Shell Midstream Partners, L.P.
Q2 2017 Earnings Call Transcript

Published: 3 Aug 2017

[Operator:]

Good morning. My name is Nova, and I'll will be your conference operator today. I would like to welcome everyone to the Second Quarter 2017 Shell Midstream Partners Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will have a question-and-session, and instructions will be given at that time. [Operator Instructions] I'll now turn the call over to Courtney Selinidis, Investor Relations Officer. You may begin your conference.

[Courtney Selinidis:]

Thank you. Welcome to the second quarter earnings conference call for Shell Midstream Partners. With me today are John Hollowell, CEO of Shell Midstream Partners; Shawn Carsten, CFO; and Kevin Nichols, Vice President, Commercial. The presentation materials shared this morning can be found on our Website, shellmidstreampartners.com, under the Events & Conferences section. 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 this morning'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 one 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. And with that, I'll turn the call over to John Hollowell.

[John Hollowell:]

Thank you, Courtney. Good morning, everyone. And thank you for your interest in Shell Midstream Partners. In the second quarter of 2017, Shell Midstream Partners generated some $66 million of net income, down about $5 million from the first quarter. Total cash available for distribution was about $89 million down about $2 million from the prior quarter. These results were mainly impacted by a planned maintenance activity primarily at Zydeco and Auger as per previous guidance, a change in presentation to include accruals in the maintenance capital adjustment and the impacts related to the timing of deferred revenue. These items were offset by the divestment of a non-core segment of Zydeco and Shawn will review the financials also of the quarter in greater detail later in the presentation, but first let me start off by discussing Shell Midstream Partners interest into the Permian Basin as we exercise our option to buy onto a new gas gathering system. This is another example of diversifying our cash flow, building on our already robust onshore portfolio and linking directly to our sponsor's footprint. Shell's unconventional portfolio includes acreage in key basins in the U.S., Canada and Argentina. These positions represent more than 11 billion barrels of discovered and perspective resources, which attracts between $2 billion and $3 million of annual capital investment from Shell. This business gives our sponsor flexibility as investment can be ramped up or down, which is valuable in the current environment. Now the Permian Basin is the most important asset within our sponsors Unconventional portfolio. Shell has around 270,000 acres in the Permian Delaware Basin and intends to invest over $1 billion a year to grow its production to 150,000 barrel per day by the end of the decade. in 2016 Shell entered into an agreement with Crestwood Equity Partners to construct, own and operate the gas gathering system for new wells drilled after June 2017. The agreement also included an equity buying provision. As announced this morning, we exercised the option to purchase 50% equity interest in the system for approximately $47 million. The close of the acquisition is subject to due diligence period and customary closing conditions and we expect the transaction to close in the fourth quarter of 2017. Now we believe this transaction presents a compelling value proposition for our unitholders. The Permian Basin is the cornerstone of Shell's Unconventionals portfolio, the purchase price represents a 4.7 times next 12 months EBITDA which is aligned more with build multiples versus buy multiples and well below comparable acquisitions in the basin by others and the system offers an opportunity for future organic growth as Shell continue to develop a dedicated acreage. Furthermore, this acquisition is the first of a number of growing opportunities for Shell Midstream Partners to provide a ministering solution to our sponsor's Unconventionals portfolio. The initial build out of the system which has put into service in June includes 60 miles of pipe with 20 receipt points, a 24-mile high-pressure heater system and four compressor stations with over 10,000 horsepower compression. The system will grow as development continues and in about 2030 the system is expected to triple in size with a capacity of no less than 250 million cubic feet per day. The system will gather gas from a majority of Shell's operated production from future wells under our long-term 20-year contract. We are pleased with the project delivered by Crestwood team who constructed the pipeline ahead of schedule, under budget and with excellent safety performance and we're starting to look forward to a long partnership with Crestwood. Now moving on to our second quarter operational results; following our most recent acquisition, Shell Midstream Partners now owns a 100% interest in the Delta, Na Kika and Refinery Gas Pipelines. The Refinery Gas Pipelines, which serves Shell's chemical plants along the Gulf Coast, have long term take-or-pay commitments and therefore provides stable cash generation quarter-over-quarter. We expect the volumes to ramp up at Delta and Na Kika as several new Gulf of Mexico fields come online and connect to the system in the beginning of 2018. Now as discussed last quarter, planned maintenance activity and produced turnarounds tend to be concentrated during the second and third quarters of the year and as such the largest variances in our results from an operational perspective the quarter were primarily driven by the maintenance activity at Zydeco and Auger. The operational performance across the remainder of the portfolio was relatively stable from the prior quarter. Now at Auger, an upstream connected producer shut in two platforms for planned turnarounds during the second quarter. Total impacted throughput on the Auger pipeline was about 50,000 barrels per day lower than the first quarter, which is slightly less than the 60,000 barrels per day impact we expected during the last quarter's call. At Zydeco, we completed the decommissioning of top-sized piping at [indiscernible] to upgrade the system and improve the operability and reliability in the home from offshore. The decommissioning work required a 22-day shut-in on the line that resulted in 40,000 fewer barrels per day flowing through the impacted segment. So, in total, the maintenance activity had a $10 million impact on our cash available for distribution as compared to the first quarter, which is in line with the guidance we provided of $9 million to $12 million. Now looking ahead to plan to perform some integrity work of the Zydeco system including a hydro test and this will require taking a portion of our Zydeco system out of service for what we estimate to be 30 to 60 days in the first quarter of 2018. Let me give you a little bit more background on our planned work. In mid-June, we discovered a small release on the Zydeco pipeline near Erath, Louisiana, which was about 23 gallons in size. We responded to the release, repaired the pipe and returned the line to service within four days. Based on our current understanding, the release is most likely a result of pressure cycling. We've taken proactive steps to reduce pressure cycling on the line like running additional pump stations and working with connected carriers. Based on our experience and industry practice, our next steps will be to run an inline inspection tool, hydrotest the system and invest in additional equipment to further minimize the effects of pressure cycling in the future. We intend to run an inline inspection tool in advance of the hydrotest to identify and repair any potential anomalies while the system is still operating. This should reduce the amount of time the system is out of service for the hydrotest. The portion of the system that will be out of service during the hydrotest is a segment between Houston and Homa. The remainder of the system including offshore volumes will not be impacted. We're in the early planning stages of the work and believe this approach is the most prudent way to enhance integrity and reliability on the system. The net impact to our cash available for distribution could be between $30 million and $60 million, primarily in the first quarter of next year. However, we do not anticipate any change to our distribution growth guidance of 20% CAGR through 2018. So, let me reemphasize, that we believe this is the right thing to do to meet the needs of our customers, investors and communities well into the future. Now I'll hand the call over to Kevin Nichols to discuss growth products that are currently in the funnel. Kevin?

[Kevin Nichols:]

Thanks John. It's been about a year since we last provided an update on the two large-scale midstream projects that we have under construction at Shell Pipeline Company. The Falcon Pipeline, which will supply Shell's Pennsylvania chemical project and the Mattox Pipeline, the oil export line for the Appomattox platform in the Gulf of Mexico. So, let me start off by talking about Falcon. It's a 97-mile pipeline connecting ethylene from the Marcellus and Utica reservoirs in Pennsylvania and Ohio into Shell new chemical project in Pennsylvania. Once online, the plant is expected to be one of the most competitive polyethylene producers in United States. I'm happy to report that the Falcon pipeline is on schedule, right-of-way acquisition is progressing well, permanent submittal is scheduled for later this summer and mainline construction is expected to start in spring of 2019. So now let's move offshore. The Mattox pipeline is an 89-mile Deepwater Gulf of Mexico export pipeline connecting Shell's Appomattox volumes into the Proteus and Endymion system. Late last year Shell Midstream Partners purchased an interest in Proteus and Endymion from BP and as of July 1, Shell Pipeline Company took over operations of the system. The acquisition from BP along with the construction of the Mattox pipeline creates a new pipeline corridor out to the frontier areas of the Gulf of Mexico that will greatly benefit from significant growth once Appomattox comes online. The Mattox pipeline is well under construction. The project is ahead of schedule, under budget and we will begin laying pipe in the fourth quarter of this year. Undoubtedly, Appomattox and the Pennsylvania Chemical project are exciting projects in the Shell portfolio. Each of these projects have key midstream components that will be very well-suited to drop in the MLP once the projects are complete. With that, let me hand it over to Shawn Carsten to walk you through the financials the quarter.

[Shawn Carsten:]

Thanks Kevin and good morning, everyone. In total, cash available for distribution was $88.7 million, slightly lower than the previous quarter. During the quarter, we saw material impact to our results due to a change in the presentation to include accruals in the maintenance capital adjustment and the cash impact related to deferred revenue. In total, fee volumes accounted for about $10 million less cash available for distribution compared to the first quarter. The change in the presentation of the maintenance capital adjustment to include accruals for work performed in the period is better aligned with the timing of billings for reimbursement and is in line with the treatment of cash reserves in partnership agreement. This change is being applied prospectively and therefore results in a one-time adjustment of approximately $5 million to capture accruals previously recorded, but not yet paid. In addition, as we've seen in previous quarters, deferred revenue, cash adjustments due to other shipments can create quarter-over-quarter variance due to the timing of the adjustment. This quarter that impact was about $5 million. As John mentioned earlier, the total impact of higher maintenance projects completed during the second quarter was about $10 million largely driven by Auger and Zydeco. This impact was seen across revenue and capital expenditures due to the various types of projects that occurred during this quarter. And finally, as announced in May, we completed the divestment of a non-core segment of the Zydeco pipeline, which generated divestment proceeds for the partnership of approximately $19 million. Looking ahead to Q3, underlying performance of our assets is expected to be stable compared to the current quarter and maintenance spend is expected to be about half of Q2. A good run rate for operating cost going forward included the new consolidated assets will be around $28 million. Although this can fluctuate from time to time depending on activity. The partnership declared a distribution of $0.34 per LP unit for the second quarter. This was a 4.5% increase over the prior quarter's distribution and 21% higher than the second quarter of 2016. The resulting distribution coverage ratio for the quarter was around 1.3 times. This distribution was in line with the previously communicated guidance to deliver distribution growth of at least 20% CAGR through 2018. Finally, let me close by discussing the partnership's balance sheet and liquidity. At the end of the second quarter, the partnership had total cash and cash equivalents of $135 million and total debt outstanding about $1.26 billion. The leverage ratios for the quarter were about 3.1 times net debt to adjusted EBITDA. Now while our debt levels are on the high side of our targeted range we are comfortable in our ability to deliver growth plans while maintaining our desired leverage. With that, I'll turn the call back over to John for some closing remarks.

[John Hollowell:]

Thanks Shawn. We certainly provided a lot of information today. So, let me take a moment to summarize the points I hope you've taken away from the call. First, Shell is committed to running a safe and reliable business, which is clear by the actions we're taken on the Zydeco system. This work will impact results primarily in the first quarter of next year, but this will not impact our current distribution guidance. We're executing on our growth strategy. Shell Midstream Partners plans to enter the Permian Basin in support of an important growth asset for our sponsor. It's an exciting opportunity for us and provides organic growth opportunities as development continues. And finally, midstream growth projects at our sponsors are progressing well. As these projects come online, they will serve as critical assets in our runway to fuel our growth into the future. And with that, let me open the call up for your questions.

[Operator:]

[Operator instructions] Our first question comes from the line of Jeremy Tonet of JPMorgan.

[Bill:]

Good morning. This is Bill on for Jeremy. Quarterly results have looked pretty lumpy over the past couple of quarters. Is there any color you could share on what will more run rate, EBITDA look like going forward?

[Shawn Carsten:]

Of course, this is Shawn. Of course, they do change from time to time. As you can see from our results, you can look at somewhere in the neighborhood of $90 million. But of course, as said with that it can fluctuate from quarter-to-quarter.

[John Hollowell:]

As it did this quarter with the maintenance activity, which we try to signal those unique things in the lookahead as we do in each of the quarterly calls.

[Bill:]

Thanks. And then on the Permian, congratulations on entering that basin. Are you interested in crude asset as well there or will you be focused primarily more on that gas and any interest in M&A longer-term to support the sponsor's production?

[John Hollowell:]

Well, we certainly look at this as a great opportunity to get a foothold into the Permian through our sponsor's activity and yes, to your point Bill, it leads to other opportunities in the future, including crude gathering, water processing and other activities that can clearly fit within the Shell Midstream Partners' portfolio. So again, we're excited just to be able to get into the Permian in a way that aligns with our sponsor and we certainly look forward to the opportunity to grow on the gas gathering side with Crestwood as our partner, but also look for other opportunities into the future as the project matures.

[Bill:]

Great. And then one more for me. Any color you can share on current share on the GOM Outlook for the rest the year given the commodity price environment?

[John Hollowell:]

Yeah, we still continue to stay -- remain consistent with our expectations that production volumes, our throughput volumes in our system will increase. They have this year -- early this year and continue to be that way. Producers continue to develop projects. Some projects are scheduled to come online at the beginning of next year that will tie into the Na Kika system and Delta system and another system in the Eastern Gulf of Mexico. So, activity continues to go on in the Gulf of Mexico. Producers continue to find ways to develop projects at prices that can compete in the current market environment and we're starting to see some of those projects really come online towards the end of this year, early next year.

[Bill:]

Great. Thanks for taking my questions.

[John Hollowell:]

You bet Bill. Thank you.

[Operator:]

Our next question comes from the line of Brian Zarahn of Mizuho. Your line is open.

[John Hollowell:]

Good morning, Brian.

[Brian Zarahn:]

Good morning, John. Zydeco maintenance in the first quarter of next year, is that $30 million to $60 million. Is that revenue, is that EBITDA?

[John Hollowell:]

It's cash available for distribution Brian.

[Brian Zarahn:]

Okay. And I guess is there an ability to pass along any of those costs or is that just has to be absorbed?

[John Hollowell:]

No. Those will be when you say pass along, what do you mean?

[Brian Zarahn:]

Into the tariff or any type of recovery on to shippers.

[John Hollowell:]

No Brian. That's not -- no we're going to pass those costs into the tariff. Making sure we have a safe and reliable system is top priority for us. We feel this is the right move to make to do that. We're doing the right thing we think to in a proactive way by the way to make sure we have the enhanced the integrity and the reliability of the system. So, we will press ahead, but no, we won't pass that on to anybody else.

[Brian Zarahn:]

And then I guess, toss out that impact, you do have the Permian acquisition contribution. It looks like the Gulf volumes are expected to continue to have some growth or anything else we should be thinking about in terms of offsets to Zydeco impact next year?

[John Hollowell:]

I think you got a lot of pretty much the two that we would think of. A lot of the offshore volumes have been developing nicely and maturing. We're expecting those to come on toward the front part of next year, but I think the way you highlighted, it is good it's -- those are the two things that can offset it. But then again, we think we're doing the right thing here and the prudent thing and we have the ability to -- again we're not going to reduce our guidance. We think, we can absorb this in 2018, it still deliver on our distribution guidance of 20% CAGR through 2018 Brian.

[Brian Zarahn:]

And then I guess on the Gulf, what type of opportunities or potential opportunities do you see for exports and then anything related to loop?

[John Hollowell:]

Loop, maybe I'll start and maybe Kevin can kick in, but Loop made the announcement whether looking at being able to export as well to import. We do that as positive. As you well know Shell owns -- has an ownership in Loop, which is in the runway for Shell Midstream Partners, so that's good. And Kevin, you might be able to speak a little bit more to what the view is on exports out of the loop, it's relationship with Shell Midstream Partners.

[Kevin Nichols:]

No, I think there is stuff out in the public domain of what they’ve announced and they're evaluating opportunities and reversing one of the inbound lines for export. So that's a positive sign and again, we've said with the Zydeco system, we want to keep it connected to as many destinations and sources accrued as possible and that allows us to feed some of those export opportunities.

[Brian Zarahn:]

Okay. Thanks Kevin. Thanks John.

[John Hollowell:]

You bet.

[Operator:]

[Operator instructions] Our next question comes from the line of Mark Carlucci of Morgan Stanley.

[Mark Carlucci:]

Hi. How are you?

[John Hollowell:]

Good Mark. How are you?

[Mark Carlucci:]

Doing well. During the quarter, there were a few headlines suggesting some weakness on Colonial. It looked like volumes came in pretty in line. I was just curious if you had any thoughts on that or kind of the go-forward outlook?

[John Hollowell:]

Yeah. So, Colonial doesn’t comment on the demand and movements on their shippers. What I can say with discussions with Colonial is that Colonial and the management team is not expecting any long-term change to demand forecast for the system. They're work in five-day cycles. So there have been a few cycles that have not been on allocation, but their view of the long-term is still the same.

[Mark Carlucci:]

Understood and then on the Permian acquisitions, so 4.7 times next 12 months, are you able to provide any sense of the growth trajectory there?

[John Hollowell:]

We're working the sponsor on what that growth trajectory would be. We don't have that information in detail at this time Mark.

[Mark Carlucci:]

Okay. Understood. Thank you.

[John Hollowell:]

Thank you.

[Operator:]

Thank you. And we have no further questions. And now, I would like to turn the call back to Courtney Selinidis.

[Courtney Selinidis:]

Thank you very much for your interest in Shell Midstream Partners. For additional follow-up questions, feel free to contact me directly. My contact information can be found on the presentation materials as well as on our website shellmidstreampartners.com.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the call. You may now disconnect. Everyone, have a wonderful day.