The Crude Glut’s Silver Lining
About this time last year, there were a number of stories warning about the status of crude oil inventories in the U.S. I wrote several articles addressing this, but the overriding message was that there was more spare crude storage capacity than advertised, and that the situation would soon improve.
Inventories did in fact decline from a peak in April through July as refineries increased throughput for the summer driving season. Crude oil prices spiked from the lower $40s in early March to reach $60/bbl by early May.
But then shale oil production proved to be more resilient than most expected, and in late summer inventories once more began to rise. In October they eclipsed the levels set in April and continued to rise from there. The only saving grace was that new storage capacity continued to increase as well.
The inventory situation today, however, looks worse than it did a year ago. It’s not only a U.S. phenomenon, as the International Energy Agency (IEA) recently noted:
“Global inventories rose by a notional 1 billion barrels in 2014-15 with the fundamentals suggesting a further build of 285 mb over the course of 2016. Despite significant capacity expansions over 2016, this stock build will put storage infrastructure under pressure and could see floating storage become profitable.”
But it isn’t only floating storage that looks profitable at the moment. Inventories are very high at Cushing, Oklahoma, which is the country’s most important storage hub as well as the designated point of delivery for the commodity’s New York Mercantile Exchange’s futures contracts. The tight capacity means that business is good for companies that own storage infrastructure assets in Cushing.
In April 2015, Cushing stocks reached an all-time record level of 62.2 million barrels, but they then declined through September to 53.4 million barrels. Since then they have again been on the rise, hitting 64.7 million barrels last month. Part of the reason is that the market has been in contango, a condition in which the more distant futures contracts are priced above those expiring soonest. Contango makes it profitable for producers to store crude oil for later delivery.
Which companies have a major storage presence in Cushing?
According to a list recently compiled by the Tulsa World, the eight largest storage providers in Cushing are:
- Enbridge Energy Partners (NYSE: EEP) – 20 million barrels (mb) of storage
- Plains GP Holdings (NYSE: PAGP) – 20 mb
- Magellan Midstream Partners (NYSE: MMP) – 12 mb
- Rose Rock Midstream (NYSE: RRMS) – 7.6 mb
- Blueknight Energy Partners (NASDAQ: BKEP) – 6.6 mb
- NGL Energy Partners (NYSE: NGL) – 4.1 mb
- CVR Refining (NYSE: CVRR) – 3.8 mb
- Enterprise Products Partners (NYSE: EPD) – 3.3 mb
Others, including TransCanada (NYSE: TRP) and Sunoco Logistics (NYSE: SXL), account for another 3 mb of storage capacity in the aggregate.
As was the case last year, we will likely see a peak in inventories over the next month or so ahead of summer driving season. But until we begin to see some substantial declines in U.S. shale oil production, inventories in Cushing are likely to remain high — to the benefit of the above-listed companies.
ETP Comes In From Cold
Energy Transfer Partners (NYSE: ETP) reported weak fourth-quarter results last week, because how could it not? Adjustable segment EBITDA was down 11% year-over-year, primarily because of a cyclical windfall in fuel retailing a year ago, but also because the midstream margin got squeezed by the 13-year-low in the price of natural gas liquids.
The distribution coverage ratio of 1.07 for the quarter and 0.99 for the year was boosted by one-time tax benefits. Adjusting for these but also for unusually high maintenance capital spending, distributable cash flow would have covered just 90% of the quarterly distribution, management acknowledged.
The unit price slid 9% on the news, though that came in the wake of a 56% rally in the two weeks following the Feb. 8 low. Since that comedown, units have marked time at a discount of roughly 15-20% year-to-date.
The annualized yield is near 15% on a distribution management hopes not to cut unless there is no other way to preserve the partnership’s imperiled investment-grade credit rating.
The good news is that ETP will only be an opportunistic at-the-market equity seller, its 2016 capital spending needs largely pre-funded from prior borrowing and asset sales.
Cash flow is likely to stay on the skimpy side until the middle of next year, at which point the CEO expects to be “cooking with grease” following the completion of pending growth projects.
On the positive side of the ledger, ETP continues to benefit from its rising NGL fractionation and transport volumes and from the related growth at Sunoco Logistics (NYSE: SXL), an affiliated MLP in which ETP retains a 27.5% equity stake.
Furthermore, while slumping NGL prices hit fourth-quarter margins, volumes have held up and have been on the rise early in 2016, management noted.
But perhaps the best reason to allocate new capital to ETP is that the sheer panic that has gripped the MLP sector for months appears to have run its course. ETP sponsor Energy Transfer Equity (NYSE: ETE) is up 7% since the eve of the fourth-quarter report despite the weak numbers and the continuing lack of clarity about its commitment to the merger with Williams on current terms.
Growth pick ETE remains the #2 Best Buy below $15. We’re upgrading ETP to a Buy below $35 in the Growth Portfolio.
— Igor Greenwald