1. Please see page 6 for rating definitions, important disclosures and
required analyst certifications. All estimates/forecasts are as of 02/02/18
unless otherwise stated. 02/02/18 06:55:38 ET
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February 2, 2018 | Equity Research
Weekender: Midstream, The Elusive
Commodity Play
A Tale Of Two Countries. While marketing through Toronto this week,
we couldn’t help but note the stark difference in sentiment. Year to
date, U.S. midstream stocks (Wells Fargo MLP Index) are up 5.2%
(compared to 5.5% for the S&P500), while Canadian midstream is
down (an almost symmetrical) 6.9%. In Canada, the worry is all about
interest rates (the ten year U.S. treasury yield is up to 2.72%, the
highest since 4/22/14), bond yields, and the knock off effects on utility
and pipeline stocks. Meanwhile in the U.S.…
Playing For Commodity. Notwithstanding the pullback this week,
investors are looking to play the commodity. They’re asking us how to
capture upside commodity leverage in the midstream sector. For 2018-
2019, our models currently reflect crude prices of $52-58/Bbl (WTI),
natural gas prices of $3.00-3.25/MMBtu (Henry Hub) and NGL prices of
$0.63-0.76/gallon (Mt. Belvieu). This compares to current prices of
$64/Bbl, $3/MMBtu, and $0.73/gallon (as high as $0.80/gallon last
month), respectively (see Exhibit 1 for an overview of commodity
prices). If current prices hold, what is the impact to our models and
who is best positioned to benefit?
The Midstream Sector Has Changed. While there used to be several
companies with meaningful commodity price exposure, many of those
companies are gone. The remaining midstream companies have, by
and large, re-structured to fee-based contracts away from commodity.
The truth is, there are very few ways to gain meaningful direct
commodity exposure in the U.S. midstream space anymore (side note:
If an investor is looking to play commodity upside, there are obviously
better places to look than midstream energy).
So Who DOES Have Exposure? We count 7 midstream companies in
our universe with commodity driven cash flow accounting for greater
than 5% of total EBITDA. Among the larger cap companies, TRGP and
DCP have the most direct exposure (unhedged exposure at 38% and
43% of EBITDA, respectively). The others in the group include ENBL,
EPD, ETP, KMI, and NGL. Slim pickins!!
Running Sensitivities. If we use current commodity prices in our
model for 2018, EBITDA for these 7 companies increase by 2% (the
median). The companies with the most exposure on this basis include
DCP (4%), TRGP (3%), and NGL (2%). Please see Exhibit 2 for details
by company.
The Bigger Question – Volumes. Of course, the real question is this.
At a $65/Bbl oil price, what is the impact to our volume forecasts?
That’s the other question that investors are asking us. Unfortunately,
that’s a lot harder to answer or model. Here are some parameters,
though.
Continued inside.
Midstream/MLPs
Michael Blum
Senior Analyst|212-214-5037
michael.j.blum@wellsfargo.com
Sharon Lui, CPA
Senior Analyst|212-214-5035
sharon.lui@wellsfargo.com
Praneeth Satish
Senior Analyst|212-214-8056
praneeth.satish@wellsfargo.com
Ned Baramov, CFA
Senior Analyst|212-214-8021
ned.baramov@wellsfargo.com
Eric Shiu
Associate Analyst|212-214-5038
eric.shiu@wellsfargo.com
Nicholas Daly
Associate Analyst|212-214-8012
nicholas.daly@wellsfargo.com
Zachary Cantor
Associate Analyst|212-214-5050
zachary.cantor@wellsfargo.com
2. Midstream/MLPs Equity Research
2 | Wells Fargo Securities, LLC
Our Current Baseline Forecasts. While we model each company individually based upon their specific
basins, geographic footprints and associated drilling activity, we use our colleagues’ U.S. oil and gas
production forecasts as a baseline to guide our models. Our integrated/refining team forecast U.S. crude
production growth of 13.4% (to 10.5 MBbls/d in 2018) and 10.5% in 2019 (11.7 MBbls/d). Our E&P
team forecasts U.S. natural gas production growth of 6.7% in 2018 (78.1 Bcf/d) and 5.8% in 2019
(82.6 Bcf/d). We forecast NGL supply growth of 12.6% in 2018 (4.7 MBbls/d) and 7.4% in 2019 (5.1
MBbls/d). How much would those numbers change if commodity prices remain elevated relative to our
model? Hard to say. However, in broad terms, we believe drilling activity could accelerate in the “second
tier” oil basins if oil prices hold at or near current levels. This includes the Bakken, DJ/Niobrara, and
perhaps even the Eagle Ford. Bottom line, the volume question is much hard to answer. As we slog
through earnings season, we’ll leave that one for another time.
Exhibit 1. Commodity Price Assumptions In Our Models Versus Current Prices
Wells Fargo Current
Price Deck Commodity
Commodity Price Assumptions FY2018E Prices
Crude oil - WTI ($/Bbl) $53.25 $64.00
Natural gas - HH ($/MMBtu) $3.00 $3.00
Ethane - Mt. Belvieu ($/g) $0.30 $0.27
Propane - Mt. Belvieu ($/g) $0.79 $0.85
Isobutane - Mt. Belvieu ($/g) $0.95 $1.09
Normal butane - Mt. Belvieu ($/g) $0.91 $0.83
Natural gasoline - Mt. Belvieu ($/g) $1.23 $1.42
NGL composite price - Mt. Belvieu ($/g) $0.69 $0.73
Note: Current prices reflect intraday pricing as of 1/31/18.
Source: Bloomberg and Wells Fargo Securities, LLC estimates
Exhibit 2. Commodity Price Sensitivity – Impact On EBITDA
($MM) 2018E EBITDA Estimates Based On EBITDA
# Ticker Price Deck Current Prices Change (%)
1. DCP $1,098 $1,145 4.3%
2. ENBL $1,014 $1,027 1.4%
3. EPD $6,174 $6,241 1.1%
4. ETP $7,257 $7,277 0.3%
5. KMI $7,340 $7,398 0.8%
6. NGL $547 $559 2.2%
7. TRGP $1,260 $1,295 2.8%
Median 1.4%
Note 1: Estimates for NGL represent calendar year figures.
Source: FactSet and Wells Fargo Securities, LLC estimates
Investor Topics
Explaining recent weakness in midstream sector
What’s driving Canadian midstream underperformance relative to US midstream?
EPD weakness in light of solid earnings
Deep dive interest in KMI
Outlook on NGL prices
MMP’s 2019-20 distribution growth guidance of 5-8%.
3. Weekender: Midstream, The Elusive Commodity Play Equity Research
Wells Fargo Securities, LLC | 3
Model Requests
ANDX
BPL
EPD
EEP
ETP
HEP
HESM
KMI
MMP
NBLX
PAA
PBFX
PSXP
TRGP
SEMG
SUN
WES
WMB
WPZ
5. Weekender: Midstream, The Elusive Commodity Play Equity Research
Wells Fargo Securities, LLC | 5
MLP Glossary Of Terms
Available Cash Flow: Available cash flow is the cash flow available to
the common unitholders and the general partner.
Backwardation: A market condition in which future commodity prices
are lower than spot prices. A backwardated market usually occurs when
demand exceeds supply.
Contango: A market condition in which future commodity prices are
greater than spot prices. The higher future price is often due to the cost
associated with storing and insuring the underlying commodity.
British Thermal Unit (Btu): A unit of measurement for energy
representing the amount of heat required to raise the temperature of
one pound of water one degree Fahrenheit.
Current Yield: The current yield is calculated by taking the current
declared quarterly distribution annualized and dividing it by current stock
price.
Dekatherm: A dekatherm is a measurement of energy content. One
dekatherm is the approximate energy content of 1,000 cubic feet of
natural gas (or 1 Mcf).
Distributable Cash Flow (DCF): DCF is the cash flow available to be
paid to common unitholders after payments to the general partner.
Distribution (Dividend) Discount Model (DDM): DDM is an equity
valuation tool used to estimate the present value of a stock based on the
expected distributions (or dividends/future cash flow) received from the
company.
Distribution: In a typical partnership agreement, the MLP is required to
distribute all of its “available cash.” MLPs typically distribute all available
cash flow (i.e. cash flow from operations less maintenance capex) to
unitholders in the form of distributions (similar to dividends). However,
management typically has some discretion in how much cash flow they
choose to pay out.
Distribution Coverage Ratio: The coverage ratio indicates the cash
available for distribution for every dollar to be distributed. The ratio is
calculated by dividing available cash flow by distributions paid. Investors
typically associate the coverage ratio as the “cushion” a partnership has
in paying its cash distribution. In this context, the higher the ratio, the
greater the safety of the distribution.
Dropdown: A dropdown is the sale of an asset from the parent
company (or sponsor company) to the underlying partnership.
Dropdowns can also be defined as a transaction between two affiliated
companies.
Earnings Before Interest, Taxes, Depreciation and Amortization
(EBITDA): EBITDA is a non-GAAP measure used to provide an
approximation of a company’s profitability. This measure excludes the
potential distortion that accounting and financing rules may have on a
company’s earnings; therefore, EBITDA is a useful tool when comparing
companies that incur large amounts of depreciation expense because it
excludes these non-cash items which could understate the company’s
true performance.
Earnings Per Unit (EPU): An MLPs’ EPU is synonymous with a C corp.’s
earnings per share (EPS). EPU is calculated by dividing net income
allocated to the limited partners divided by the weighted average units
outstanding at the end of the period.
EBITDA Multiple: An EBITDA multiple is the expected return an
acquisition or organic growth project is estimated to generate. For
example, a $100 million investment at an 8x EBITDA multiple, would be
expected to generate approximately $12.5 million of EBITDA on an
annual basis (or a 12.5% return).
Excess Cash Flow: Excess cash flow is the cash flow that remains after
distributions have been paid to common and subordinated unitholders
and general partner.
Fractionation: Fractionation is the process that involves the separation
of the NGLs into discrete NGL purity products (i.e. ethane, propane,
normal butane, iso-butane, and natural gasoline).
Frac Spread (also known as “Processing Margin”): The processing
margin is the difference between the price of natural gas and a
composite price for NGLs on a BTU-equivalent basis.
General Partner (GP): The GP (1) manages the day-to-day
operations of the partnership, (2) generally has a 2% ownership stake
in the partnership, and (3) is eligible to receive an incentive distribution
(through the ownership of the MLPs’ incentive distribution rights).
Incentive Distribution Rights (IDRs): IDRs allow the holder
(typically the general partner) to receive an increasing percentage of
quarterly distributions after the MQD and target distribution thresholds
have been achieved. In most partnerships, IDRs can reach a tier
wherein the GP is receiving 50% of every incremental dollar paid to the
LP unitholders. This is known as the 50/50 or “high splits” tier.
Limited Partner (LP): The LP (1) provides capital, (2) has no role in
the MLPs’ operations or management, and (3) receives cash
distributions.
Liquid Petroleum Gases (LPGs): LPGs are created (as a byproduct)
during the refining of crude oil or from natural gas production. LPGs are
typically a mixed form of propane and butane.
Maintenance Capital Expenditures (Capex): Maintenance capex is
the investment required to maintain the partnership’s existing assets.
Natural Gas Liquids (NGLs): NGLs are extracted from the raw
natural gas stream into a liquid mix (consisting of ethane, propane,
butane, iso-butane, and natural gasoline). The NGLs are then typically
transported via pipelines to fractionation facilities.
Organic Growth Capital Expenditures (Capex): Organic growth
capex is investments used to expand a company’s operating capacity or
operating income over the long-term.
Processing: Natural gas processing involves the separation of raw
natural gas into “pipeline quality” gas and natural gas liquids.
Tax Deferral Rate: A percentage of the cash distribution to the
unitholder that is tax deferred until the security is sold. The tax deferral
rate on distributions ranges from 40-90%. The tax deferral rate is an
approximation provided by the partnership and is only effective for a
certain period of time.
Energy Industry Abbreviations
Bbls: Barrels
Bcf/d: One billion cubic feet per day
MBtu: One thousand Btus.
Mcf: One thousand cubic feet of natural gas.
MBbls: One thousand barrels.
MBbls/d: One thousand barrels per day.
MM: In millions.
MMBbls: One million barrels.
MMBbls/d: One million barrels per day.
MMBtu: One million Btus.
MMBtu/d: One million Btus per day.
MMcf: One million cubic feet of natural gas.
MMcf/d: One million cubic feet of natural gas per day.
Tcf: One trillion cubic feet of gas.
6. Midstream/MLPs Equity Research
6 | Wells Fargo Securities, LLC
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STOCK RATING
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market over the next 12 months. BUY
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market over the next 12 months. HOLD
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next 12 months. SELL
SECTOR RATING
O=Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months.
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months.
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V=A stock is defined as volatile if the stock price has fluctuated by +/-20% or greater in at least 8 of the past 24 months or
if the analyst expects significant volatility. All IPO stocks are automatically rated volatile within the first 24 months of
trading.
As of: February 2, 2018
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