisees. The integrated refining and marketing operations result in a higher netback relative to the wholesale market alone. Most of these locations are in Minnesota and western Wisconsin where the SuperAmerica brand stacks up well against top national fuel retailers. The retail business is a very small piece of the pie though. In the first quarter of 2015 this unit generated EBITDA of just over $4 million while the entire company had EBITDA of nearly $130 million. NTI also has a 17% interest in the 455,000 barrel per day Minnesota Pipeline which carries crude from the hub in Clearbrook, Minnesota to the St. Paul Park refinery. FINANCES / BALANCE SHEET NTI was the first publicly traded Master Limited Partnership (MLP) to derive its income solely from refining and marketing operations. Under the MLP structure NTI is required to return substantially all of its cash flow after paying maintenance capex and debt service to shareholders. Now determining what is maintenance capex and the proper amount of working capital is not a black and white situation, and the board of directors can retain cash for special purposes at their discretion, but shareholders are still much more likely to see capital returned under this kind of structure.

14 I ll get into the dividends below, but one other very positive for the stock is that management has enough cash now to complete a couple very profitable upgrades that pay out in under two years: 1. A $19 million upgrade to #2 Crude Unit gets them $10 M EBITDA/yr 2. A $30 million spend on two new desalters gets them $22 M EBITDA/yr And they are also improving #1 Crude Unit to get more high value distillates out. They also say there is a surprising difference in crude quality across the Bakken, and they are working to source oil directly from particular areas and not just take whatever comes down the pipe from Clearbrook. This is a great use of cash flow dramatically improving refinery economics in a one-refinery company. But a lot of the cash flow NTI does generate goes to dividends. NTI does not intend to use debt to maintain a given level of dividend should cash flow for a quarter fall short. That means that the distributions are really determined by quarterly cash flow and are therefore volatile. The Q distribution was $1.08 per share. They went public in late 2012 and paid out $1.48 in Q In calendar 2013 they paid out a total of $3.49 per share and in calendar 2014 it was $2.71 per share. Over time the volumes that the refinery puts through (which has gone from 75-94K bopd in two years) and the crack spread (could be very volatile) will determine the distribution. Most MLPs are midstream companies whose revenues are based on fees, and don t have much exposure to commodity pricing like NTI does. But variable rate MLPs only get a small premium to what traditional C-Corp structures (Valero, Phillips 66, Western Refining etc.) receives from the market. Against a trailing twelve month EBITA level of $451 million, NTI carries about $240 million of net debt. That is a pretty comfortable amount of debt, but remember if

15 that crack spread moves against the company (spread between WTI and Brent narrows) the EBITA figure can shrink in a hurry. NTI carries a credit facility that has borrowing availability of $300 million but currently has nothing drawn. The debt the company does carry is in the form of secured notes maturing in 2017 and VALUATION It s a volatile industry, and both cash flows and distributions can be volatile at NTI see the two charts below. Over two quarters, EBITDA and distributions can go up or down 50%

16 Though, you could argue that if you add back the $55.2 million of cash held back in Q as a discretionary working capital reserve all of the last three quarters have seen the company generate nearly $100 million in cash available for distribution. Historically, NTI has traded at an average yield of 12%. Last quarter it paid a $1.08 dividend which on an annualized basis it 17% which would suggest that the stock prices needs to rise.

17 Is that $1.08 dividend sustainable for full year? Probably not, but the company could have paid the same dividend in Q as well if it hadn t chosen to withhold some cash to pay off a debt. Analyst estimates suggest that distributions over the next 12 months will be around $3.50 per unit which is a 13.7%. So there is likely some stock appreciation here and there is also the big yield on top of it. There is something else. There is considerable chatter about WNR which already owns over 30% of the stock buying all of NTI. And if not that, then at least buying $400 million worth of logistics assets (pipeline etc) that NTI has but would likely be better suited for WNR. Personally, I expect WNR to buy NTI at some point for a very small premium. They are both essentially one refinery companies. Either of these could be positive for the stock price. WHAT THE ANALYSTS SAY FIRM TARGET PRICE Barclays $34.00 Cowen $28.00 Credit Suisse $33.00 JP Morgan $26.00 RBC $30.00

18 STOCK CHART CONCLUSION NTI is now run by one of the best management teams in the business Western Refining. They proven their worth by improving their own crack spreads against the PADD II benchmark vs. previous management underperforming it. The Market is expecting WNR to buy NTI, and that will keep a good bid under the stock in these market conditions. A wall of 400, ,000 bopd of Canadian crude is expected to come back online in H2 2015, which should lower oil prices a lot in PADD II, the Midwest.

19 Any drop in production the Bakken has will be more than made up for by increased Canadian imports. So NTI s profitability should increase; it makes sense that PADD II oil prices will be the most impacted by that large glut of Canadian crude. Two highly profitable new improvements at St. Paul Park refinery has the potential to increase cash flow by $25 million a year organically. Remember this is a one refinery company any fire or downtime will cause this stock to drop hard, even if temporarily.