The midstream sector has undergone several changes in recent years. Companies used to have no problem obtaining cheap outside financing to expand their operations. However, given the continued challenges of the oil market, it's much more expensive to fund projects these days. That's forced the sector to shift its approach.
One way pipeline companies have done that is by forming partnerships to develop projects so they can share the costs and improve returns. Oil infrastructure-focused master limited partnership Plains All American Pipeline (PAA -1.11%) is one of several companies in the sector to embrace this strategy to develop new projects. The company recently unveiled its latest partnership, this time with Holly Energy Partners (HEP), to build a new pipeline and storage terminal in Oklahoma. That project, once completed, will give both companies more fuel to potentially increase their already high-yielding dividends.
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Drilling down into the latest partnership
Holly Energy Partners and Plains All American are forming a 50-50 joint venture (JV) called Cushing Connect Pipeline & Terminal. The JV will develop and build a new 160,000-barrel-per-day oil pipeline. It will connect an oil hub in Cushing, Oklahoma, to a refining complex owned by HollyFrontier (HFC) in Tulsa. The JV will also own and operate 1.5 million barrels of oil storage capacity in Cushing. That storage terminal should be in service by the second quarter of next year, while the pipeline should come online by the first quarter of 2021.
The partners plan to invest $130 million into the JV, which includes the contribution of a terminal currently owned by Plains All American valued at $40 million. That investment will supply both companies with predictable income backed by long-term contracts with HollyFrontier.
By teaming up on this project, Plains All American and Holly Energy Partners can continue growing their operations for a minimal investment. In Plains All American's case, it only needs to invest roughly $25 million in cash. In exchange, it will receive a 50% share of the JV's anticipated annual earnings, which should be in the range of $14.4 million to $16.5 million. Holly Energy Partners, meanwhile, only needs to invest $65 million for its 50% share of that anticipated income.
Why this partnership makes sense
Those small investment requirements make it much easier for both companies to continue growing. Holly Energy, in particular, needs to keep its funding commitments to a minimum. That's because it's currently paying out all its cash flow to maintain its 10.6%-yielding distribution to investors. However, thanks to this partnership with Plains All American, it's cash flow should keep rising, which could allow it to continue increasing its payout. That would enable it to maintain a streak that has lasted for 59 straight quarters.
Meanwhile, for Plains All American, this JV enables it to optimize an existing asset while growing its earnings with a minimal investment. It's part of the company's strategy to work with industry partners so that it can invest in a growing list of expansion projects without a large capital commitment.
The company, for example, is leading the development of Wink-to-Webster, which is a major oil pipeline project to move crude out of the Permian Basin. However, instead of funding the lion's share of the project, Plains All American only needs to finance 16% after bringing on several partners to help build the large-scale pipeline. Meanwhile, the company recently sold a 33% stake in its Red River Pipeline to Delek Logistics for $128 million. That deal more than funds an expansion of that system, giving Plains All American some additional cash to reinvest in other projects such as its JV with Holly Energy. Overall, the company now has added seven new partner-backed projects to its backlog in the past year, which will help drive faster growth over the next couple of years. That should give it plenty of fuel to continue increasing its 7.2%-yielding dividend.
Stretching their investment dollars
Energy companies will often team up on projects to reduce risk. However, midstream-focused companies are increasingly going that route to help reduce their funding commitments so that they can continue growing while paying high-yielding dividends. Plains All American is becoming a master at this strategy, which is one of the many reasons it's a great stock for income-focused investors to consider buying.
