Shell Midstream Partners, L.P.
Q1 2020 Earnings Call Transcript

Published: 7 May 2020

[Operator:]

Good morning. My name is [Shalon] (Ph). And I will be your conference operator today. At this time, I would like to welcome everyone to the today’s webcast for Shell Midstream Partners.I will now turn the call over to Jamie Parker, Investor Relations Officer. You may begin your conference.

[Jamie Parker:]

Thank you. Welcome to the today’s webcast for Shell Midstream Partners. With me today are Kevin Nichols, CEO; Shawn Carsten, CFO; and Steve Ledbetter, VP Commercial and Business Development.Slide 2 contains our Safe Harbor statement. We will be making Forward-Looking Statements related to future events and expectations during the presentation and Q&A session. Actual results may differ materially from such statements and factors that could cause actual results to be different are included here as well as in today’s press release and under Risk Factors in our filings with the SEC.Today’s call also contains certain non-GAAP financial measures. Please refer to the earnings press release and Appendix 1 of this presentation for important disclosures regarding such measures including reconciliations to the most comparable GAAP financial measures. We will take questions at the end of the presentation.With that, I will turn the call over to Kevin Nichols.

[Kevin Nichols:]

Thanks, Jamie, and good morning, everyone. And welcome to our first quarter webcast. These are extraordinary times both within our industry as well as worldwide. So before we begin, let me acknowledge the dynamic circumstances that we are all facing and tell you how Shell Midstream is responding. Keeping care of our people and our assets top of mind.Our operational teams are all taking recommended precautions, while keeping our facilities fully operational, and running safely to ensure we keep America’s energy moving. And I’m very proud of my team who continues to give their best under these difficult circumstances.Shell has a long history of caring, listening, responding to our customers, our colleagues and communities. And we will do what is necessary to manage and recover from this unique time in our history.So with the current landscape serving as the backdrop for today’s call, I will focus my comments in three areas, the impacts we are seeing across our business, the actions that we are taking in the short-term and ultimately how we are positioned for long-term resilience. Something we have always demonstrated.So let me start with the impacts that we are seeing across our business from the unprecedented supply demand volatility. The assets currently experiencing the most impact are those transporting refined products.The industry is seeing demand reduction across the country of approximately 50% for gasoline 80% for jet fuel and around 10% for diesel. And these reductions are impacting pipeline throughput, as well as causing refineries in the U.S. to lower run rates and in some cases shut down.So with refineries consuming less crude, crude is finding its way to storage, which is quickly filling up. And this is causing producers in some basins to reduce production. The situation remains dynamic and our systems will be impacted by varying degrees, should the demand and balance continue. I will leave it to Shawn to talk more about the second quarter later in his section.So how are we taking action in the near-term to navigate through the uncertainty? There are three distinct levers we are pulling real time. First, we are maximizing opportunities to grow revenue, particularly with storage. As an example, we secured additional storage in the Mars Cavern to meet customers’ needs for crude storage on our systems, given the contango market environment.Second, we are actively reducing our costs. Focusing on must have activities not only to reduce exposure in the near-term, but ultimately to achieve sustainable cost reduction. Something I will discuss more in future quarters. And third, we are selectively reducing discretionary project spend, without sacrificing long-term growth aspirations.It is important to note that despite the difficult environment, we continue to progress discussions with producers for the Mars expansion project. We expect to the sign definitive agreements by the end of the year, and have a project online in 2021.So now, let me talk about how we are positioned for long-term resilience. In the offshore, and in general, as it relates to crude, there has been much talk about lower price environments, and which areas of crude production will be affected. We believe that the production basis we serve will fare better than others.Let me tell you more about this. It is been reported that certain onshore and shallow water producers have started to shut in production. However, it is important to note that the majority of the customers we serve in the Gulf of Mexico are large investment grade companies with the ability to weather the current environment.On top of that, volumes that we transport are predominantly medium sour our crude grade, which is the refining centers in the Gulf Coast needs to maximize diesel production. And diesel is the refined product in the highest demand in today’s environment.This advantage is supplemented by our corridor systems optionality with access to multiple refining centers, and access to storage hubs like Loop, St. James, and the Strategic Petroleum Reserve, also with access to water.To-date, the crude is being impacted the most both in terms of production as well as price, are those that are landlocked, with less access to water. With the unique optionality and crude grade advantage along with a lower marginal cost of production, we feel strongly that the Gulf will retaining its long-term strength and as always, we believe we are well positioned with one of the premier quarter networks to capture these benefits for the partnership.Lastly, in our onshore portfolio, our assets span the commodity supply chain, and possess unique advantages long-term. Examples include Colonial and Explorer, which are the most cost efficient options to the respective demand centers and markets from the Gulf Coast.Zydeco still one of the best connected systems onshore for crude in the Gulf Coast. And in the case of refinery gas pipelines and Norco Logistics assets, we transport and store the primary feedstock to keep our affiliates running backed by long-term take or pay contracts. Like the offshore we believe our onshore assets are well positioned and should ramp up once the man recovers.So before I turn the call over to Shawn, let me leave you with a few thoughts. While the entire country and our industry are dealing with difficult times, our portfolio is well positioned and is resilient.We are taking actions to manage the business in the short-term all the while progressing value added long-term projects for the partnership. And Shell Midstream and our customers are well positioned to weather the current macro environment.Clearly there is uncertainty in the markets at this time. However, our forward outlook is more about U.S. demand recovery and less about commodity price. And I’m confident in our ability to rebound the strength as demand in the U.S. moves towards recovery.So with that, I will turn it over to Shawn. Shawn.

[Shawn Carsten:]

Thanks, Kevin. Let me go over the full quarter results where we saw continued strength across our portfolio through the first quarter. For the quarter, the partners performed in-line with our expectations, earning $138 million in net income, generating $196 million and adjusted EBITDA and delivering $170 million in cash available for distribution.Now when we look quarter-over-quarter, the primary drivers on EBITDA and cash level basis or higher distributions from Colonial and Explore and increase throughput on the Eastern Corridor partially offset by not having the - reimbursement payment, which was received last quarter.So now let me move quickly to our forward guidance. As Kevin discussed earlier, there are quite a few moving pieces that could affect the partnership’s earnings for the second quarter of 2020. On April 1st, we closed on the acquisition of the Mattox Pipeline and the Norco Logistics assets from Shell.And as previously discussed, the assets are backed by long-term fixed commitments, and are expected to provide an estimated 125 million to 135 million of cash flow from operations. All this during the 12-months following the closing of the acquisition.Now in the CapEx space, we now plan to spend about 38 million for the year of which around six million will be growth capital. Now this is a reduction from prior guidance of 46 million of CapEx spend in 2020.This reduction is primarily related to maintenance capital as we have deferred projects to outer years and have slowed our Permian growth. And in the near-term we face headwinds related to reduce refined products demand across our finished product systems, along with the subsequent impacts on crude storage and ultimately our producers.Now these challenges are primarily related to demand destruction, which facts up value chain all the way to crude. We anticipate our second quarter coverage ratio to be less than one time. But given the current levels of uncertainty, we are unable to provide a reliable range of outcomes at this time.The level of impact will be dependent on how long refined products demand remains low and if crude throughput on our systems is further curtailed. So let me remind everyone of our strong financial framework and a conservative balance sheet.We entered the current macro environment from a position of strengths. We have over 1.2 billion of liquidity available to us and with very few facility covenants with our lender Shell. And as highlighted earlier, we continue to hold a very positive long-term view on our onshore assets, which provide cost advantage transport to key command centers, along with access to export over the water.We are also positive on our Gulf of Mexico, where our producers have already made their investment. And we believe the majority will continue to produce as long as they can place their barrels. Let there be no mistake, these are volatile times. So we will update investors and future quarters as the market dynamics play out.Now, we currently intend to maintain our distribution rate of $0.46 per limited partners unit for the second quarter of 2020. And we will utilize our balance sheet to cover any operational cash flow shortfalls where needed.Our board will monitor the current business environment and make decisions regarding future distributions on a quarter-by-quarter basis.So with all that, we will now take your questions. Operator?

[Operator:]

[Operator Instructions]. And your first question comes from the line of Shneur Gershuni [UBS].

[Unidentified Analyst:]

This is [Michelle] (Ph) on for Shneur. Just a quick question on the distribution policy. It seems a language in today’s press releases change on the distribution and given the context that Shell cut its dividends. Has the commitment change and Shell Ex might follow the path of Shell? Or is it more scenario that Shell is closely following its own volume drivers for the virus and Shell Ex drivers are different than Shells?

[Kevin Nichols:]

Yes, thanks for that question. No, I wouldn’t read anything through to that from Shell. And what is happening there. COVID-19 has introduced just a tremendous amount of uncertainty. And as Shawn and I have said on the call we are more driven by demand and what happens with demand recovery.We have seen some early signs of recovery just within this last week, but it is very early days and very difficult for us to predict what is going to happen further out. So we think it is a responsible thing to do to review the business on a quarter-by-quarter basis with the Board. We feel confident in quarter two, we are halfway through quarter two and that is why we gave you the guidance for quarter two.

[Shawn Carsten:]

And Michelle it is Shawn. Just to add in to what Kevin said. I want to remind you that RDF portfolio is a global portfolio across a number of businesses. Now our business is less about price and more about demand as Kevin highlighted. And so we have very little commodity exposure.And we believe strongly in the basins that we work in, in the assets that we have. But we are a very small portion of the RDF. So you shouldn’t read through from what RDF might have done to our assets or to our distribution policy.

[Unidentified Analyst:]

Great. That is helpful.

[Operator:]

Thank you. Your next question comes from line of Theresa Chen, Barclays.

[Kevin Nichols:]

Hey, Teresa.

[Theresa Chen:]

Good morning. Hi, thank you for taking my questions. In addition to the Norco and Mattox assets. Can you just remind us how much of your business as a whole is supported by volume commitments?

[Kevin Nichols:]

So we haven’t given the exact breakdown of that. But let me, we have three kind of areas that that I would break it down into. The take or pay contracts and it is like the Norco Logistics, the terminal assets that we have refinery gas assets that we Zydeco has a take or pay.Then we have traditionally thought about our fee base but reasonable cash flow with a life of lease or dedication of lease offshore. And there is a high switching costs or almost an insurmountable barrier to switching offshore. So once people connect to our corridor systems is a very ratable but it is about production and production flows.I think Shawn in that bucket kind of gave you information about once the producers make that sizable investment in those offshore production hubs. They have a very low marginal cost of production from wells. And Gulf of Mexico has held up comparatively speaking to onshore sales and such. So those are tradable flows as well.And then the fees exposure that we have is on the kind of the refined product systems. But remember Colonial and Explorer serve some of the more key market demand areas for the United States, and they are the premier assets as far as the most efficient cost effective way to serve those demand centers. So, we feel like they are very strong and as demand recovers they will have a position of strength.

[Theresa Chen:]

Got it. And on and on the topic of potential uptick in demand and to your earlier comments. So across the board there has been data and other anecdotal evidence from market participants and as well as the DOE staff, that while the year-over-year change is still negative, as far as gasoline demand goes, the pace of decline seems to have moved. Is that what you were referring to? Or can you just speak generally to what you are seeing in terms of demand in your assets leverage refinery utilization, as well as the interest in Explorer and Colonial?

[Kevin Nichols:]

Yes. So I will probably let Steve talk to you. He is closer to what we are seeing on demand and plugged into the marketplace with regards to gasoline and diesel and such.

[Steve Ledbetter:]

Hey Theresa, this is Steve. As Kevin mentioned earlier you know this is a pretty volatile dynamic situation, but we have regular active conversations with all ports of our business as well as inside of midstream, as well as our affiliates. And we are monitoring storage constraints as well as reduction in demand patterns or increase in demand patterns on gasoline. But those all inform and play into the lever that we pull and how we how we position the business to maneuver over the next several quarters.

[Kevin Nichols:]

Yes, so Theresa one thing we are seeing momentarily now is a move slightly back in the refining centers, the gasoline, some early signs of gasoline picking up. But again, it is only been in the recent days and it is too early to draw conclusions from that.

[Theresa Chen:]

Understood. And as you plan for the next call it 12-months to 18-months and beyond. What underlies your fundamental assumptions? Is it V shaped recovery or U shaped, are you baking in contingency plans? Should we see a second wave of the virus later this year? Can you share any color on your thinking around that?

[Kevin Nichols:]

Yes, so that is kind of the COVID-19 uncertainty and the high degree and range of uncertainty that exists out in the marketplace. U shaped, L shaped, V shaped, W. we do win scenarios to manage and predict our business and what we would do under the circumstances.But again, we are focused on making sure that our assets are positioned that when the recovery comes, we actually benefit from that strength. And, I guess I would highlight so far in the Gulf of Mexico. When you look at what is happened with production and the production cuts, we have not seen a material cut to production offshore, like you have seen onshore.A couple of maybe points that I will throw it over to Steve to talk about the Gulf of Mexico strength which drives our thinking.

[Steve Ledbetter:]

Yes. Thank you Kevin. You know, we like our position in the Gulf for a few reasons. One, we believe - and we are favorable from geographic exposure perspective with concentration of assets to the Gulf Coast and pad three, which offers efficient and cost effective access to refinery systems storage and export across the water.Second, I would say is really favorable crude exposure versus some of the basins. We predominantly transport medium sour grade barrels with match to demand patterns currently needed for refineries as well as into the future.We also have favorable producer exposure. As Kevin mentioned, these are large cost effective lower breakeven cost than some of the other basins than what you are seeing in the marketplace. And then again, we have limited exposure from a credit worthiness perspective.Again, most of our shippers, producers are large investment grade producers, and we think this helps us not only weather this storm, but we also believe these are key points that continue to make us believe in the strength longer term and our position in the Gulf of Mexico.

[Theresa Chen:]

Great. Thank you very much. Hope you all stay safe and well.

[Kevin Nichols:]

You as well. Hope everyone is safe.

[Operator:]

Your next question comes from the line of Derek Walker from Bank of America.

[Kevin Nichols:]

Good morning Derek. How are you?

[Derek Walker:]

Good morning guys. Thanks for taking my question. Just a couple from me. Maybe I will start with some of this short-term actions. Kevin, you mentioned maximizing revenue opportunities with the Mars Cavern. Can you just give us a little bit more background on sort of how that came about, where are some of the rate that you are charging some of the customer there, and is that more of a single revenue for the remainder of the year or how does that, how this contracts unfold?

[Kevin Nichols:]

Yes, so Thanks, Derek. I will turn it over to Steve. I don’t know that we are going to get specifics on individual contracts. But he can talk to you more about the different stores opportunities that we have actually pulled the trigger on.

[Steve Ledbetter:]

Thanks Derek. I think what you are looking for is how are we leveraging our current assets and maximizing. We have various opportunities where we have storage assets across our systems. And we have several contracts, we bid into leveraging some of the storage at homer and some water access across the docks.And then the second Cavern and Mars, they provides available storage as well as ratability for the flows that are continuing to produce offshore. But in general, we will continue to look for opportunities across our system and put those into our business.

[Kevin Nichols:]

And our rates are competitive market rates with anybody that is out there looking to offer storage to folks.

[Derek Walker:]

Got it. I guess, do you have a sense sort of like in the aggregate, what you think the uplift is associated with it?

[Steve Ledbetter:]

Well, we are not going to give guidance now around the additional revenue that is coming. Other than just know that wherever we have a barrel of storage, we are pulling that because storage is a hot commodity right now.

[Derek Walker:]

Okay, thanks for that. And maybe on the Mars expansion. It sounds like you are trying to have some stuff by the end of the year. How should we think about the cadence expansion in 2021 in services, is that more of a year-end kind of 2021 mid-year. How should we think about the timing of that project?

[Steve Ledbetter:]

So the timing on when it will be executed and come online, I believe is that the question?

[Derek Walker:]

Yes.

[Steve Ledbetter:]

Yes. So, we are still in the midst of defining the commercial construct which will inform the final detail design. The good thing is, lots of conversations still progressing. The demand is still there. We anticipate final definitive agreement by the end of the year and we will be online mid-year timeframe by 2021.

[Kevin Nichols:]

It is really in advance, Derek, ahead of Vito and Powernap, which are still on the original schedule.

[Derek Walker:]

Okay perfect. And then maybe just last one for me. I mean, would you characterize since we have April under our belt would you characterize that month is sort of particularly given that you are seeing some uptick, as sort of the - kind of a tougher month for 2Q? And if you were to kind of make April, sort of the May, June timeframe as well, do you have a sense of what the coverage ratio would be? If April results would be kind of the full quarter?

[Steve Ledbetter:]

Yes. So again, I think you are asking for us to be a little bit more definitive in that less than one coverage ratio. And we are only halfway through the quarter. June is still out there. There is a lot of moving parts and that still have to unfold.We have seen some positive recovery in gasoline some demand that is heading in the right direction, but what happens as states lift their restriction and whether or not they actually continue with that or they shut that down. There is just a lot of volatility for us to get exact with the range there.

[Derek Walker:]

Okay. Great. Thanks guys, that is it from me. I appreciate it.

[Kevin Nichols:]

Thank you. stay safe please.

[Derek Walker:]

Likewise.

[Operator:]

Your next question comes from the line of Robert Mosca [Mizuho Securities].

[Robert Mosca:]

Hi good morning everyone.

[Kevin Nichols:]

Hey Rob, how are you?

[Robert Mosca:]

So in regards to your sub one time covenant anticipation for the second quarter. Just given the distribution waiver beginning next quarter and contributions and crop down assets. Is that coverage rate being calculated a little differently to reflect what coverage would be without the waiver, just seems like you guys might have some breathing rooms before going sub - some of those items coming up next quarter?

[Kevin Nichols:]

Yes. So the guidance that we provided is really around what we are seeing with the market. So we were pretty optimistic, if you recall from the early part of the year, when we announced the deal being completed.But with the COVID-19 hitting us in kind of late-March, it is just too difficult for us to see form a - given the volatility in our earnings for the assets to provide any kind of guidance. So in a normal world, yes, we would have been well above 1.0 coverage. But we will see where Q2 lands us.

[Robert Mosca:]

Understood. And then if I could just had an operational question, particularly on what you are seeing offshore. And I know you already answered the first part of my question speaking to the demand for Gulf of Mexico barrels in the Gulf Refinery Systems. But can you perhaps opine on the eastern corridor volume reduction? And then just anything you are seeing as far as the timelines for longer term exploration projects offshore?

[Shawn Carsten:]

Yes. So I will start and then I will turn it over Steve. We have been talking about the Gulf of Mexico for a very long time, and it is gone through various different cycles around different crude prices and then that kind of thing. And with the funnel offshore that once people take their investment decisions, those projects are pretty much committed.So the near-term and the medium-term is less likely to be affected with new projects coming on. As an example, Vito and Powernap coming on next year. And there is a couple beyond that, where they are well into construction.If there was to be an impact, it would come in delays and new things coming into the funnel, which have really more of that five, seven year out time horizon. So we will have to wait and see what happens. And that will depend on volatility and how long we are in this kind of demand situation.With regards to Eastern Corridor, I will let Steve answer that.

[Steve Ledbetter:]

Yes thanks. So I think the exposure on the east really is around concentration for smaller producers or higher cost to produce steel as well as some of the crude grades, being more of an HLS type expose barrel that may not match up as well with the current demand patterns. We have seen very little impact to the to our business and impact to the Eastern Corridor to this point, but it is something we continue to monitor.Again, the majority of our crude that we transport through the central corridor and others is medium sour it matches up very, very well. And our exposure points we mentioned earlier are relevant for this situation as well as the long-term.

[Robert Mosca:]

Okay. Thank you. That is really helpful.

[Kevin Nichols:]

Thanks be safe.

[Operator:]

Your next question comes from TJ Schultz from RBC Capital.

[Kevin Nichols:]

Hi TJ.

[TJ Schultz:]

Hey Good morning, just one follow-up on the distribution. So my understanding was that coverage would be tight this year and kind of a transition period and then grow overtime. And you have the flexibility to withstand tighter coverage just given your asset mix and the balance sheet. Does anything changed relative to your outlook on coverage and proving beyond 2020. And if you are looking at the distribution on kind of a quarter-by-quarter basis now, where you are keeping it flat in the second quarter and what might be a trough demand quarter, just how you are thinking longer term for coverage improvements.

[Kevin Nichols:]

I think our story is still there with regards to the business that we see coming on board, the Mars expansion projects, some additional offshore production. And some of the other projects that we see across our portfolio that hasn’t changed.What really has changed right now is just the level of uncertainty with from COVID-19 and demand destruction. And what really is going to happen with demand over the rest of the year. And so we will have to watch and see what happens with demand.I think it is more of that refined product story. We think the basin in the Gulf of Mexico and crude holds up well. But we are going to have to wait and see what happens with demand. So, I think that is really the big change.

[TJ Schultz:]

Okay. I appreciate it. Thank you.

[Operator:]

Your next question comes from the line of Joe Martoglio for JPMorgan.

[Kevin Nichols:]

Good morning Joe.

[Joe Martoglio:]

Good morning. I just wanted to ask maybe dive in a little more on while you are seeing offshore and the shines there. I think Murphy said this morning, they are dialing back production a bit. I’m wondering if that flows onto your systems. And then also, a lot of the production from the majors I guess, how, if they are dialing back as much or what you are seeing there?

[Kevin Nichols:]

Maybe I will let Steve give more detailed, but overall, we have not seen the material impact to our systems offshore. And the other thing would be that I know people were focused on storage and it becoming physical that where you couldn’t put your crude anywhere because there were more crude than there was needed to refine. And that would curtailed. We have not seen that materialize.There are some players in shallow water and some of the smaller players for financial reasons are either pulling their turnaround forwards to do it in this timeframe or for financial reasons they are choosing to do something, but it hasn’t been material and it doesn’t impact our large offshore production customers. Steve anything you want to add there?

[Steve Ledbetter:]

No. I think you covered it well Kevin.

[Joe Martoglio:]

Okay. That makes sense thanks for that. And then also another one, I appreciate the color you give about kind of overall refined product trends. But wanting to see I guess, on your system, can you say I guess what you are seeing on kind of Colonial and Explorer quarter to-date and is that consistent with the country’s trends? And then maybe I will try on the crude side, I guess what are you seeing on Zydeco quarter to-date?

[Kevin Nichols:]

Yes, I will take the first part and then I will ask Steve to answer on Zydeco part. We don’t talk on behalf of Colonial, which is an independently run company that we are one owner of. But obviously Colonial is one of the largest flagship finished product systems. And so it correlates to what you see demand happening across the country, especially in the northeast.It is the most cost efficient, most effective way to transport and meet demand in key market centers and in all those states in the Eastern seaboard. So as demand returns, it would be the pipeline system that would recover with strength.On Zydeco, maybe you could comment.

[Steve Ledbetter:]

So on Zydeco, I mean what we see is we still see the strength in volumes currently on the system. And we believe that is again, testament to Zydeco remaining a strategic asset in Gulf Coast that can compete, connects multiple training hubs, refining centers, storage as well as export access across the water. So we are pleased with our position in Zydeco continues to perform well.

[Joe Martoglio:]

Okay. Great. Thank you. I appreciate the color. That is all for me.

[Kevin Nichols:]

Yes. Thank you and be safe.

[Operator:]

We have no further questions. I will now turn the call back over to Jamie Parker.

[Jamie Parker:]

We thank everyone for their interest in Shell Midstream Partners. And 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 as well as on our website shellmidstreampartners.com.

[Operator:]

This concludes today’s conference. You may now disconnect.