Cypress Not Shaken by Oil Quake

According to the Energy Information Administration (EIA), hydraulic fracturing, or “fracking”, is now responsible for over 50% of U.S. oil production:


But the growth in fracking hasn’t been without controversy. There is a widespread belief — albeit almost entirely unfounded — that fracking is putting our drinking water at risk. Some have even claimed — again with little basis in fact — that natural gas is worse than coal when it comes to climate change because of methane leaks that take place during production.

While I am confident, based on the scientific studies I have reviewed, that neither of these claims is supported, one thing that does seem to be true is a claimed link between fracking and earthquakes. There seems to be at least a correlation (but maybe a causal link in Western Canada). My home state of Oklahoma now has more earthquakes than California, and that doesn’t appear to be a coincidence.

Fracking requires millions of gallons of water to be pumped deep underground at high pressure to fracture the rock containing the hydrocarbons. Some of that water flows back to the surface, and must be disposed.

There are several options for dealing with the water that flows back to the surface, but in many cases the water is simply injected back underground. It is the disposal of this wastewater that is most likely causing the uptick in earthquakes, according to a peer-reviewed study from Stanford University. When that water is injected near a fault, it is postulated that it can cause the fault to move — triggering an earthquake.    

As a result, states have begun to target underground wastewater disposal for elimination. For example, the Oklahoma Corporation Commission has asked oil companies to reduce the volume of wastewater pumped through disposal wells. Homeowners are also filing lawsuits against oil companies as a result of earthquake damage to their property.

But if underground disposal begins to be restricted, what other options are available to oil companies? Actually, there is an MLP for that. (I might add that treatment of fracking wastewater and water produced during oil and gas production are issues I am working on at my day job.)

In last week’s issue, I discussed the upstream MLPs. As I warned, they are quite volatile. An alternative for investors looking for exposure to the upstream space could be one of the so-called “fracking enablers.” These are companies that provide services to upstream producers. Examples are sand providers (sand is used in fracking to hold open the fractures) or companies that handle wastewater disposal.

An example would be Cypress Energy Partners (NYSE: CELP), which provides saltwater disposal and other water and environmental services to onshore oil and natural gas producers in North Dakota and West Texas. The partnership also has a pipeline inspection and integrity services division.

Cypress went public in January 2014 as the first MLP specializing in water and environmental services and pipeline maintenance. The partnership has seven saltwater disposal facilities in the Bakken in North Dakota and two in the Permian Basin in Texas. The facilities receive a fee for each barrel of fracking wastewater or produced water that is disposed, and derive additional revenue from sales of the residual oil recovered in the process.

Cypress wasn’t spared the downturn in the oil and gas industry, but neither did it suffer the 50%-plus decline of every oil and gas production MLP over the past year. Cypress is down about 40% over the past 12 months but, again unlike most of the upstream MLPs, it managed to keep its distribution stable in 2015, while nearly matching 2014’s distributable cash flow (DCF).

For Q4 2015 Cypress reported:

  • Revenue of $89.8 million, down 12.1% from the same period in the prior year
  • Gross margin of 12.8% for the quarter versus 11.8% in the same period in the prior year
  • Adjusted EBITDA of $5.6 million versus $4.4 million for the same period in the prior year
  • Distributable cash flow of $3.7 million, compared with $4.3 million a year earlier
  • Distribution of $0.406413 per unit for the three months ended Dec. 31, which was unchanged from the previous quarter but 4.9% over the minimum quarterly distribution of $0.3875, and works out to a current annualized yield of 20.8%
  • A coverage ratio of 1.52x on common units.

 For all of fiscal 2015, Cypress reported:

  • Revenue of $371.2 million, down 8.2% from 2014
  • Distributable cash flow of $17.2 million, compared with $17.8 million for the period from Jan. 21, 2014 (the IPO date) through Dec. 31, 2014
  • Adjusted EBITDA of $24.7 million, down 13.3% from $28.5 million in 2014
  • Adjusted EBITDA of $23.1 million, up 26.9% from $18.2 million for 2014
  • Net income of $4.1 million versus a net loss of $20.3 million in 2014.

As Cypress notes, lower oil prices have hit its wastewater disposal business. In Q4 2015 the partnership disposed of 4.3 million barrels of saltwater at average revenue of $0.68 per barrel, which was down 36.4% from the prior year per barrel average of $1.07. Cypress warned of the risks of asset impairments over the next few quarters unless commodity prices rebound.

However, the partnership indicated that it remains well within its debt covenants. Cypress reported a leverage ratio of 3.07x versus a covenant limit of 4.0x, and interest coverage ratio of 4.84x versus the covenant of 3.0x as of Dec. 31. These ratios provide some assurance that Cypress can survive this downturn.  

Make no mistake — this is a very a risky space. But if you are looking for some MLP exposure to a recovery in oil prices, Cypress Energy Partners may be a safer bet than directly owning one of the driller MLPs.  

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)


Portfolio Update

Williams Sues Energy Transfer

The grudge match between bickering merger partners Energy Transfer Equity (NYSE: ETE) and Williams (NYSE: WMB) is headed for multiple courtrooms, now that Williams has sued its increasingly regretful buyer over the recent private offering protecting Energy Transfer’s insiders from some of the consequences of a future distribution cut.

In addition to suing Energy Transfer over the offering in Delaware court, Williams also filed suit against ETE Chief Executive Kelcy Warren in Texas accusing him of wrongful interference with the merger. Warren was the principal investor in the offering, which allowed him to defer some current distributions and be compensated in two years with discounted ETE shares whether or not the MLP subsequently cuts its payout.

Williams insisted it remains committed to the deal and intends to schedule a shareholder vote on it, as it must do in order to protect itself from penalties under the merger agreement.

But the lawsuits led investors to further discount the likelihood that merger will proceed, and as a result ETE units and Williams shares rallied.

It’s not hard to see why. Energy Transfer is supposed to pay out $6.05 billion in cash under the merger’s terms, saddling the merged company with that much additional debt and risking potentially costly credit downgrades in the current environment. If the merger fails that cash will stay put, curbing the credit risk not only for Energy Transfer unitholders but also for Williams shareholders who would end up owning a new class of Energy Transfer equity if the merger is somehow completed.

It makes all the sense in the world for Williams to seek to invalidate Energy Transfer’s offering, which was clearly intended to make the merger less appealing to Williams shareholders. But if the courts fail to oblige, the market reaction suggests both companies might still benefit from revising the merger terms or scrapping the deal entirely.

There’s still plenty of upside to both investments once the uncertainty is resolved. Growth pick ETE is the #2 Best Buy below $15; WMB is a buy below $20 in the Aggressive Portfolio.

— Igor Greenwald


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