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Magellan Midstream Partners LP (NYSE:MMP)
Q3 2020 Earnings Call
Oct 30, 2020, 1:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, everyone, and welcome to the Magellan Midstream Partners Third Quarter 2020 Earnings Call. [Operator Instructions] Afterwards, we will conduct a question-and-answer session. Friday, October 30, 2020.

I would now like to turn the conference over to Mike Mears, Chief Executive Officer. Please go ahead.

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

All right. Well, hello, and thank you for joining us today to discuss Magellan's third quarter financial results, our latest outlook for the full year and other topics of interest to you. Before we get started, I must remind you that management will be making forward-looking statements as defined by the Securities and Exchange Commission. Such statements are based on our current judgments regarding the factors that could impact the future performance of Magellan, but actual outcomes could be materially different. You should review the risk factors and other information discussed in our filings with the SEC and form your own opinions about Magellan's future performance. You may have noticed that Magellan issued two new news releases this morning. In addition to reporting our financial results for the third quarter, We also announced the publication of our inaugural sustainability report, which is now available on our website. Sustainability is definitely not new to Magellan, and we take our responsibility very seriously to safely and reliably deliver petroleum products that are essential and beneficial of the everyday lives and not only in our nation but the world for many years to come.

We also recognize the growing stakeholder interest in transparency around ESG practices, and hope you find the report to be informative. Switching to earnings. Magellan's business continues to be resilient and deliver solid results during the year. It has been one of the most challenging periods on record as our industry and nations try to move forward in the midst of the pandemic and the related economic disruption. With that said, our third quarter results exceeded our expectations by a notable margin, benefiting from a number of favorable items, including lower expenses, better-than-expected commodity profits, and slightly higher refined products revenues. Our CFO, Jeff Holman, will now review our third quarter financial results versus the year-ago period in more detail, then I'll be back to discuss our latest outlook for 2020 before answering your questions.

Jeff L. Holman -- Senior Vice President, Chief Financial Officer and Treasurer

As usual, I'll be making references to certain non-GAAP financial metrics, including operating margin and distributable cash flow, or DCF. We have included exhibits to our earnings release to reconcile these metrics to their nearest GAAP measure. Earlier this morning, we reported third quarter net income of $211.6 million or $0.94 per unit on a diluted basis, compared to $273 million or $1.19 per unit in the third quarter of 2019. Excluding the impact of mark-to-market activity adjusted diluted earnings per unit was $0.97, which, as Mike pointed out, exceeded the expected range of between $0.75 and $0.85, which we provided with our second quarter earnings release. Distributable cash flow for the quarter was $258.8 million, $48 million lower than the $306.8 million reported in third quarter 2019, primarily due to a combination of lower refined products transportation volumes, lower crude oil spot shipments and lower commodity margins in the current quarter. So turning first to our refined products segment. Refined products generated $239 million of operating margin in third quarter 2020, a decrease of about $32 million versus the 2019 period, with most of that decrease resulting as expected from the impact of the pandemic on travel and economic activity, as transportation and terminals revenue for the segment also decreased by about $32 million. Gasoline and aviation fuel remains the hardest hit by the pandemic and related restrictions, while lower drilling activity also negatively impacted distillate volumes. Third quarter base refined products wins, excluding the impact of growth projects, we're about 15% lower than third quarter 2019 for all products combined with gasoline, distillate and aviation fuel seeing declines of 11%, 18% and 35%, respectively.

Including the impact of growth projects, overall refined products volumes were about 13% lower than the 2019 period. Revenues also decreased as a result of the sale of three marine terminals in first quarter 2020 and the decommissioning of our ammonia system in late 2019. These declines were partially offset by higher average tariff rates, which were favorably impacted by the average 3.5% tariff increase that went into effect on July one of this year as well as by fewer short-haul movements, which earned a lower rate. We also benefited from recently completed growth projects, including the West Texas expansion that began operations during the quarter, as well as our East Houston-to-Hearne project that became operational in late 2019. Operating expenses for the refined products segment decreased $8.7 million between periods, partially reflecting the lower throughput and terminal activity during the quarter, lower integrity spending and the absence of costs related to the sold or decommissioned assets I mentioned a moment ago, as well as the cost-saving efforts of our business optimization program, partially offset by less favorable product overages, which reduced operating expenses. Other operating income decreased $3.1 million due to insurance proceeds received in third quarter '19 related to Hurricane Harvey. Product margin decreased $8.2 million compared to third quarter 2019, primarily due to unrealized losses on hedges, which do not affect our calculation of DCF compared to gains last year, partially offset by higher sales volumes related to our fractionation activities.

Refined products equity earnings increased approximately $3 million versus third quarter 2019, primarily due to a higher contribution from the expansion of our Pasadena Marine Terminal joint venture, which began coming online in first quarter 2020, partially offset by lower contributions from our Powder Springs joint venture, in part due to mark-to-market gains in the prior year. Moving now to our crude oil segment. Third quarter operating margin of $135.8 million was about $20 million lower than third quarter 2019. Crude oil transportation and terminals revenue decreased slightly in the current quarter. Volumes on Longhorn averaged 277,000 barrels per day compared to 282,000 barrels per day in the third quarter of 2019. As expected, our customers continued to ship at or near the commitment levels. Volumes related to affiliate marketing activities during the quarter largely offset a decrease in third-party shipments, and the current period do not include any third-party movements in our posted spot tariff rate. I'll note that the revenues from our affiliate marketing activities are reflected in transportation revenue rather than product margin beginning this quarter. Consistent with the guidance we've given all year, we are not currently expecting any third-party spot volumes on Longhorn for the remainder of 2020, nor do we currently anticipate earning meaningful margins on any of our own uncommitted marketing activities. Just given where differentials currently are and the supply and demand dynamics, that make it unlikely for those differentials to widen in the near future.

Instead, our forecast continues to reflect our assumption that our customers will ship at their commitment levels while our marketing affiliate continues to ship barrels person to its committed buy-sell agreements. You may recall that approximately 75,000 barrels per day of commitments on Longhorn were set to expire on September 30. As we have noted for some time now, the current environment, and particularly, the current balance between production and takeaway capacity is not very supportive of new long-term contracts. So as anticipated, we have turned to our affiliate marketing activities to optimize utilization on Longhorn by entering into shorter-term buy-sell arrangements with customers that will encourage continued high utilization of the pipeline and the margin we earn from them, driven primarily by the prevailing in Houston. Turning now to other crude oil revenues. Reported volumes on our Houston distribution system decreased significantly in the third quarter 2020 versus third quarter 2019, with most of the decrease resulting from the change in the way customers contract for access to our Seabrook joint venture export terminal. As we discussed on our call last quarter, this change simply results in lower reported transportation volumes on our distribution system, offset by higher terminalling revenue. Our HCF volumes were also negatively impacted by lower receipts from BridgeTex, while lower crude oil prices continue to impact the value of tender barrels we received on our pipelines. These declines were partially offset by increased utilization of our East Houston storage at higher average rates during the quarter. Crude oil operating expenses increased $2 million during the period, primarily due to the timing of scheduled asset integrity spending and less favorable product overages. Crude oil equity earnings decreased $14 million between periods.

BridgeTex equity earnings declined primarily due to lower spot volumes in the current period as well as to a committed shipper using previously earned credits during the quarter, resulting in BridgeTex volumes of 333,000 barrels per day compared to 444,000 barrels per day in 2019. Saddlehorn earnings were lower primarily as a result of our sale of the 10% interest in the joint venture during the first quarter of 2020. Otherwise, Saddlehorn results were relatively in line as lower volumes of 164,000 barrels per day compared to 185,000 barrels per day in the 2019 period, were offset by higher average rates and lower operating costs. Consistent with our remarks regarding spot barrels on Longhorn, we continue to anticipate no spot barrels or any other uncoated barrels on either BridgeTex or Saddlehorn for the remainder of the year. And our guidance assumes that volumes continue to track existing customer commitments. Finally, product margin for the crude oil segment was $4.6 million unfavorable for the 2019 period, primarily as a result of the reclassification of margins we earn from affiliate marketing activities to transportation revenue, to conform to the current period's presentation mentioned previously. Moving now to other variances. Depreciation, amortization and impairment expense increased $15.2 million compared to third quarter '19, primarily due to the impairment of certain terminalling assets during the period as well as higher depreciation-related assets recently placed into service. G&A expense decreased $13.1 million primarily due to lower incentive compensation accruals, which reflect our lower forecasted 2020 results. Net interest expense was $5.4 million higher in the current quarter, primarily due to lower capitalized interest as a result of lower ongoing construction activity.

We also had higher average debt outstanding as a result of borrowings, primarily made to finance our growth projects, partially offset by a slightly lower average rate compared to the 2019 period. Our weighted average interest rate was approximately 4.3% during the recent quarter, and our average outstanding debt was $4.9 billion. At September 30, total long-term debt outstanding was $4.95 billion. Gain on disposition of assets was $2.6 million unfavorable due to an additional gain recorded in the prior year related to our discontinued Delaware Basin pipeline project that was sold to a third party. Moving to capital allocation, balance sheet metrics and liquidity. During the quarter, we repurchased nearly 1.4 million units at an average purchase price of $36.87, for a total spend of $50 million. That brings the total number of units repurchased year-to-date to five million units at a total cost of $252 million. As we have consistently noted in discussions of our repurchase program, the timing, price and volume of any unit repurchases will depend on a number of factors, including, but not limited to: our expected expansion of capital spending, excess cash available, balance sheet metrics, legal and regulatory requirements, as well as market conditions and the trading price of our common units. In terms of liquidity and leverage, we continue to have $1 billion credit facility available to us through mid-2024, with $248 million drawn on our commercial paper program at September 30. Our next bond maturity isn't until 2025, and our leverage ratio remains strong at 3.2 times for compliance purposes at the end of the quarter, well below our long-stated limit of four times.

With that, I'll turn the call back over to Mike to discuss our guidance for the remainder of the year.

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Thank you, Jeff. As we near the end of 2020, we have revised our DCF guidance for the year to $1.025 billion, which you may recall was the midpoint of our previous forecasted range. While the trajectory of the recovery for refined products demand to more historically normal levels still remains a bit unclear, we elected not to provide a 2020 DCF guidance range this quarter, since it appears that refined products demand is relatively stable at the moment. Therefore, our 2020 DCF guidance forecast generally assumes that recent refined product demand trends continue, and that we experienced no new material social restrictions in our market areas for the remainder of the year. Specifically, we estimate that our fourth quarter base business volumes, which excludes the benefit of recent expansion projects, will be 13% lower than the fourth quarter of 2019. By product, we expect base gasoline to be down 8%, distillates lower by 12%, and aviation fuel up by closer to 50%. These estimates also exclude our South Texas movements, which represent more of a supply push system, with short-haul volume that moves at a very low rate. We have also seen lower volume on the system in 2020, and once you factor in the South Texas volumes and incremental volumes from our recent Texas growth projects, we expect all-in fourth quarter refined product shipments to be about 7% lower than the 2019 period.

The demand dynamics of our system have been interesting to observe during the current environment. Our more rural markets are basically back to pre-pandemic levels, whereas our larger metropolitan regions have been slower to return to work, school and everyday activity. So their fuel demand continues to be below historical levels. We have also experienced a slower ramp for volumes related to our expansion projects due to current market conditions. As you may recall, these projects are supported by take-or-pay commitments from strong counterparties, so in some cases, we may have deficiency payments due to us in the future. For our crude oil pipelines, we continue to assume shipments generally in line with committed volumes for the remainder of the year. Regarding our commodity-related activities, we have hedged more than 80% of our expected gas liquids blending volumes for the remainder of 2020, with margins averaging about $0.35 for the fall blending season. As is typical, we have also started to hedge our expected activity for early next year, with about 40% of spring 2021 blending hedged at a $0.25 average margin. You may recall that Magellan kicked off an optimization effort last year to identify cost savings and process improvement opportunities throughout the organization. During 2020, we have identified about $30 million of efficiencies that we believe are repeatable, with the current year benefiting by about $25 million from these efforts. We are continuing to evaluate additional areas for improvement, and we believe that annual savings could reach $50 million or more by 2022.

These savings are primarily being realized through better power and drag-reducing agent optimization and business process improvements that are leading to reduced costs across the organization. We are also making modest workforce adjustments in certain areas of the company through natural attrition, voluntary retirements and targeted reductions. Magellan has always operated in a lean manner, but we are taking opportunities to improve where we can. As previously indicated, Magellan intends to maintain our quarterly cash distribution at the current level for the remainder of 2020. Based on our DCF guidance of $1.025 billion, we expect to generate excess cash of more than $100 million in 2020, resulting in distribution coverage of approximately 1.11 times for the year. Although we do not plan to provide guidance specific to 2021 at this point, which follows our historical approach, we do currently intend to target cash distributions for 2021, consistent with our current payout level. We understand that surety of distribution is important to a significant number of our investors, and believe the current payout is sustainable next year. Magellan remains focused on executing our long-term strategy to maximize value for our investors. In addition to returning cash to investors via our quarterly distributions, we also intended to deliver incremental value by utilizing unit repurchases and investments that meet our disciplined risk/reward profile.

As Jeff mentioned, we purchased $50 million of our equity during the third quarter, and continue to actively evaluate additional purchases, all with the backdrop of ensuring we maintain our healthy balance sheet. And although investor sentiment seems to have recently turned against expansion projects, generally, we still believe that good returning low-risk investments will continue to add value for our company, as demonstrated by Magellan's historical disciplined investment approach. Our current expansion spending estimates for approved projects or $400 million this year, with $310 million of that already spent through September 30, and $40 million in 2021. We continue to evaluate several attractive relatively smaller potential growth projects that may be approved in the near term. But to be clear, we anticipate significantly reduced capital spending programs over the next few years. For instance, if we include these potential projects that may be approved in the near term, We would expect the actual 2021 growth spending likely to be in the range of $100 million.

That concludes our prepared comments. And so operator, we're now ready to turn the call over for questions.

Questions and Answers:

Operator

[Operator Instructions] And our first question comes from the line of Jeremy Tonet with JPMorgan.

Jeremy Tonet -- JPMorgan -- Analyst

Good afternoon. I was just wondering, it seems like the industry continues to mature at this point, and I'm just wondering, how you think that unfolds as far as potential consolidation here? On the upstream side, you've seen a number of transactions recently on the midstream side, we have not seen as much, and just wondering, any thoughts you might have on how that could evolve? How upstream consolidation could impact the midstream business? And granted, Magellan is in a much stronger position than many peers, there's not any imminent need to do anything, but from you guys, but wondering how you think about all that coming together there?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Well, I guess the first thing I would say is I don't think that there is or will be a correlation between upstream M&A and midstream M&A. I don't think one necessarily drives together. Obviously, it's appropriate in the upstream, and I think some -- I think it's appropriate in the midstream. But I think it's likely that the pace of midstream consolidation will be slower. Speaking for us, I mean, we frequently evaluate combinations and mergers. And as you mentioned, we're in a slightly different position than some other of our peers with regards to a strong balance sheet, healthy and relatively stable business profile. So there's not an impending urgency to do that. Nevertheless, we evaluate. And we keep in mind all the elements are critical that you would consider in a merger such as balance sheet strength and maintaining balance sheet strength the variability of the earnings profile of potential targets. We evaluate all of that. And so I probably won't go any further than that to tell you that we're active in that regard. But overall, I would expect the pace midstream M&A to occur at a slower rate. And you may not see much meaningfully happen at all. I can't -- I don't know what my peers are doing, but I wouldn't be surprised if there's very few transactions over the next year or so.

Jeremy Tonet -- JPMorgan -- Analyst

Got it. And then separately, if you look at the Magellan unit price, I think there's a case be made overly depressed at these levels, and just wondering what -- how you think about the different tools your response to address that, namely kind of unit buyback seems like something that would be at the top of the list there. You obviously don't want to increase your leverage, but is there ever an ability to sell assets to private equity to kind of create more liquidity to go after that? Or it would it ever make sense to reduce the distribution to buyback units just given uniquely cheap trading levels. Just wondering how you think about those that gives and takes?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Well, I mean, you hit on the possible levers you can pull to increase buybacks. I think we don't want to compromise our balance sheet, and we won't compromise our balance sheet to buy back units, which doesn't mean leverage may not creep up a little bit while we're buying back units, but we're going to keep it well below the 4 times coverage target that we've always stated. The first thing that can happen is just business improvement over time, which will allow for more free cash flow to buy back equity. Selling assets is an option. We did that earlier this year. We sold our marine terminals, and we purchased units. We evaluate that on a case-by-case basis, and we'll continue to do that. And if we think there's an attractive arbitrage between a private market in our public trading value such that we can execute on that, we will. It's not a core strategy of ours, but we constantly look at it. With regards to cutting our distribution to buy back equity. That's not on the list at the moment. I'm never -- I'm not going to say it's never going to be on the list. We aren't planning to do that. I think investors may have different views to whether that's a good thing to do or not a good thing to do. At this point in time, we're not planning to do that. I'll just leave it at that.

Operator

Our next question comes from the line of Tristan Richardson with SunTrust.

Tristan Richardson -- SunTrust -- Analyst

Good afternoon. Just to build on the previous questions about buybacks versus leverage. I think on the last call, Mike, you mentioned that you guys don't necessarily have an interest in seeing the free cash flow production exclusively accrued in the balance sheet, and that there is some level where leverage becomes suboptimal. Is -- could you just give us a sense of kind of maybe where a floor is in leverage, where you might be underlevered or suboptimal from a capital structure perspective?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Well, we don't -- I really don't have a good answer for you on what we consider a floor for leverage. I mean we -- in this environment, we're in the low-3s, which we think is probably a good place to be given the volatility and the uncertainty in the market right now. So as you can tell, we do feel like, though, we can -- we've got some room around that leverage ratio to buy back equity. I mean, obviously, we're borrowing, we're not in a full free cash flow environment this year. I mean, we've got -- we're spending $400 million on growth capital this year, which exceeds our excess cash. And so incremental equity purchases are increasing leverage. So we're doing a little bit of that, but we're being very, very careful in that regard. You're certainly not going to see us just ramp right up to a 4 times level just because we've got room up to our target. We may do that over time if we're in a much more stable environment, but it doesn't feel practical to take that big of a step in the current market.

Tristan Richardson -- SunTrust -- Analyst

Great. Very helpful. And then just one quick follow-up on the BridgeTex side, I think over the past couple of quarters, you guys have talked about customers with previously earned credits. I guess just at a high level, could you talk about bank credits and expiration. Do credits expire over kind of a near to medium-term? And then I guess, could you see that dynamic continue into future years just from previous eras where volumes were higher?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Well, I'll answer just generally. I mean first of all, credits do expire over time, obviously, to the extent customers are using credits in current periods, they haven't expired. But those credits are not -- can last into perpetuity. I don't have the schedule in front of me as to when those credits are going to be exhausted, but it's getting close to that point where those credits are going to be exhausted.

Operator

Our next question comes from the line of Spiro Dounis, Credit Suisse.

Spiro Dounis -- Credit Suisse -- Analyst

Mike, you mentioned the expectation for capex to be roughly $100 million next year. Any sense on what the return profile of that capex looks like? Is it in your typical historical range? Or has this -- these projects been subjected to a higher return threshold?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

We're holding the majority of our project evaluations to a higher threshold right now. And that's partly why that capital budget is expected to be as low as it is, it's because of that. So we're going to be very careful with capital deployment. We're going to -- we're requiring -- and it's not just what's the expected capital earned, it's the certainty of that, that we're also focused on. So I mean it's very clear to us that this is not an environment to be speculating on capital projects. And we're not intending to do that. And just to be clear, on the $100 million number, that's potential. I want -- I'm trying to be clear in my comments that approved projects are only totaling $40 million for next year. The $100 million is if we approve some of these incremental projects, which we haven't done yet. So they may or may not happen. But we're going to be very focused on high-return, low-risk projects.

Spiro Dounis -- Credit Suisse -- Analyst

Understood. Appreciate the clarification there. Second question is just on the FERC. You talked about entering into some buy-sell agreements on the affiliate side. It looks like the FERC is maybe looking to provide more guidance there on affiliate contracts, specifically when it comes to regulated liquids pipelines. I know that topic is close to you, can you guys talk through some of your views on what the FERC has proposed so far and any potential impact to the industry?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Well, the FERC, if you're talking about the recent notice for comment, it's really focused only on affiliate contracts for new construction. And we are -- I don't really want to get into all our comments on that, we're going to follow our comments here when they're due. I think generally speaking, the commission's thinking the right way about how affiliates contracts should be addressed, and we're going to provide that supporting comments in some area and maybe clarifying comments in other areas. I do want to be clear, though, that, in our case, our buy-sell activities are occurring only on intrastate pipelines, not interstate pipelines. So they're not under FERC jurisdiction.

Operator

And the next question is from Theresa Chen from Barclays.

Theresa Chen -- Barclays -- Analyst

First, Mike, can you provide some color on live demand data points across your areas of service, given the recent uptick, especially in the Mid-Con?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Well, I think there's a couple of things here that we look to. And one is our rural markets. And as I mentioned in the comments, our rural markets are essentially back to pre-pandemic levels. And that is, I think, attribute to the fact that most of the folks in the rural markets have been less impacted by COVID-related restrictions and shutdowns. And you also have their portion of the economy that needs to continue to run. I mean we serve a very heavy agricultural area. And so the activities around planting crops, harvesting crops and all the logistics associated with that have continued through the pandemic. If we look at our larger metropolitan areas, in the states we serve, I think the level of restrictions have generally been lower than the coasts, for example, the West Coast or the East Coast.

And so therefore, you've had more economic activity in those areas, even though our largest reductions in demand are in the urban areas, I think those reductions are still less than what you've seen in major metropolitan areas, as I said, on the East and West Coast. And to be clear, with regards to our guidance, I mean, our guidance is really just a continuation of what we've seen in the last couple of months. So we're not projecting an improvement in demand from what we've seen, say, in September and October, we're really projecting and forecasting it to be flat. And we wanted to be clear on that, too, because we haven't built into the guidance a risk of a significant segment walk down, which we aren't anticipating, and we're not hearing any rumors of that in the markets we serve. But it certainly is still something that's possible.

Theresa Chen -- Barclays -- Analyst

Understood. And following up on one of the earlier questions related to the upstream consolidation, can you talk about the potential impact it may have on your supply push assets just given the recent acceleration in consolidation among the producers. And if not immediate, given your minimum volume commitments across many of your pipes, longer term, does this change anything?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Well, I think -- I mean, first of all, you're right, it doesn't have an impact on us short-term since we're contracted -- substantially contracted with credit-worthy parties. Long term, again, I would not expect it to really change the dynamics, and the level of production is going to be what it is in the future, whether these entities have combined or not. To the extent we have healthier entities that are operating in the Permian in the future, and these combinations create healthier companies, so I think that's just a net positive. But trying to project at the expiration of the contracts what the potential impacts of these combinations might have, specifically on movements in our pipeline, it's very difficult today. We really look at it from a macro standpoint, what's the production in the Basin?

Where does it want to go? And again, we feel like we're in a very strong position with pipes going to Houston, which is both a demand and an export center. And I think if you just look at some of the trends that are expected with Permian Basin crude oil to continue to grow slightly over the next few years and production in other basins, outside the Permian to perhaps flat line or decline, that to have more Permian barrels want to go to Houston to replace those physical barrels over time. So we feel like we're in a good position from a macro standpoint. And so I'll leave it at that.

Theresa Chen -- Barclays -- Analyst

Got it. And lastly, just on the heels of your sustainability report and thinking about your assets and potential projects over the long term, how can Magellan participate in the energy transition?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Well, there's a couple of short-term things we're focusing on. The most relevant to us in the short term is renewables -- liquid renewables, like ethanol and biodiesel and renewable diesel. And we're actively evaluating expansions in all of those areas with regards to blending. Most of the ethanol blending -- well, I should say, all of the ethanol blending occurs at the terminals. So we're looking at our capabilities to expand that. Biodiesel blending today happens at the terminals. We're looking at projects to be able to blend it into the diesel stream in the pipe, which will create more efficiencies and create more transportation revenue for us. And we're also looking at the opportunities around renewable diesel. Those are more longer dated. There's really no renewable diesel that's consumed in the Midwest.

That can change over time, and we're going to be positioned to take advantage of that. We also are actively working on improving our purchase of renewable power that's coming from renewable sources. The indirect energy transition effect, but we're looking into that. When you start looking at things longer term, there's really nothing actionable there, but we've started the work to determine what are the capabilities of our assets with regards to hydrogen transportation and those sorts of things, so we understand the opportunity and we can prepare for it if it's available. But those are certainly not short-term or near-term opportunities for us.

Operator

Our next question comes the line of Shneur Gershuni, UBS.

Shneur Gershuni -- UBS -- Analyst

Just a few clarification questions for me here, first off, I'd like to respond to, Tristan in terms of how you're top line with leverage. And I just want to make sure I understood that is that you're willing to be modestly free cash flow negative in terms of deploying on a buyback if it maybe is there as long as the leverage is in check, is that a fair way to characterize your response to him?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

I think that's a fair way to characterize it.

Shneur Gershuni -- UBS -- Analyst

Perfect. Okay. And then secondly, on the capex front, you talked about the potential to FID about $100 million worth of incremental projects at this stage. I guess two questions here. One, just to clarify, was that $200 million previously, now it's $100 million? And then secondly, I recognize that you need to have contracts, and you -- your response to Spiro not wanting to deploy -- be careful in deploying capital in this environment, what are the signpost steps we need to be thinking about from a macro perspective? Is it a congestion return rigs? Or kind of the sign points that you're looking for as well also?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Well, first of all, on your first question, our current capital plan for 2021, it's $40 million. And if we approve what we expect is likely to be approved from the backlog of projects we're working on, then the total for 2021 would be roughly $100 million. So it's an incremental $60 million of projects we're talking about. I'm not sure where the $200 million number you mentioned came from. But those are the numbers that we're looking at. With regards to your second question, I mean every project is different, and the variables around it are different with regards to the returns and the risk, some of those contracts -- I mean, some of those projects, we would secure or eliminate the risk by -- contractually. There's other projects where the economics are really within our control. For instance, we have projects that would improve the logistics costs around our blending business.

So if we have a facility where it costs $0.15 a gallon to get butane into the facility so that we can blend it, and we have a project that can lower that cost of $0.05 a gallon, well, that's locked-in economics. I mean we don't have to contract for that. We know that we can capture it by improving logistic structure. And when I say that, that would be something like moving to a pipe rather than trucking, so that we know that the cost structures are absolutely would improve. So those are the kinds of things we're looking at.

Shneur Gershuni -- UBS -- Analyst

Okay. Yes. My question around the $200 million is more what you were evaluating? I recognize that you had only FID previously. And then maybe just to continue on here, just you gave some interesting comments about costs about how you started to plan last year, identified $35 million. If I heard correctly, you felt you could execute $25 million this year, which would mean an incremental $5 million would probably show up next year. And then you've identified another $20 million that would come into place over the next two years for a total of $50 million from your starting point. Is that -- did I get that right? I just wanted to clarify that.

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Yes. That's accurate.

Shneur Gershuni -- UBS -- Analyst

Okay. And then just one final question here. You've opened up the pricing for your hubs and so forth. I was just wondering if you can give us some color around that? And whether there's an opportunity -- whether there's some third-party opportunities there for you? If you can give color on that?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Well, there are some opportunities. And for everyone on the call, correct me if I'm wrong, I think what you're referencing is that we've opened up our -- trading our pricing point in East Houston for crude oil to third-party pipelines. And yes, that is creating incremental opportunity for us through. We've already captured some incremental, and it's going to be happening -- so much happened in the third quarter, but will in the future incremental volume on our distribution system associated with that. But the long-term goal is to continue to grow the benefits of that pricing point to the market, such that it drives incremental volumes and storage opportunities on our system. That's where we get the benefit. It's not really through the pricing through the contracts, it's the more effective and the more customer-friendly and the more useful that we can make that contract, the more liquidity -- physical liquidity we'll have in our system.

Operator

Our next question is from Keith Stanley with Wolfe Research.

Keith Stanley -- Wolfe Research -- Analyst

I wanted to ask about just potential regulatory strategies as we move through next year, just -- I guess you guys are forecasting refined products volumes still down double digits next quarter. So say we have a bearish case, where volumes stay well below normal through next year, so prolonged status quo. Under that scenario, would you look more closely at filing a rate case at FERC next year? Or how can we think about the criteria or time line when you'd say, OK, we need to file a rate case at this point? And then separately, just curious any updates on the FERC process and potential to seek recovery of some of the impacts from this year on volumes?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

So to address the first part of your question, as a reminder, about 2/3 of our markets are market-based, So we have the ability to increase rates in those markets without making a cost of service filing. And so in those markets, if our cost per barrel mile is not being reflected or increase in costs in barrel miles are not being reflected in our tariff, then we have the ability to increase our tariffs to offset that as we need to. The other 1/3 mark of our markets are indexed, first regulated at the index level. And so to do something different than the index, we'd have to file a cost of service rate. We are evaluating that. It's really too early to pull the trigger on that. We're not planning on filing a cost of service rate for 2020. So it's really a matter of what does 2021 actually look like. And is the deficiency in income at such a level that we are incented to file a rate case. I think it's possible that happens. It's not a certainty. We're preparing for that. We haven't been in a rate case, fortunately, since we've been in existence. These assets, we're in a rate case under the previous owner, Williams, and some of us had experience with that, and it's not something you take lightly.

It's a large endeavor to initiate a rate case. We're not opposed to doing it if we think that the benefit is worth it. And we're preparing now so that we can do that and have all of the processes in place to support one if we feel like we need to. But we're not really at a point to make a decision on that right now. On your last question, we're really waiting to see how the entire year looks with regards to cost recovery. What we found is, and you back up a little bit, a large percentage of our index markets are in rural areas. And as I mentioned, those areas have come back to essentially pre-pandemic levels. So the cost recovery there is really only relevant for a few months during the summer when we were really at the depths of the disruption of demand. And so we haven't made a final decision on whether we build it toward making the filing for the -- for that recovery because that number is turning out to be not as large as we thought it was. But we haven't made any final decisions on that yet.

Keith Stanley -- Wolfe Research -- Analyst

That's very helpful. And I'm sorry, I'm going to ask a similar question, which is, on the market-based rate side for refined products, how can we think about how sensitive the market is to larger rate increases if volumes stay very low through next year? I know you guys raised the rates, I think, 4.5% for those systems midway through this year. I mean would you expect competitors to also seek larger rate increases? Or Do you think the market will be competitive and it's tough to raise rates more than, say, 4% or 5%? Or is that a possibility if volumes stay very low?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Well, it's -- I mean our experience to date since we've had market-based rate locations, is that we've been able generally to increase the rates to compensate us for our increased costs. And when I say cost, it's really not cost, it's cost per barrel mile. Because a large percentage of the operating cost of a pipeline is fixed cost, which has to do with integrity costs and those types of things, which don't fluctuate with how much volume you move. So if you're moving less volume, your cost per barrel miles have gone up. I don't have any reason to believe that our competitors are more cost-effective than we are, such that I would think they would have the same cost per barrel mile experience that we do. And so they should have the same incentive to raise their rates. I can't tell you whether they will or not, but our expectation is that, that's what most likely would happen over time. And now, if it doesn't, obviously, we'll have to adjust. But our expectation, and I think the rational market response would suggest that that's what's going to happen.

Operator

Our next question is from Praneeth Satish with Wells Fargo.

Praneeth Satish -- Wells Fargo -- Analyst

I'm wondering if you've had any discussions to potentially merge pipelines in the Permian, basically shut down a pipeline and moved the volumes onto another under a JV structure. And I guess more broadly, is this a strategy that you think the industry could pursue?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Well, I really can't answer the first question, even if we were in conversations. I can tell you that we look to optimize our pipes all the time. And we're not opposed to talking to third parties about combinations that make sense. And I think that there may be a time when those combinations will happen or pipes are repurposed, that's probably all I can say on that.

Praneeth Satish -- Wells Fargo -- Analyst

Okay. And then on Longhorn, I understand the marketing group is taking some of the space and the tariff will approximate, I guess, the spread between hubs. But I'm wondering if you could comment on what your variable operating cost is per barrel, so I guess we can get a sense of maybe what the minimum spread is that's required to utilize this space and start moving the barrels?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Well, I mean, there's a range of variable operating costs depending on how fast the pipe is moving, whether it's near capacity or whether it's not near capacity. So those numbers are all over the board. I think that the range, which -- I can give you a range, but it's not going to be helpful because it's a big range. But I mean, I can tell you, the differential from Midland to Houston today, I think, was $0.50 a barrel. That's pretty low. And that $0.50 a barrel is within the range of variable operating costs for some pipes at some flow rates. So it's right now on the margin -- low margin opportunity at the current differentials. But I don't want to culture to a specific variable operating cost because there's such a big range. And when I say that, I'm talking like $0.15 a barrel to $0.90 a barrel. So it's -- I mean, it's a big range, and any specific pipe could be somewhere in that range at any point in time. So I don't know that, that would be really helpful for you, since you'd have to know pipeline specific, and I'm not going to quote our pipeline specific numbers.

Praneeth Satish -- Wells Fargo -- Analyst

No, I think that helps just to get a sense of it and just to understand based on the current spread.

Operator

Next question is from Michael Lapides, Goldman Sachs.

Michael Lapides -- Goldman Sachs -- Analyst

I actually have two. One is, I think it's probably for Jeff. Just want to make sure I understand what your commentary about operating costs and cost reduction for the next couple of years are. I mean if I just look at year-to-date or nine months G&A expense, that's down, I don't know, $32 million, $33 million or so. Are you expecting further savings on that line this year? And could you see that go down further in '21 or '22? Or will some of that come back? And then if there are other cost savings kind of in the operating cost bucket, how material do you think those could be? I'm just trying to parse it out a little bit between G&A versus kind of field OpEx.

Jeff L. Holman -- Senior Vice President, Chief Financial Officer and Treasurer

Some of that, Michael, is a function of this year. And so G&A is a good example with lower results. We're going to have a lower comp expense sadly. So That's a big part of the variance there, which we would not necessarily project or hope to project into the future going forward. There are some savings in G&A as part of our optimization efforts. But It's really, as Mike described more on the operations side, so power and DRA efforts, and then also just optimization of our procedures and processes kind to be more efficient at things, and we're finding a lot of opportunities for that. Some of those are revenue, some of those are margin, some of those are op expenses. There's a little G&A in there, but it's primarily on the operational side.

Michael Lapides -- Goldman Sachs -- Analyst

Got it. And then so -- is what you're saying, because like operating expense for the year, down $27 million or so year-to-date. Are you saying you think you can take another $20 million or $30 million out by the time you get to 2022? Am I understanding that correctly? Or does some of it come back and then come out?

Jeff L. Holman -- Senior Vice President, Chief Financial Officer and Treasurer

Yes. We're saying we think we can save -- we expect to see from our optimization efforts, so we're in area of $25 million this year, and we can be up more in that $50 million in a couple of years. Some of the savings, if you just look at expenses year-to-date to savings, some of those are related to the activity this year. I mean just there is some correlation between throughput activity and operating expenses as well. So when you have an off year like we've had this year, there's a little bit just like operating business as well. So you have to be a little careful extrapolating year-to-date this year. Instead, we try to isolate that $25 million of optimization that we expect to see in 2020, and seeing it grow into that $50 million. And we continue to work on that, and we continue to look for as many opportunities as we can find. Mike alluded to the fact that we've always been lean, but we are trying to take this lower capital environment and focus on efficiency, and we're seeing the fruits of that.

Michael Lapides -- Goldman Sachs -- Analyst

Got it. And my one question, just when you and the Board think about the M&A environment, right? Because when industries are going through difficult times, one of the ways to improve things is to use M&A as a tool to reduce costs. But when you look across the different asset types and different businesses within midstream energy, are there ones you look at and say, "You know what? That's a business type that kind of fits what my risk return metrics would look like." Versus others, would you say, "you know what, that's just -- I mean, maybe at some crazy low price. But in general, that's just a lower-quality business and it would dilute my return on capital or kind of match my risk return metrics and therefore, kind of thanks, but no thanks." I'm just trying to think about what are the asset types that you kind of think about as, hey, that's off the table versus, hey, you know what? We would look at and consider it, but obviously, M&A is hard and price depend and all that, but these are asset types that would fit within our mill?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Well, that's -- I mean, I think you described exactly how the process works. I mean there are peer companies that are more like that. And when I say more like that, these have stable primarily fee-based businesses with less volatility that would be more attractive to us than, say, a business that's entirely commodity sensitive, just to use the two extremes. Now that doesn't mean we won't look at both businesses, but the hurdle for us to be interested is much higher on higher variability business. And generally speaking, if a business is more like us from the business mix, you typically are going to have higher opportunities for cost savings because you're doing similar things and you don't need to duplicate that, whereas if it's a very different business, that you're buying, for example, a processing business versus a pipeline business, well, You need the whole skill set, you need to keep the whole skill set of people who know the processing business so there's less efficiency and less opportunities for cost savings.

So all those things go into the evaluations. Generally -- but those are just part of it. I mean you also have balance sheet issues. you have corporate structural issues, you have the geographic location of the assets. I mean all of those things go into it. And so the short answer is, I mean, there are companies who are more interested than others, and there's companies who were less interest than others that we don't think would be a good fit, and some that we think would be a good fit. So that's how where we spend most of our time when we're evaluating this. So I think I just agreed with what you just said. I just said it a different way.

Michael Lapides -- Goldman Sachs -- Analyst

No, understood. I appreciate it, Mike. Thank you.

Operator

And our last question comes from the line of Derek Walker, Bank of America.

Derek Walker -- Bank of America -- Analyst

Most of my questions have been answered, but maybe I'll just ask a couple of quick ones. In the press release, you mentioned sort of this target distribution cover at least 1.2 times, once refined products demand and commodity prices stabilize or return to historical levels. Is that an event that you see happening some time in '21? Is that sort of back half '21? I guess how should we think about some of that commentary from your perspective?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Well, I mean that's -- I mean, essentially, you're asking for 2021 guidance, which we're not prepared to give yet. I mean when I just look at the landscape right now, that's a tough question to answer. I mean, I think 2021 still has a lot of uncertainty. One, is there a vaccine going to be available? One, is it going to be widely dispersed? When are people going to feel comfortable going back to their normal lives and the normal mobility. We're going to build a view on that when we provide our 2021 plan. But as probably is true with anyone who builds a projection with that, it's going to be subject to a lot of assumptions. And when you make that many assumptions, you probably aren't going to get them all right. So I'm not prepared to give you an answer on that today. I think -- what I would say is, at some point, we will be back to normal. And so when we talk about that in the context of what's in the press release, We're talking about that some time. I don't know if it's -- right now, if it's next year or if it's 2022, and at some point, we will be, but we'll have more color on that when we give guidance in January.

Derek Walker -- Bank of America -- Analyst

Got it. And then maybe just last, just a clarification point. Mike, you talked about sort of the rural areas being kind of back to pre-COVID levels, and urban areas still feel the impact. So as far as the fourth quarter numbers that you referenced, should we think about those as really just being in the urban areas as far as the quarter year-over-year numbers?

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

No. Those are total numbers, because -- I mean -- so essentially, what you can read into that is the urban areas are doing worse than the numbers we're providing. And it's being offset by the rural areas back at the current level. So those are total numbers. And again, I'd reiterate those numbers are essentially what we're seeing right now. I mean, so we're not expecting improvement in the fourth quarter from what we've seen or experienced, say, in September and October, we're expecting it to stay the same. But those are our actual -- kind of our actual range right now. And so I hope that answers the question.

Operator

And Mr. Mears, those are all the questions we have. I'll turn it back over to you.

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

All right. Well, thank you, everyone, for your time today, and we appreciate your continued interest in Magellan, and we will talk to you soon.

Operator

[Operator Closing Remarks]

Duration: 38 minutes

Call participants:

Michael N. Mears -- Chairman of the Board, President and Chie Executive Officer

Jeff L. Holman -- Senior Vice President, Chief Financial Officer and Treasurer

Jeremy Tonet -- JPMorgan -- Analyst

Tristan Richardson -- SunTrust -- Analyst

Spiro Dounis -- Credit Suisse -- Analyst

Theresa Chen -- Barclays -- Analyst

Shneur Gershuni -- UBS -- Analyst

Keith Stanley -- Wolfe Research -- Analyst

Praneeth Satish -- Wells Fargo -- Analyst

Michael Lapides -- Goldman Sachs -- Analyst

Derek Walker -- Bank of America -- Analyst

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