Shell Midstream Partners, L.P.
Q2 2021 Earnings Call Transcript

Published: 30 Jul 2021

[Operator:]

Good morning. My name is Kevin, and I'll be your conference operator today. At this time, I'd like to welcome everyone to today's Webcast for Shell Midstream Partners. All participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. . I will now turn the call over to Jamie Parker, Investor Relations Officer. You may begin your conference.

[Jamie Parker:]

Thank you. Welcome to today's webcast for Shell Midstream Partners. With me today are Steve Ledbetter, CEO; Shawn Carsten, CFO; and Sean Guillory, VP, Commercial and Business Development.

[Steven Ledbetter:]

Thanks, Jamie. Good morning, and welcome to our second quarter earnings webcast. Overall, our assets performed well for the quarter. I'm proud that our people and assets continue to show strength in the face of ongoing volatility. Some key operational highlights for the quarter include continued resilience in the Gulf of Mexico as a whole with new tiebacks into our Delta system coming online. In the onshore, Zydeco volumes are up approximately 8% since last quarter. And I'm pleased to report the system is now almost fully contracted through May 2022, which continues to demonstrate the strategic value of that asset to our business. Additionally, we saw a significant uptick in Explorer, primarily due to refinery turnarounds in the Midwest. You've heard me speak to our own business improvement efforts that we've taken over the past several months, all to increase competitiveness and ensure longer-term sustainability. We are on track to deliver against our $30 million to $40 million commitment by year-end. In summary, our portfolio has proven resilient throughout a pandemic that has affected markets globally, and we've taken a number of measures internally to stay cost efficient. But as I look ahead to the medium term, the Partnership faces significant headwinds. As you know, the distribution waiver from our general partner ended with the first quarter distribution, and the Partnership's preferred units are eligible for conversion in 2022. Also, our business has yet to see a full return to normal in the market. As we've seen in recent days, COVID infection rates driven by new variants continue to gain momentum, and we cannot predict how that will impact the macro environment as we still continue to see softness in regional demand that our refined product lines serve.

[Shawn Carsten:]

Great. Thanks, Steve. As I reflect on the quarter, our assets have continued to perform in this challenging pandemic environment. So first, let me cover a few of our key financial metrics for the quarter. Our total revenue was $148 million, an increase of $9 million from the first quarter. Now this was primarily related to increased throughput on Zydeco as newly committed contracts started in the second quarter, bringing our mainline contracted capacity to 350,000 barrels per day. We also recognized increased product revenue related to allowance oil sales during the quarter. Now all this increase was partially offset by lower offshore throughput when compared to the first quarter. Our operating expense was $83 million, up about $8 million from the prior quarter. Now this is primarily related to timing of project spend on our Zydeco and Norco assets, along with an increase in the cost of allowance oil sales. Our income from equity investments was $105 million, up $3 million from the prior quarter, mostly due to increased volumes on Explorer as it benefited from longer-than-expected refinery turnarounds in the Midwest during this quarter. All of these increases were partially offset by decreased earnings from Colonial. With all this, adjusted EBITDA attributable to the Partnership was $207 million. And after interest expense, maintenance capital and other adjustments, total cash available for distribution was $186 million. It's important to note that in the second quarter, the Partnership recognized a onetime cash help of $10 million from the previously announced Anacortes asset swap as well as $2 million related to the Auger 12-inch sale.

[Operator:]

. Our first question comes from Shneur Gershuni with UBS.

[Shneur Gershuni:]

Just to start off, really just a quick question. I don't want to really belabor this and so forth, but I just kind of wanted to understand the decision around the distribution rightsizing. And I don't want to come across as being opposed to it. I think it does make sense. I was just curious about specifically the timing. A lot of the drivers that you mentioned on the conference call were known a couple of quarters ago and so forth. Was it really just about the timing around the waiver expiration that drove the decision? Or were there some other factors?

[Steven Ledbetter:]

Shneur, good morning, this is Steve. I'll take that question. As it relates to the timing -- I mean, first of all, what I'd like to say is that I'm proud of the performance of the business and the team, despite what's going on with the continued volatility and uncertainty as the pandemic continues to rage and actually increase in some areas. As far as the timing goes, I think there's a couple of notable items that -- onetime benefits that we don't expect to see moving forward that as Shawn articulated without would have -- without the rebase would have put our coverage below 1. The first one was associated with Explorer and the increase in terms of value we saw there associated with the refineries being in turnaround in the Midwest, and we're back online now, and we don't expect that to continue. As we mentioned, demand has continued to be soft and not back to pre-COVID levels. The second one I'd say is that uplift from the balancing payment for the recent asset swap between Zydeco and in a quarter. So that is really around the timing. But in general, the components that went into it, I think altogether made sense for us to do that this quarter. But as we mentioned, softness continues. There's a high degree of uncertainty in terms of demand. The pandemic impacts continue to linger. And in particular, Colonial recently elected not to declare the second quarter dividend, primarily given the headwinds around the uncertainty of the pending rate case as well as well as that cyberattack in the Huntersville repair. Our internal view of the rate case from the analysis we've done is that we believe there's potential for a negative outcome. And the reduced dividend makes then longer than 1 quarter. In addition to that, we're entering -- we're in the midst of hurricane season. And while it's been light thus far, we've got a long way to go. And then as you mentioned, the distribution waiver rolling off after Q1 and then the preferred units becoming eligible for conversion next year, those headwinds kind of drove us to the decision to take the rebase now. Again, I wanted to reiterate that it'll allow us to average 1.1x or greater for this foreseeable future.

[Shneur Gershuni:]

Okay. Got it. Maybe if we can pivot to Slide #7, where you kind of lay out the framework. It's kind of interesting to me that you put return of capital second and then drop down third. Was that on purpose from a signaling perspective? Is dropdown still something that you're going to consider? I would imagine that post distribution cut, you can actually equity fund internally acquisitions from Shell. So just kind of wondering how we should think about in terms of priorities here? You get to 3x levered. Are you buying back units? Or are you buying assets from Shell? Just kind of curious how we should think about the rank order of priorities after a small bolt-on and quick payback projects?

[Shawn Carsten:]

Yes. Shneur, this is Shawn. I hope you're doing well. Actually, you should read into the order on the slide. Look, these are just a menu of options that we'll use with our excess cash as we have any. As Steve highlighted earlier, we expect some headwinds in the foreseeable future, so we'll get through that. But at some point, we will have, and we expect to have excess cash and we'll deploy it at the appropriate time when it makes sense and where it makes the most sense for unitholders. And so I don't think I would read into the order on the slide in terms of priorities, it's just the menu of options that we have.

[Shneur Gershuni:]

Okay. So we should -- the takeaway is you have excess cash flow now. If you get to 3x leverage or some leverage level, like we should either expect to see a return of capital or we should see you growing the business?

[Shawn Carsten:]

We're not guiding on how you should necessarily interpret that. So we'll have more guidance as we move along over the next quarters.

[Operator:]

Our next question comes from Theresa Chen with Barclays.

[Theresa Chen:]

So maybe first starting on the future of Colonial, since it seems like you've already done some work around it, Steve. When you say that the outcome of the rate case, it could be negative, can you just remind us what are the shippers asking for at this point? Like, the magnitude of decrease, since I think it was several dockets now consolidated into one. And then where do you think it could shake out as far as a percentage decrease to the weighted average rate?

[Steven Ledbetter:]

Yes. I mean again, that's hard to -- thanks, Theresa. This is Steve. That's hard to determine at this point. What we do believe and in our view, given all the analysis and modeling that we've seen is that there could be a negative outcome, which again would challenge the potential for further cash distributions more than just 1 quarter. For specifics around the rate case, I'd point you back to Colonial for any more detail.

[Theresa Chen:]

Okay. And then just on your affiliates FID of Whale, is there any way SHLX can participate in that from an infrastructure perspective? And if so, what kind of economics can that generate for you?

[Sean Guillory:]

Theresa, this is Sean Guillory. I'll go ahead and take that one. And thanks for the question. What I would tell you is that we're extremely excited to see the continued activity in the Gulf of Mexico and the Whale project itself is just another proof point of the continued investment and resilience that you see in the basin. The Whale field itself is in the Western Gulf areas of the Gulf of Mexico, and that if you look at our map scenario that SHLX doesn't currently have any corridor pipeline. But what I'll tell you is we're still evaluating how we can expand our presence in the West. And combining that with the multiple opportunities we have in the Central and Eastern Gulf to grow both volume and value for SHLX unitholders as we move forward.

[Operator:]

Our next question comes from Doug Irwin with Credit with Credit Suisse.

[Doug Irwin:]

Maybe a follow-up on dropdowns, which it sounds like are still kind of wait and see. I know you've talked about the Falcon Ethane System as a potential dropdown candidate at one point. I think that petchem facility is still under construction. I'm just curious what the rest of the backlog looks like, if you could provide any sort of color on what other type of assets might be available for dropdown, maybe if there's even anything tied to some of the sponsor’s energy transition efforts that might make sense for SHLX?

[Steven Ledbetter:]

Yes, thanks. This is Steve. The Falcon Pipeline, as you mentioned, mechanically complete, waiting for start-up of the plant. There are several other midstream assets, and there's a wide array of assets that could be accessed should the market suggest and make sense for the Partnership given what we see right now, that might not make sense. But as we've talked about with our financial framework, it is a menu option that we can access at the right time.

[Doug Irwin:]

Okay. Got it. And then, I guess, you mentioned, I guess, on organic projects with the potential Lockport project around the Capline reversal. Just curious kind of on a broader level, if you can talk about maybe some of the changing dynamics around St. James with that reversal coming online? And maybe what kind of opportunities are there SHLX and what projects could look like in terms of being able to leverage export markets? Would they be kind of more greenfield type projects? Is there a potential to maybe reverse some pipes that are already on the system. Just curious what opportunities are out there as well?

[Steven Ledbetter:]

Okay. I'll try to unpack that. There's a lot there, a lot in that one. So maybe I'll give a bit of a high-level view of the types of things and kind of our screening criteria and then I'll have Sean talk a little bit more about the specifics of Lockport and a couple of others. As we look forward to deploy capital, again, we're going to do the thing that makes the most sense for the unitholder, but we do see opportunities, to defend and grow our heartlands, that's both the Gulf of Mexico as well as onshore. The way we are looking at projects to take advantage of the market, our assets in the ground, we see now command a bit of a strategic premium at this point. And the way we evaluate the projects and screening criteria is relatively quick paybacks with kind of a mid-teen type returns. And depending on the type of solution for those projects, we'd look at capital in the area from $10 million to $50 million, but that depends on how we play those cards and unfold the solutions for the customers. And we continue to evaluate several of them. So with that, I'll turn it to Sean to give you a bit of color on the 2 projects that we've talked about.

[Sean Guillory:]

Yes. Thanks, Steve. I appreciate the question, and thank you for that. Now what I would tell you is that right now, we believe that one of our competitive advantages is our diversified footprint with assets in the ground and as you mentioned, the ability to provide connectivity to the key market centers in the Gulf Coast and the Midwest. Right now, there are a number of opportunities that we're developing, but still haven't been FIDed but have a range of potential capital outlays. Steve talked a bit about the Lockport -- potential Lockport project. With the amount of capital we could spend on that would be available for tents and available connections. But I would also draw you to another part of our heartland, which is developing projects in the Gulf of Mexico, particularly in the Western part of the Gulf of Mexico that will provide one of our key corridor assets, the ability to capture future developments in the near future. And similar to what Steve mentioned before in terms of the capital outlay and range of capital we could spend on it, it could possibly be $30 million to $50 million. But when we have something a bit more definitive on all those opportunities, we'll come back to the market at that time.

[Operator:]

Next question comes from Gabe Moreen with Mizuho.

[Gabriel Moreen:]

I just had a quick question on the prefs that your parent owns. Is -- at this point, is it fair to say that your assumption is that those prefs will actually convert at this point? Or do you think there's still some uncertainty around that?

[Steven Ledbetter:]

So I wouldn't read through that there's certainty that they will convert. Certainly, that's an option that the sponsor has. The way we've rebased the distribution and the financial framework, we have accommodated for whatever headwinds exist that we could foresee and will allow us to average a 1.1x coverage for the foreseeable future.

[Gabriel Moreen:]

Okay. That was helpful in terms of answering that. And then the dropdowns that you've done from your parent previously have been quite sizable, I guess, by and large. I'm not sure what the average transaction value has been and certainly been up there. Would it be possible to do smaller transactions? I mean, clearly, with potentially a free cash flow profile that's improved, I'm just wondering, from a sizing standpoint, if you'd also be open to doing some smaller transactions, not just the bigger one.

[Steven Ledbetter:]

I think it's a good point and a good question. And certainly, the rebasing of the distribution and the financial framework gives us a menu of options, and that includes smaller things and using some of the cash to make the best decision to grow accretion for all the unitholders. So that certainly is in the slate of potential.

[Shawn Carsten:]

And Gabe, this is Shawn. I think if you look back in history, they're all part of a bigger transaction. But often times, we had the ability to take smaller portions, right? So we acquired a part of our sponsor's ownership in Explorer over time, right? And so we have kind of not infinite, but a number of opportunities in ways to make transactions happen.

[Operator:]

Our next question comes from Derek Walker with Bank of America.

[Derek Walker:]

Maybe just a follow-up on Gabe's question. Just on the 1.1 coverage, is there any other -- Steve, I know you talked to sort of capture sort of the headwinds that you see, but is there anything else that we should think about that's kind of baked into that assumption? Is it just the preferred converting? Do you have -- are you assuming no distribution from Colonial or just a reduced distribution? Any other things that we think about just like refined product demand not coming back as quickly. What other factors are kind of factored into that 1.1 number?

[Steven Ledbetter:]

Yes. I think what you're looking for is a bit more specificity, and I can appreciate that. We have taken into account our view of many of the headwinds, including the view of the rate case and from all the analysis we've done, potential for a negative outcome with reduced distributions, it makes them longer than 1 quarter. Again, from a conservative perspective and all the headwinds that we know about and can model, this rebase puts us in a position to meet the 1.1 -- to average 1.1x coverage moving forward.

[Derek Walker:]

Got it. And then maybe just a quick one on cost saves. I know your target is 30 million to 40 million. Is that -- where do you guys stand on that? And I guess, do you see any opportunities for further cost reductions?

[Steven Ledbetter:]

Yes, great. I'm very proud of our business and the team and how we've gone and looked at that. It's comprised of many different things, multiskilling, rebasing third-party contractor usage, logistics, optimization and rebalancing projects, procurement strategy, et cetera. It takes all of that to get done very well to deliver this 30 million to 40 million run rate as we exit 2021, and we are on path to do that. Now having said that, we will, as part of our base business have a continuous journey to look to optimize and take additional value and costs out of the -- or increase value and take additional costs out of the system.

[Operator:]

And there are no further questions at this time. I'd like to turn the call back to Jamie Parker.

[Jamie Parker:]

Thank you very much for your interest in Shell Midstream Partners. If you have any additional follow-up questions following today's presentation, please feel free to give me a call directly. My contact information can be found on the presentation materials, so is on our website, shellmidstreampartners.com. Thank you.

[Operator:]

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.