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High-Yield MLPs: The Good, the Bad and the Ugly — Part 2

By Roger S. Conrad on Mar. 3, 2015

With almost 3.14 million in aggregate horsepower, Exterran Partners LP is the largest provider of contract compression in the US by a wide margin and boasts assets in all the major US shale basins and conventional plays.

The MLP usually inks six- to 12-month initial contracts with customers, after which both parties can cancel the agreement with 30-days notice. Producers typically pay a fee to move compression equipment into place, an investment that helps to dissuade them from exiting the contract.

Exterran Partners doesn’t take title to any hydrocarbons, and customers supply the natural gas needed to power the compression units. The majority of the firm’s contracts require customer to pay a monthly fee regardless of production disruptions; if adverse weather or excess gas supply force the producer to shut in wells, Exterran Partners still gets paid.

In terms of contract renewals, lower-horsepower capacity that’s closer to the wellhead remains most at risk, especially in second- and third-tier basins with lower initial production rates and steeper decline curves.

Compression associated with gathering and processing tends to be stickier, though significant declines in throughput volumes can prompt customers to send some compression units packing.

Exterran Partners has deployed about 16 percent of its horsepower in gas-lift applications where the compressor enhances oil production by offsetting the natural dissipation of geologic pressure.

Lower oil prices shouldn’t affect renewals on this installed base, as incremental lifting costs remain attractive and few upstream operators will shut in producing wells. However, demand related to new well completions could come under pressure, leading to potential softness in pricing for gas-lift units.

About half Exterran Partners’ compression capacity operates in liquids-rich plays, with the other half leased to customers in basins that produce primarily natural gas. During the MLP’s third-quarter earnings call, management characterized roughly 20 percent of its capacity in these gas-focused areas as “very stable horsepower in very cost-effective shale gas plays.”

In recent years, the partnership has benefited from robust demand for compression capacity, thanks to the ongoing build-out of gas-gathering and -processing systems to support drilling activity in the nation’s leading shale oil and gas plays.

Tight supply-demand balances for compression services in popular liquids-rich plays also enabled Exterran Partners and its peers to push through price increases.

However, comments during the firm’s fourth-quarter earnings call suggest that management expects organic growth to slow in coming quarters, as upstream operators scale back spending and drilling activity.

Management announced that Exterran Partners has reduced planned capital expenditures by about one-third relative to the previous year, with about 70 percent of its capacity additions slated to arrive in the first half of 2015.

In light of the murky outlook for the back half of 2015, CEO D. Bradley Childers avoided discussing forward prices for compression services, dismissing the topic as “too controversial.”

But Childers’ forecast for a “sloppy market” over the next few years, where compression capacity relocates from marginal plays to centers of continued drilling activity, suggests that the MLP expects the supply-demand balance could loosen in some areas.

The potential to push through price increases also looks extremely limited at a time when producers and gathering and processing outfits have moved aggressively to cut costs.

Over the past few years, Exterran Partners’ growth opportunities in prolific shale basins have more than compensated for declining demand for horsepower in dry-gas basins; we would expect the churn rate in these marginal basins to accelerate in coming quarters.

Although the prospects for reduced drilling activity and spending should lower utilization rates and pressure pricing, Exterran Partners generated enough cash flow in the fourth quarter to cover its distribution by 1.41 times—a high margin of safety.

The MLP’s general partner also plans to drop down its 640 horsepower of compression capacity and its service business, which provides repair, maintenance and aftermarket parts for compressors.

Management hasn’t provided a time frame for these transactions to occur, though we wouldn’t expect any movement until after Exterran Holdings spins off its international operations, a transaction that’s expected to occur in the second quarter.

Weakness in oil, gas and NGL prices also creates opportunities, as producers seek to monetize their compression assets to shore up the balance sheet and reduce their capital intensity by outsourcing this function.

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