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MLP Weekly: Plain Talk

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After weeks of speculating how the market may react to lower 2015/2016 growth as a result of low energy prices, the market provided a glimpse of how MLP investors would respond.  Fear and Panic, coupled with legitimate Fundamental concerns, crushed units this week, ignited by Q&A comments by Plain All American's management team on their Wednesday morning conference call.  These comments created uncertainty about whether other Management teams have been less than forthcoming about market conditions, and questioned the perspective that Midstream units, with their take or pay agreements, were highly insulated from margin pressures associated with lower volumes.  Or, as suggested by Energy Transfer CEO, Warren Kelcy, was Plains using market conditions as an excuse for poor management.  The market has reacted to the former, sending the benchmark index down over -25% for the year and nearly -10% for the week.   After listening to over 100 conference calls, the market will have a difficult time, if current energy prices persist, assessing the impact of rollover take or pay contracts, which increasingly will have a higher level of exposure to either price or production volumes. The concept of a fixed toll road, a common marketing pitch for midstream MLP's, will be a misnomer if crude prices continue in the $40-$50 range through 2016.



Plain Talk


By the time Plains All American finished their Q2 Q&A, the price of $PAA declined 16% and lowered their market cap by $2,500,000,000.  By week's end, Plains All American GP, which owns the IDR's and receives 50% of the incremental increase in distributions for current units and those issued in the future, declined over -30%, well below their $22.00 IPO price from October 2013.  Since that date, PAGP has distributed $1.19 in cash, and is trading  -$4.30 below the IPO price.  So what caused this rapid deconstruction of value?  As the chart below indicates. Plains released their earnings after the close on August 4th, which stated that 2015 EBITDA midpoint guidance would be lowered by $50MM, or $0.125 per unit.  Upon the market open, both PAA and PAGP fell around 5% on this news.  The earnings call, and release of the company presentation started at 11:00 AM EDT, at which point PAA had recovered slightly.  Management reviewed their performance and CEO Greg Armstrong concluded the call with the following comments:


"We assumed capital markets access would be restricted if commodity prices fell meaningfully and that therefore it would inhibit the ongoing development of logistics projects that we believe are marginal or unnecessary.That has proved not to be the case, at least until here very recently. And as a result, there has been more midstream logistics capacity built than we previously forecasted, and it's either has been built or under construction and that will increase competition and also the impact our volumes and margin."


"The second factor is the magnitude of the impact on regional markets and differentials that ship-or-pay arrangements have had and will likely continue to have during periods where volume growth falls short of company forecasts. "


"If current conditions remain challenging into early 2016, among the options we will need to consider is whether to view 2016 as a transition year with much lower distribution growth or as a year to defer any distribution growth until 2017 when coverage increases as a result of meaningfully higher EBITDA levels related to our various growth projects”


These comments accelerated the declines and sent PAGP into a free fall as 0% 2016 PAA distribution growth would mean that PAGP would only increase distributions from an increase in new unit issuance of PAA,  which given the drop in PAA, would make such issuance more expensive and further deteriorate Distributable Cash Flow.  The market seemed to disregard the fact that Plains expects to increase 2017 EBITDA by 30% as a result of projects, with firm commitments, which are in development.  Plains also targets a 1.05x coverage ratio, which means that in a down year, their growth would need to be funded by the balance sheet.  Although many other MLPs use this approach, Plains management takes a more conservative approach, and may defer growth for the long term benefit of unit holders.  At a 7.86% tax deferred yield and a strong balance sheet, Plains offers a very attractive entry point for what may be the worst case set of expectations.





Management Comments


This week, over 68 units reported their Q2 results, and below are a few noteworthy comments from the Q&A sessions


On Midstream Crude Pipelines

Plains CEO comments to the question of where excess capacity exists "I would say in general it's across the board."  For which Energy Transfer's CEO responds to a similar question "The pipeline business will overbuild until the end of time. I mean that's what competitive people do. We've done it. Others have done it around us. And then you find yourself – you must scavenge a product from others when you see volume declines. Then how do you do that? Well, you provide more services than your peers do. You provide more optionality. So this is something we'll always live through. But I'll tell you, people that give guidance and then turn around and have a bad financial reporting period and then throw all of us under the bus. Hey, by the way, don't focus on us, focus on the industry. This is an industry problem. That gets a little frustrating for me."


On the Impact of Crude Storage Levels

Plains CEO comments “So we're expecting to end the year somewhere between 23 million and 80 million barrels above normal. That's got to be worked off. We think that could make the first six months of 2016 difficult??


On Asset Valuations

Plains CEO Comments "we've bid on 20 to 30 acquisitions where we felt very good about wanting to own those assets having synergies. And in many cases we were outbid by 30%, 40%, even 50%."


On Marcellus and Utica Volumes

Targa CEO Comments "And I will tell you that I think the challenge for everybody up there right now is getting the takeaway capacity out of the area. And so, there's no doubt that the potential was there at this point. I don't think anybody that's involved or engaged in the there's an adequate call for it by the market. But as we sit today, the market – the supply side is desperate to see those expansion projects come online on the gas takeaway side to be able to alleviate that. So I think that's really the curtailment, if you will, right now, that will stop that from being – going gangbusters. "  

"But the real impact was from shut-ins, particularly from producers up in the Susquehanna County area and some very substantial shut-ins that are due to lack of infrastructure availability."


On Following the MPLX Growth Strategy

Since MPLX announced their plan to purchase Markwest Energy Partners, their units are down -22%.  High Growth sponsored units have declined and management teams have had to respond to questions of whether they will follow the MPLX growth strategy.  Dominion CEO comments "In terms of the MLP sector in general, it appears that some investors have shown concern based on recent transactions around change in business practice or at least change in philosophy on their business mix. DM will not go that way. DM is going to stay with what we told investors in February. That we have a great dropdown story, regulated assets, very firm earnings. And if we decide to acquire anything, it will fit that same portfolio."


On Whether LNG contracts are being renegotiated

Dominion's CEO, which is developing the Cove Point LNG terminal for exports, comments "No".


On Frac Sand Pricing

Emerge Energy CEO comments "With more than two-thirds of our contracts tied to a WTI pricing index, we believe this unique approach with our customers will provide higher confidence that our sand prices will recover quicker and to perhaps higher levels than many other proppant suppliers….the contract amendments that are WTI linked do not provide for price reductions with a move below $50. So, there are certain thresholds that are in place to take advantage of increases in WTI above the $50 threshold. And the contracts vary by customer and move in different threshold levels, but where we don't have downside in our pricing because of the recent drop below $50. "


Funds and Flows


Over the last 2 years, MLP ownership has become more concentrated by institutions who offer packaged funds. Since 2013, individual ownership of MLPs has increased by 10%, or 300,00,000 units, owned by 4.5MM individual entities, as per metrics reported by PwC.  Since 2012, fund assets have increased by $33B, primarily through the issuance of new funds.  Given the rapid losses associated with MLP funds as indicated below, fund outflows should be a concern, particularly for the large cap units held across most of the funds listed below.  The top 5 holdings for the Oppenheimer funds include ETE, ETP, EPD, MMP and WPZ as of 6/30/15.   




With Crude trading at $45 and the fundamental outlook murky at best, Now is the time for investors to assess and discuss the opportunities and risks for MLP investments.  Please join a panel of seasoned experts on September 16th to learn more about MLP's and the most rewarding Income and Total Return strategies.


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