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May 13, 2018

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Midstream Week Thoughts: Checking the Boxes

Midstream resumed gains this week, with similar gains across MLPs, U.S. and Canadian corps.  Oil and the broad stock market rallied as well.  No surprise, but $70/bbl seems to be a positive for energy stocks broadly.  Midstream-specific sentiment has also benefitted from solid earnings season that included baby steps towards resolution of pending simplifications, de-leveraging, etc.  The MLP Index is just one more good week away from being flat for the year (including distributions).

This week might provide further progress on simplification and other potential strategic transactions, with expectations high for the Williams analyst day (5/17), the last meaningful scheduled event ahead of the MLPA conference next week.
The final week of 1Q earnings included major asset sales from Enbridge and drop-down clarity for ANDX.  MPC snapped its fingers last week and seemingly orphaned ANDX, Andeavor wrestled the infinity gauntlet back from MPC and reversed ANDX’s fate by re-instituting the drop-downs.
High Standards
Given that its Mother’s Day Weekend, a Mom related analogy is in order.  As a married man and father, I don’t get to just watch 80s action films, 90s cult classics and super hero movies.  I’ve had my fill of romantic comedies too.  One of those films was Monster-in-Law, a forgettable rom-com where Jane Fonda plays a rich mom who thinks Jennifer Lopez isn’t good enough for her son and spends the movie trying to break them up.

Midstream continues its transition to a more sustainable business model, a Midstream 2.0 model I wrote about in a whitepaper published a few years ago.  In that paper, I identified the boxes that Midstream companies should aspire to check: lower leverage, higher coverage and no IDRs. The challenge or lament is that among 60-ish midstream MLPs and 30-ish more midstream corporations (including Canada), there aren’t more than a handful that check all the boxes.  Not many of them are perfect enough to bring home to Jane Fonda’s portfolio.
2018 is a good year to own a midstream asset.  Producer activity is up, production is up, utilization is growing tight, driving opportunities to expand infrastructure.  We want to be able to identify that midstream assets will perform well in this fundamental environment but to do that, in many cases you’ve got to take on one or more of the following issues: high IDR take, strained balance sheets, low coverage, funding gaps, orphan risk and FERC uncertainty.  In investor parlance, almost all MLPs have a bit of hair on them.
The hair phenomenon is partially responsible for the high multiple at which OKE trades.  It’s the cleanest story in the universe (at the moment).  There are others that check some of the boxes.  Among MLPs it might be MMP or EPD, but they are still MLPs, which carry guilt by association (or index inclusion) with bad actors also structured as MLPs.  Others, like WMB/WPZ and PAA/PAGP have taken dramatic steps to join the Midstream 2.0 movement, but still get dragged down on big MLP index selloff days.
In investing generally, it’s rare to find the perfect company that checks all the asset and financial boxes and trades at an attractive valuation.  Identifying midstream companies that are executing on plans that will eventually check more boxes takes research, foresight and experience, and the market remains skeptical and content to stick with names that already check all the boxes.
That’s where active management and portfolio management becomes crucial.   With a portfolio, you can build a mix of companies with quality asset exposure and those transitioning to Midstream 2.0 model, with management teams you trust to be good stewards of capital.  Importantly, you can avoid some of the lower quality management teams, financial situations and assets.
As a married man, like Robin Williams in Good Will Hunting, I know perfection is a fool’s errand.  High standards are important, and you can certainly do better than owning the entire hairy sector passively, but there is some good stuff worth paying attention to in the midstream sector.

Winners & Losers
DCP reported solid 1Q results and an NGL pipeline solution from the DJ Basin, which when combined with higher commodity prices propelled DCP to the top of the group this week.  NBLX was second best this week, helped by news that sponsor NBL committed volumes to the EPIC pipeline that came with an option for a stake in the pipeline.  GLP and EEP reported results that the market liked, while SMLP rallied on no news.  The biggest losers this week were CAPL and BKEP, both had distribution cut announcements.

The YTD leaderboard saw some serious changes week over week.  EQM is now the 3rd worst performing MLP this year, despite no operational or growth hiccups since IPO, so it must all be the complexity and IDRs the market doesn’t like.  NS and SMLP climbed out of the bottom 5 and BKEP joined the bottom 5.  NRP took over the top spot from CCLP.  PAA dropped out of the top 5, replaced by CEQP.

General Partners & Midstream Corporations
GPs and Midstream corporations as a group were roughly inline with the AMZ this week.  SEMG’s White Cliffs NGL conversion and results were well received by the market.  PAGP was the clear laggard on results that beat, but disappointed on S&L upside in 2018 and commentary on Permian competition.

OKE extended its YTD lead in the group with another top 5 performance this week.   LNG leapfrogged PAGP for the second spot.  WMB closed the week down just 9.9% for the year, back into single digit negatives ahead of its analyst day next week.

Canadian Midstream Corporations
Enbridge was the clear winner, outperforming the group for a second straight week.  Enbridge had strong results and some major asset sales this week, but the Minnesota PUC decision in June on Line 3 replacement still looms.  Line 3 and Trans Mountain Expansion (and its end of May self-imposed deadline) both loom large for Canadian energy, including those smaller companies servicing producers in Canada.

Despite Enbridge’s recent strength, it hasn’t climbed any higher on the YTD leaderboard.  Canadian midstream did reach a milestone this week, however, when Keyera finished the week positive for the year so that at least one in the group is positive.

News of the (Midstream) Week
Plenty of news this week, including two major drop-down announcements, very large assets sales, and a creative and capital efficient development project.  Also, we got some very small signs of capital markets activity resurfacing.
Capital Markets

  • DCP Midstream (DCP) priced public offering of 6mm of its 7.875% Series B Fixed-to-Floating Rate Cumulative Redeemable Perpetual Preferred units at $25/unit, raising $150mm (press release)
    • Distributions fixed at 7.875% through June 15, 2023, then switch to 3-month LIBOR +4.919%
  • Enable Midstream (ENBL) priced offering of $800mm of 4.95% senior notes due 2028 at 99.197% of face value (press release)

Growth Projects / M&A

  • Enbridge (ENB-CA) announced separate sales of Midcoast Operating and 49% of its interests in select renewable power assets for a combined total of USD $2.5bn
    • Midcoast Operating, which conducts ENB’s U.S. NGL gathering, processing, transportation, and marketing businesses, was sold to an affiliate of ArcLight Capital Partners for $1.12bn (press release)
    • The renewable assets, including North American solar and wind and German offshore wind, were monetized through a newly created JV with Canada Pension Plan Investment Board (CPPIB) for $1.4bn (press release)
      • ENB will continue to manage, operate, and provide administrative services for the renewable assets
      • The JV will pursue future European offshore wind projects across all stages of development
  • SemGroup (SEMG) announced plans to convert a portion of the White Cliffs Pipeline system to NGL service, underpinned by a volume commitment from DCP Midstream (press release)
    • SEMG, who owns 51% of White Cliffs and is the operator, expects the project to cost $60-66mm and will fund 51%
    • In service is expected to be Q4 2019 and construction is estimated to cost less than 4x EBITDA
    • One of the 12-inch-diameter pipelines will be converted from crude service to NGL Y-grade service connecting the DJ Basin to Cushing, OK and will have an initial capacity of 90,000 bpd that will be expandable to 120,000 bpd
    • SEMG will construct a 12-mile extension of White Cliffs south of Cushing to interconnect with Southern Hills Pipeline to move NGLs south to Mont Belvieu
  • In a related announcement, DCP Midstream (DCP) announced plans to construct a 25-mile pipeline in the DJ Basin, connecting its Southern Hills Pipeline system to White Cliffs (press release)
    • DCP has entered into 10-year agreement for up to 50,000 bpd on White Cliffs
  • Shell Midstream (SHLX) announced the dropdown of the Amberjack Pipeline Company from Shell (RDSB) for $1.22bn (press release)
    • The Amberjack pipeline, located in the Gulf of Mexico, currently transports 300,000 bpd
    • Following the completion of the anticipated growth projects, SHLX’s share of Amberjack’s net income is expected to reach an annual run rate of $145mm with an associated quarterly dividend of $40mm, implying an 8.4x multiple
    • Acquisition funded with borrowings on its credit facility
  • Andeavor Logistics (ANDX) announced that it expects sponsor ANDV to offer assets totaling $1.6-1.7bn, including Permian gathering assets and ANDV’s remaining refining logistics assets (press release)
    • Assets include Rio Pipeline, the Conan gathering system and the Los Angeles Refinery Interconnect Pipeline
    • Expected to be funded with equity back to ANDV amounting to 40-50% of the purchase price
  • Noble Energy (NBL) finalized agreement with EPIC Pipeline to transport crude oil from the Delaware Basin to Corpus Christi (press release)
    • NBL has secured options to acquire up to 30% ownership in the EPIC crude pipeline and up to 15% ownership in the EPIC NGL pipeline
      • These options expire in Q1 2019 and can also be exercised by Noble Midstream (NBLX)
  • Blueknight Energy (BKEP), Kingfisher Midstream, and affiliates of Ergon, Inc. announced the construction of a new crude oil pipeline serving STACK producers in central Oklahoma (press release)
    • The pipeline will have an initial capacity of 90,000 bpd, expandable to 175,000 bpd


  • According to Reuters, Enbridge has received strong initial bids as high as CAD$4.5bn for its Western Canadian assets (Reuters)
  • Enbridge responds to ALJ, reinforcing its regulatory case on Line 3 replacement project (press release)
  • Boardwalk Pipeline (BWP) shareholder, TAM Capital Management, issued an open letter to the boards of Loews and BWP following the negative stock reaction from Loews consideration of exercising its right to call and purchase all of BWP’s outstanding units (press release)
    • The call allows Loews to purchase BWP at a price equal to the average closing price for 180 trading days prior to three days before the call is exercised
    • The letter expressed outrage toward Loews and their actions to artificially depress the stock price