The MLP IPO Boom and Its Discontents

The past two installments of MLP Investing Insider have focused on the growing pipeline of initial public offerings (IPO) and analyzed the sudden upsurge in downstream operators, particularly wholesale fuel distributors, seeking to go public as master limited partnerships (MLP).

In July 2012, three of the companies that have publicly disclosed intentions to spin off assets as an MLP have filed S-1 registration statements with the US Securities and Exchange Commission (SEC).

Marathon Petroleum Corp (NYSE: MPC), itself a recent spin-off from Marathon Oil Corp (NYSE: MRO), has made the next step in monetizing some of its midstream assets in MPLX LP (NYSE: MPLX).

According to the S-1 filing, the publicly traded partnership would own a 51 percent operating interest in a transportation network that includes 962 miles of crude oil pipelines and 1,819 miles of refined-product pipelines. These systems include a barge dock on the Mississippi River near Wood River, Ill., with about 80 million barrels per day of capacity and four storage facilities in Illinois and Indiana. MLPX would also own a butane storage facility in West Virginia that can accommodate up to 1 million barrels of the natural gas liquid.

The company’s sponsor, Marathon Petroleum, would still own a number of midstream assets that could be transferred to MPLX via drop-down transactions, including the remaining 49 percent interest in the publicly traded partnership’s pipeline system and 5,000 miles of additional oil and refined-product pipelines.

Meanwhile, offshore contract driller SeaDrill (NYSE: SDRL), on July 3 issued a press release disclosing that its wholly owned subsidiary, SeaDrill Partners LLC, had confidentially submitted the first draft of its registration statement to the SEC. The new publicly traded partnership’s assets would include an interest in two semisubmersible drilling rigs, one drillship and one semi-tender rig that are currently in its parent’s fleet.

On July 12, Delek Logistics Partners LP (NYSE: DKL) followed in the footsteps of fellow wholesale fuel distributors Northern Tier Energy LP (NYSE: NTI) and Sprague Resources LP (NYSE: SRLP), filing its S-1 statement with the SEC.

The prospective publicly traded partnership, a spin-off of integrated downstream operator Delek US Holdings (NYSE: DK), would divide its operations into two business segments: pipelines and transportation (62.4 percent of 2011 revenue), and wholesale marketing and terminals (37.6 percent).

Delek Logistics Partners’ pipelines and transportation assets would include the Lion Pipeline system, which transports crude oil to and refined products from Delek US Holdings’ El Dorado refinery in Arkansas, and the SALA gathering system, which also serves this facility. The MLP would also own the Paline Pipeline system that delivers crude oil to Chevron Corp’s (NYSE: CVX) refinery in Nederland, Texas, from Longview, Texas, and the East Texas Crude Logistics System that supplies Delek US Holdings’ refinery in Tyler, Texas.

The wholesale marketing and terminals business would include five 100 percent-owned, light-product terminals and provide marketing services for all the refined products–minus jet fuel and petroleum coke–from Delek US Holdings’ Tyler refinery, as well as other customers in Texas and Tennessee.

These recent S-1 filings bring the total number of prospective MLPs that have submitted S-1 forms to the SEC to 15.

Source: Bloomberg

However, investors should note that, aside from SeaDrill Partners LLC, this list omits any registration statements that were filed confidentially since President Barack Obama signed the Jumpstart Our Business Startups (JOBS) Act into law on April 5, 2012. This statute allows “emerging growth companies”–firms with less than $1 billion in annual revenue–to submit their documentation to the SEC for a confidential review and wait until 21 days before their IPO to file publicly.

MLP Profits will initiate coverage all these MLPs, if and when they go public. In the meantime, we will continue to monitor second-quarter results and related conference calls for other companies that are considering spinning off assets as publicly traded partnerships.

Although a number of companies have spun off midstream assets as publicly traded partnerships, exploration and production companies have expressed the most resistance to this trend and a handful have stated that they plan to keep these operations in-house.

Devon Energy Corp (NYSE: DVN), for example, has explored monetizing its pipeline and processing assets through an IPO on several occasions. The company, which boasts the most extensive midstream operations of any US independent producer, owns more than 6,500 miles of pipelines, 300 compressor units and eight gas-processing plants with a total intake capacity of 1.2 billion cubic feet per day.

Given the recent upsurge in MLP IPOs and the tax advantages associated with the structure, one would assume that these assets would command a higher valuation as a publicly traded partnership. But as Devon Energy’s CEO John Richels explained during the Q-and-A portion of the company’s 2012 Analyst Day, not every piece of midstream infrastructure is suited for an MLP:

[I]n 2007, or the beginning of 2008, we actually announced that we were going to put it [the company’s midstream assets] into an MLP….[T]he investment thesis at the time was that…these MLP assets trade for 12 times EBITDA [earnings before interest, taxes, depreciation and amortization], and you’re trading at 6, or wherever we were at the time….But what we found is, the assets that are in our midstream, and where we generate our EBITDA in our operating profit through our midstream operation, is subject to commodity price fluctuations because they tend to be percentage-of-proceeds…contracts. And so as we got more into that, it became obvious, and our advice from our investment bankers was, that those assets, because they have commodity price exposure, trade more like 8 times rather than the 12….[A]nd we have very low basis in those assets. So we’d have to pay a big check to Uncle Sam and frankly it ended up, we were giving up a strategic asset, and all of us as shareholders wouldn’t have seen it. So we decided not to go ahead with that. It’s something we revisit from time to time, to see if those circumstances change, but at this point in time it just doesn’t make sense.

Although today’s income-seeking investors often prize higher-yielding fare, the market tends to reward MLPs that generate stable cash flow and pay their distributions reliably, particularly after corporate titans such as General Electric (NYSE: GE) and Bank of America Corp (NYSE: BAC) slashed their dividends.

After energy prices collapsed during the credit crunch and Great Recession, many MLPs sought to limit their exposure to commodity prices. For example, since 2007 Regency Energy Partners LP (NYSE: RGP), a midstream operator that owns gathering and processing assets, has diversified its business lines and restructured contracts to almost double its fee-based income to about 80 percent of total cash flow.

Percent-of-proceeds contracts guarantee the processor a predetermined portion of the proceeds from the sale of the resultant natural gas and/or natural gas liquids (NGL). These agreements, which can involve significant exposure to commodity prices, fell out of vogue in 2010 and 2011 as producers sought to take advantage of elevated oil and NGL prices and midstream operator favored the stability of fixed-fee contracts.

EOG Resources (NYSE: EOG) has amassed some of the best acreage in North America’s liquids-rich shale plays, including the Bakken Shale and the Eagle Ford Shale. But investors often overlook the firm’s midstream and marketing operations, which in 2011 accounted for 23 percent of the company’s overall revenue.

In a conference call to discuss EOG Resources’ results from the third quarter of 2011, CEO Mark Papa’s succinctly explained why the company wouldn’t consider spinning off these assets in an MLP: “We just like to keep our whole accounting and the company very simple. So pretty much zero chance of that happening.”

Pioneer Natural Resources (NYSE: PXD), an independent producer that operates in the Barnett Shale, the Permian Basin and the Eagle Ford Shale, among other plays, likewise doesn’t plan to monetize its midstream assets in this fashion. At the Credit Suisse Energy Summit in February 2012, CEO Scott Sheffield noted that management preferred to maintain “a simple structure that people can understand” and that the company “[didn’t] need to sit there and do anything in regard to our midstream assets.”

In this instance, financial need is what separates Devon Energy, EOG Resources and Pioneer Natural Resources from names that have already spun off their midstream operations in an MLP or are considering monetizing these assets in this manner.