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Q4 Takeaways: Big Growth and High Stakes in the Permian Basin

By Peter Staas on Feb. 2, 2018

It’s the most wonderful time of the year: fourth-quarter earnings season is in full swing for the energy sector.

Subscribers can find our take on Halliburton (NYSE: HAL) and Schlumberger’s (NYSE: SLB) results and key takeaways from their conference calls in the Jan. 24 issue of Energy & Income Advisor.

My colleague Roger Conrad delved into Kinder Morgan’s (NYSE: KMI) earnings and their read-throughs for other companies in last week’s installment of Energy Investing Weekly. As the first US midstream operator to report each quarter, Kinder Morgan’s results provide a valuable initial glimpse into key trends.

However, in the midstream space, we look to commentary from the management team at Enterprise Products Partners LP (NYSE: EPD) for insights into the direction of North American commodity prices and emerging opportunities throughout the energy value chain.

Not only is this publicly traded partnership a foundational holding in any energy portfolio (at the right price), but also CEO Jim Teague and his team have proved particularly prescient about bigger-picture developments–and how to profit from them.

This candor and insight stand out against other management teams that tend to emphasize company-specific projects and anticipated distribution growth with scant reference to trends in the industry at large.

Not surprisingly, Enterprise Products Partners routinely draws the biggest crowds at the MLP Association’s annual investor conference—an event that we attend every year as part of our research process.

This time around, Enterprise Products Partners again highlighted its ongoing push to reduce equity issuance as a means of funding growth-related capital expenditures by building excess cash flow. Earlier this year, the master limited partnership (MLP) slowed its rate of quarterly distribution growth, with an eye toward achieving a self-funding model by 2019.

This shift changed the nature of the conversation in the midstream space, though Enterprise Products Partners’ conservative distribution policy and existing excess cash flow gave it a leg up in moving in this direction. (See Slowing, But Still Growing.)

Meanwhile, the partnership’s strong fourth-quarter results benefited, in part, from robust gas-processing and NGL (natural gas liquids) fractionation margins—one of the reasons we pounded the table for MLPs when the group came under pressure from tax-loss selling last fall.

Enterprise Products Partners also emphasized the importance of international exports to provide a release valve for growing US hydrocarbon production, with activity on its Gulf Coast docks increasing 50 percent from year-ago levels and the MLP making a final investment decision on an ethylene export project. (Read more about the winners and losers from the looming Gulf Coast petrochemical complex in Moving Down the Petrochemical Chain.)

Exports figure to be an ongoing growth story, with Enterprise Products Partners’ management team indicating that US NGL production—especially from the Permian Basin—would overwhelm existing propane and butane export capacity, depressing prices and leading to further expansion opportunities.

Perhaps the most interesting takeaway from Enterprise Products Partners’ fourth-quarter earnings call was management’s acknowledgement that the latest generation of pipelines providing takeaway capacity from the Permian Basin would feature significantly lower tariffs than existing lines.

This admission gibes with comments from exploration and production companies in the Permian Basin regarding transportation costs. Equally important, the comment underscores the competitive threat posed by the massive amounts of private-equity money pouring into the midstream projects at a time when many larger MLPs must contend with higher costs of equity capital and are focused on repairing their balance sheets.

For example, private equity-backed EPIC Midstream Partners secured Noble Energy (NYSE: NBL) as a shipper on its proposed 550,000 barrel-per-day pipeline to connect the Eagle Ford Shale and Permian Basin to refining and export capacity in Corpus Christi, Texas. The company’s website boasts that EPIC crude pipeline offers marketers and upstream operators “customer-friendly contract terms” that reportedly are at a significant discount to legacy assets.

This intense competition creates re-contracting risk for existing pipelines and underscores that investors must keep a level head and an eye on the potential risk in a world where every midstream and upstream operator wants to buy a Permian basin merit badge, no matter the cost. For more on this phenomenon, see Permian Basin to Take Market Share in a Short-Cycle World.)

In this environment, midstream operators with an integrated asset base will find themselves at a competitive advantage because they can cut a customer a break at one link in the value chain and make it up down the line. Investors should also focus on midstream names that sponsored by one of the Permian Basin’s leading producers.

 

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