Getting more oil on the move
Enterprise Products Partners looks set to maintain its leading position in the expansion of US midstream logistics over the next two years
The ongoing US upstream revolution will offer continued expansion in connecting growing hydrocarbons production to domestic end-user and export opportunities. But Enterprise and its competitors will need to continue to be attentive to their balance sheets as the market remains skittish about financing the volatile energy sector. Meanwhile, the company is strengthening its balance sheet in an apparent transition to a more conventional corporate financial model from its current limited partnership LP structure.
The US Energy Information Administration's (EIA's) latest Short-Term Energy Outlook, published 15 January, estimates that US crude oil production averaged 10.9mn bl/d last year, and will grow to 12.1mn bl/d this year, and 12.9mn bl/d in 2020. The EIA expects that hydrocarbon gas liquids will grow by a further 900,000 bl/d over the same period, with chemical feedstock ethane accounting for about half of that increase. Most of this production is expected to arise from the Permian Basin in West Texas and New Mexico, where Enterprise is particularly strong.
Clear the way
Much of Enterprise's activity is aimed at resolving logistical bottlenecks that have arisen and are expected to arise as US hydrocarbons outlook increases. In a December 2018 presentation to the Wells Fargo Pipeline and Utility Symposium, Enterprise president and chief financial officer Randy Fowler said the company had $6bn in "growth capital" projects under construction and expected to be on stream by 2021.
Fowler added that the company had simultaneously increased its annual distributions per unit and its self-financing of growth projects. This reflects an emphasis on ensuring consistent returns to attract institutional investors in the face of market reluctance to finance energy projects given the volatile oil prices of the past few years, which coincided with upheavals in the master limited partnership (MLP) market.
"There's a push to return cash to shareholders in any form possible," says David Amoss, research analyst with Heikkinen Energy Advisors in Houston.
Enterprise's principal capital projects aim to ease constraints affecting liquids producers. The EIA estimates that the Permian basin will provide the largest share of new US output through 2020, with crude production rising by 1.1mn bl/d from its current level to 4.8mn bl/d. "The Permian Basin is the crown jewel of the US Lower-48 growth story," says a US oil industry consultant.
Source: Enterprise Product Partners
Enterprise is currently moving 570,000 bl/d of crude through its 575,000 bl/d Midland- to- Sealey pipeline in Texas and expects to have converted an existing natural gas liquids (NGL) line to transport crude by mid-2019. The company says its Red Hills-Loving-Midland pipeline capacity can be expanded by 270,000 bl/d to 470,000 bl/d. It also expects to add 500,000 blarrels of crude oil storage capacity at Midland to the 3mn barrels it built over the past two years. The additional logistics capacity will improve transport to key Texas refining hubs and the Gulf Coast's growing oil export terminals.
LTO for export
Heikkinen Energy's Amoss notes that as US production increases, the contour of midstream infrastructure is developing so as to channel the relatively heavier crudes in the largely light tight oil (LTO) output to the US refining system, while lighter crudes are destined for export. Enterprise is developing an offshore oil-export terminal for which it expects to receive approval in 2020. Several such terminals are under development, all aimed at facilitating the loading of very large crude carriers of 200,000-t deadweight or more, which are unable to fully load at Texas ports.
Analysts say that, with at least four such terminals under development, there is a risk that one or more may fail to be constructed. Enterprise may have developed a competitive advantage, however, in co-sponsoring and providing delivery points for the CME/NYMEX West Texas Intermediate (WTI) Houston Crude Oil Futures Contract. That contract began trading in November and provides for physical delivery at the Enterprise Houston system, including its Houston (ECHO) or Houston Ship Channel (EHSC) or Genoa Junction terminals. Delivery quality is a 40-44° API crude with 0.275pc sulphur. Analysts say an established typical export quality of the crude will help dispel lingering market concerns over the consistency in quality of US LTO, which have made some buyers reluctant to buy it on a term basis.
Building on the increase in US NGL production, Enterprise is also expanding NGL and petrochemical logistics operations. After bringing its Orla I and II gas plants and Mont Belvieu IX fractionation unit into service in 2018, the company expects up to 56pc of capital spending through 2020 to be dedicated to the NGL sector, including $4.5bn in 2019 on the Orla III gas plant; an ethylene export dock to meet increased demand for ethylene from foreign buyers, particularly in Northwest Europe and India; and its Mentone gas plant and additional Mont Belvieu fractionation in 2020.
Financing this expansion is requiring a modification in the approach to financing by Enterprise and other LPs. Amos and Heikkinen Energy Advisors and others note that the sector faces several challenges, both in financing required projects and in attracting equity from potential investors.
In financing projects, analysts say that because of the roller-coaster ride in oil prices between 2015 and 2018, both upstream E&P and midstream companies were tarred with the same energy volatility brush. East Daley Capital Advisors, in its latest "Dirty Little Secrets" report, notes that "there is a strained relationship between declining equity markets and growing US production fuelling the midstream sector".
Amos points out that retail investor interest in the midstream sector has declined following a 2015 drop in expected secure distribution levels and MLP market values. That interest was fuelled by individual investors seeking income, but institutional interest in the sector has not since grown to compensate. He suggests that midstream LPs have several challenges to face in their relationships with institutional investors. These include investment mandates; tax documentation complexities linked to the MLP structure; and past poor experience with the allocation of returns between limited partners and general partners, generally to the advantage of the General Partners. This governance problem has affected many institutional investors' view of the LP sector. Amos points out that Enterprise has already moved to minimise such issues within its current structure. Nevertheless, it suffers from the current poor image of the energy sector as a whole.
Source: Enterprise Product Partners
Analysts believe several LPs may follow Kinder Morgan's move, converting to a conventional "C-corporation" joint-stock structure from a partnership structure. The US Tax Cuts and Jobs Act, which President Donald Trump signed into law in 2017, may provide an impetus for this. However, it seems that many in the industry doubt the permanence of that reform, and may want to see "another cycle" of tax adjustments before being convinced to take the plunge into a new corporate structure.
New finance infrastructure
The tightness of equity finance in the market has prompted many midstream companies to lessen their dependence on external bank finance in developing new infrastructure. In the case of Enterprise, Fowler noted in his December presentation that the company is relying increasingly on cash flow rather than debt to generate investment equity. Over a "two-year transition period" ending in 2019 the company is evolving towards a "more traditional financial model" by increasingly self-funding investments and reducing its leverage to a target of 3.5 times its long-term earnings before interest, tax, depreciation and amortisation.
Source: Enterprise Product Partners
By the end of Q3 2018, that multiple was at 3.6, down from a peak of 4.4 in 2016, according to Fowler's December presentation. Enterprise says it sees potential to distribute capital to investors via distribution growth and buybacks from 2020 forward. Simultaneously, it has adjusted its debt characteristics, 78pc of its debt has a maturity of at least 10 years, and 99pc of all its debt at the end of 2018 was fixed-rate at an average interest rate of 4.7pc, up 10 basis points from the end of 2017. Fixed-rate debt dovetails with the structure of long-term tariffs on Enterprise's fee-based asset portfolio.
Enterprise's projects over the next three years are intended to face what the company sees as the US hydrocarbon industry's near-term challenges. It expects that demand for transportation services from the key Permian basin will continue to be high, based on the number of drilled but uncompleted wells in the basin. It also expects NGL transportation and fractionation capacity demand to remain high, particularly as both the Permian and the Marcellus/Utica basins in the Northeast will remain major producers of liquids.
While some analysts still question the longevity of the US shale revolution, given the short cycles and rapid decline rates of most developments, Enterprise and others believe it is here for the long haul. The US exploration and production sector has "staying power and significant volumetric upside", Fowler said in his December presentation.
Analysts believe the broad MLP-based midstream sector would benefit from stability in the oil price outlook, as well as from the terms of the Trump tax reform, if they are maintained. But they think it unlikely that retail investors, most of whom were older, will return to MLPs with the enthusiasm that they displayed earlier in the decade. However, institutional desire for yield may substitute for them and emerge to supply the equity the sector will need in order to complete its buildout of new infrastructure.