Will Changes in Midstream Leave This Company Behind?

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When it comes to the midstream industry, it's rare that the first word that comes to mind is "exciting." Pipelines and storage tanks hardly invoke emotions among investors. But those following the space sure have gotten a good dose of excitement lately. Between the changing fundamentals of oil and gas supplies in the U.S. and recent M&A activity, there's a lot going on in a typically dull industry

With so much fervor surrounding all this movement, some investors are starting to wonder whether some of the quieter companies still have what it takes to survive. Let's check in with Magellan Midstream Partners (NYSE: MMP  ) and see whether the current movements in the industry could leave the company in the dust.

The times, they are a-changin'
Magellan has for the most part built its entire midstream network on finished petroleum products. Its pipeline network was almost specifically designed to deliver and store refined products from refineries in the Gulf of Mexico to markets across the Midwest. This was a business model perfectly set for a country that was addicted to oil imports.

Here's the problem with that model today: In the past couple of years, America's domestic supplies have helped the country start to kick its import habit. Now, instead of moving gasoline to the Midwest, we need to move crude from the Midwest to the Gulf. Even worse, it appears that demand for gasoline is waning. Valero (NYSE: VLO  ) , the United States' largest independent refiner of petroleum products, just commented in its recent earnings release that this past quarter saw a decline in total gasoline sales across North America.

This news is a bit of a double whammy for the company, and it showed in Magellan's most recent earnings release. Pipeline volume for refined products decreased by 1.2 million barrels for the quarter, or about 2% overall.

Big fish getting bigger
One of the largest competitive advantages for a midstream company is its ability to be a one-stop shop for an E&P company or a refiner to move feedstock to wherever it needs. The fewer companies between the final destination, the better. This is one reason we've seen such a large uptick in M&A activity in recent months.

Kinder Morgan Energy Partners (UNKNOWN: KMP.DL  ) just announced that it has agreed to acquire Copano Energy (UNKNOWN: CPNO.DL  ) for $5 billion. This news comes on the heels of Energy Transfer Partners' (NYSE: ETP  ) announcement of its merger with Sunoco, which gives it a 40% share of Sunoco Logistics Partners (NYSE: SXL  ) .

Both of these moves were done to help build out the companies' respective networks. In Kinder Morgan's case, the company gets critical infrastructure in the Niobrara, Mississippian Lime, and Eagle Ford plays -- three of the United States' hot emerging shale plays. For Energy Transfer Partners, it just went from a very large player in the Gulf states to a completely national operation. The combined network covers all oil and gas plays south of Kansas, as well as the Utica and Marcellus shale.

These kinds of movements from its competitors could put Magellan under a lot of pressure to deliver a wider-reaching network.

What a Fool believes
During Magellan's most recent conference call, CEO Michael Mears stated that while the company is open to acquiring new assets, it doesn't see anything priced well enough to make a play at this time. Rather than grow through acquisition, the company aspires to organic growth. 

The company has plans to convert its longhorn pipeline to deliver 225,000 barrels per day of Permian crude to refineries in the Houston area. It also has partnered with Occidental Petroleum (NYSE: OXY  ) to construct the BridgeTex pipeline, another Permian-to-Houston pipeline that will provide up to 300,000 bpd capacity. Magellan certainly picked the right dance partner for the Permian, as Occidental is the largest producer in the Permian Basin by a wide margin.

For investors who were concerned that a refined product-heavy infrastructure wouldn't be sustainable, the move to build out these Permian pipelines should be encouraging. These two pipelines are a sure sign that the company understands the market shifts in the industry. It's likely that this move will be the driving force behind the company's growth. When committing to more than 500,000 bpd from a single shale play, it's a smart decision to work with the region's dominant player. If refined product demand continues to decline, look for Magellan to convert some of its other pipelines for crude transportation. 

If trying to follow all of the recent movements in the midstream space has your head spinning, then check out our premium research report on Energy Transfer Partners. Motley Fool analyst Aimee Duffy will guide you through the importance of the network effect for a midstream company and what it can mean for you. You can get your own copy of this report by clicking here.

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