Genesis Energy (GEL) Q1 2022 Earnings Call Transcript

Genesis Energy (GEL -1.84%)
Q1 2022 Earnings Call
May 04, 2022, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Genesis Energy LP first quarter 2022 earnings call. [Operator instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Dwayne Morley, vice president, investor relations for Genesis Energy. Thank you.

You may begin.

Dwayne Morley -- Vice President, Investor Relations

Good morning. Welcome to the 2022 first quarter conference call for Genesis Energy. Genesis Energy has four business segments. The offshore pipeline transportation segment is engaged in providing the critical infrastructure to move oil produced from the long-lived, world-class reservoirs from the deepwater Gulf of Mexico to onshore refining centers.

The sodium minerals and sulfur services segment includes trona and trona-based exploring, mining, processing, producing, marketing, and selling activities as well as the processing of sour gas streams to remove sulfur at refining operations. The onshore facilities transportation segment is engaged in the transportation, handling, blending, storage, and supply of energy products, including crude oil and refined products. The marine transportation segment is engaged in the maritime transportation of primarily refined petroleum products. Genesis operations are primarily located in Wyoming, the Gulf Coast states, and the Gulf of Mexico.

During this conference call, management may be making forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934. The law provides safe harbor protection to encourage companies to provide forward-looking information. Genesis intends to avail itself of those safe harbor provisions and directs you to its most recently filed and future filings with the Securities and Exchange Commission. We also encourage you to visit our website at genesisenergy.com, where a copy of the press release we issued today is located.

Press release also presents a reconciliation of non-GAAP financial measures to the most comparable GAAP financial measures. At this time, I would like to introduce Grant Sims, CEO of Genesis Energy LP. Mr. Sims will be joined by Bob Deere, chief financial officer; and Ryan Sims, senior vice president, finance and corporate development.

Grant Sims -- Chief Executive Officer

Thanks, Dwayne, and good morning to everyone, and thanks for listening in. As we stated in our earnings release this morning, the first quarter of 2022 was an exciting quarter for Genesis as the performance of our market-leading businesses exceeded our internal expectations. Strong demand for soda ash drove increased prices in all of our markets, especially the export market, and we're starting to see activity levels in the Gulf of Mexico begin to ramp with first production from Murphy's King's Quay starting last month and first volumes from Argos just around the corner. We continue to see fundamentally driven momentum in our soda ash business, which when combined with the expected ramp in volumes on our Gulf of Mexico infrastructure will continue to drive earnings growth and improving leverage metrics over the remainder of 2022 and into the years ahead.

I wanted to take this opportunity to provide an update on the new opportunities in the Gulf of Mexico that we have mentioned over the past several quarters. Today, I'm excited to announce that we have entered into definitive agreements to provide gathering and transportation services for 100% of the crude oil production associated with two brand-new stand-alone deepwater upstream developments with a combined production handling capacity of some 160,000 barrels of oil per day, with first oil from both expected in the late 2024 or early to mid-2025 time frame. In conjunction with these new upstream developments, we expect to spend approximately $500 million net to our ownership interest spread out over the next three years, expanding the capacity of the CHOP system as well as building a new 100% owned, approximately 105-mile 20-inch diameter pipeline, what we call the SYNC pipeline to connect one of the upstream developments to our existing footprint. Both of these new upstream developments include life-of-lease dedications to our assets.

Additionally, they both include long-term take-or-pay arrangements that represent a roughly five times build multiple on a combined basis, which multiple would be closer to four times if the producers hit just 75% of their expected production profiles. It's important to recognize that these calculated multiples assume absolutely 0 other production or additional developments ever being tied into SYNC or CHOPS, which is totally unrealistic. In fact, we are already in early discussions with the operators of several additional new opportunities, representing potentially some 150,000 barrels a day of incremental production, which more likely than not will seek to access at least a portion of this new capacity starting as early as 2024. These volumes are newly identified subsea tiebacks or secondary recovery operations like waterflood projects designed by the operator to increase and/or extend the production handling at existing stand-alone developments already connected to or that can otherwise access our pipelines to shore.

We are also currently aware of at least one new stand-alone development that if ultimately sanction could potentially come our way. Our new 100% owned SYNC pipeline will connect the Walker Ridge area of the Gulf of Mexico directly to the CHOP system and the Garden Bank 72 platform with the Shenandoah development serving as the anchored production facility. The Shenandoah project operated by BOE exploration production is located in Walker Ridge Blocks 51, 52, and 53 and we'll have production handling capacity of approximately 100,000 barrels per day with first deliveries of oil anticipated in late 2024 or early 2025 and will be further transported to shore through our 64% owned CHOPS pipeline. The second upstream development, Salamanca, is operated by LLOG and located across multiple blocks in the deepwater area of Keathley Canyon with an expected production handling capacity of approximately 60,000 barrels per day and first deliveries of oil anticipated in early to mid-2025.

The Salamanca development will be directly connected into our 100% owned SEKCO pipeline for further transportation downstream through our existing pipeline footprint. As we alluded to in our release, we have also entered into an agreement with LLOG to sell our idled Independence Hub platform to service the floating production system for the Salamanca development. The repurposed hub will not only accelerate the date of first oil and reduce the total development cost but will also reduce the environmental footprint of this development relative to the option of constructing a new deepwater production facility. A win-win situation for the producers and us.

The sale of the Independence Hub platform for gross proceeds of $40 million will result in a gain in a cash distribution of $32 million net to our 80% ownership interest. These proceeds, when combined with the gross proceeds of approximately $418 million we received from the sale of a 36% minority interest in the CHOP system, have effectively allowed us to prefund the vast majority of the capital required to expand the capacity of CHOPS and construct the SYNC pipeline. We would expect to use increasing cash flow and availability under our senior secured credit facility to fund the capital expenditures over the next few years. In addition, we will receive project completion credit associated with the capital we spend over the next several years under our calculated leverage ratio for bank compliance purposes.

These two new upstream developments, along with the SYNC pipeline and CHOPS expansion represent a tremendous opportunity for Genesis. We are able to deploy capital at an extremely attractive multiple that is underpinned by life-of-lease dedications and creditworthy take-or-pay arrangements much the same as our very successful SEKCO pipeline, which was constructed some 8 years ago. And it, quite frankly, has already contracted two additional fields that were unknown at that time. By extending our reach geographically in the Central Gulf of Mexico and adding capacity to the CHOP system, both of which have effectively been underwritten by these two anchor developments, Genesis is well-positioned to attract high-margin incremental volumes to our industry-leading network of offshore pipelines at little to no future capital ever required.

I'd also point out that the realized margins per barrel, both on our laterals and on the Poseidon or CHOP systems are increasing as we facilitate the gathering and transportation to shore from the very active Central Gulf of Mexico deepwater areas as pipeline capacity becomes a dramatically more scarce commodity. We believe and have demonstrated it time and time again that these types of investments will provide long-term value to all of our stakeholders for many, many decades to come. Now, I'll touch briefly on our individual business. As we mentioned in our earnings release, the first quarter was challenging in our offshore business from an operational and mechanical point of view.

In fact, relative to our expectations, we would estimate that quarterly margin in the first quarter was negatively affected by some $8 million. Most, if not all, of the issues we experienced have since been rectified in the second quarter so far is reflective of more normal and expected operations. There is no doubt that the rest of 2022 will be exciting for us in the offshore. On April 12, Murphy announced that they achieved first oil at their King's Quay floating production system, which is supporting their Khaleesi, Mormont, and Samurai field developments in the deepwater Gulf of Mexico, and we have started to receive these volumes on our pipelines.

Volumes from Kings Quay are expected to ramp to its design capacity of some 85,000 barrels per day and 100 million cubic feet of gas per day as incremental wells are connected in the coming months. As a reminder, we will handle these molecules some four times with all of the oil produced, being gathered through our 100%-owned Shenzi lateral and then split evenly between our 64% owned CHOP system and our 64% owned Poseidon system for transportation to shore. In addition, all of the associated gas production will flow on our 100% owned Anaconda gas gathering system and then on our 26% owned Nautilus gas system for ultimate transportation to shore. The second major project we expect to come online this year is BP's Argos floating production system, which is supporting their Mad Dog 2 development and remains on track for first oil in the third quarter.

With a large number of wells predrilled, volumes from Argos are expected to ramp to its nameplate design capacity of 140,000 barrels per day over the subsequent six months or so after the date of first production. King's Quay and Argos, combined with Shenandoah, Salamanca, and the newly identified opportunities I referenced earlier, all coming on within the next four or five years represent a tremendous runway of additional growth in volumes and importantly, significant incremental financial performance that we expect to see from our Gulf of Mexico franchise in the coming years. Turning to our sodium minerals and sulfur services segment, we continue to see robust demand for soda ash across the globe and specifically in our export markets. The market for soda ash worldwide remains very tight and is leading to strong soda ash pricing in all of our markets.

We are starting to see the real effects of strong demand and soda ash supply being impacted by a net decrease in global supply we mentioned last quarter when a 1.3-million-ton synthetic production facility in China closed at the end of 2021. According to our analysis as well as third-party reports, for the global supply and demand of soda ash to balance, the market requires China's installed synthetic production capacity to operate at a roughly 95% to 96% rate. Historically, China has only operated at around a 90% rate. In January and February of 2022, Chinese operating rates dropped to some 83% and 84%, respectively.

As a result, the worldwide market is even tighter than what we would have otherwise expected. I'd also note that the situation in Ukraine is not overly relevant to the world's soda ash market, and we have no direct exposure to such terribly unfortunate situation. We do, however, continue to monitor geopolitical events and recognize there could be a slowdown in economic activity worldwide, especially as measured against recent periods where the world was recovering from the policy decisions made during the height of the COVID pandemic. However, it is our view that it would take a heretofore unidentified black swan event to significantly much less materially affects the current and forecasted supply and demand dynamics for soda ash.

These fundamentally driven market conditions, coupled with the rise in energy input costs and increasing awareness of the environmental footprint of synthetic production provide, we believe, a very constructive backdrop for soda ash pricing for the remainder of this year. We would expect these conditions to continue over the near to intermediate-term and importantly, still be in place as we discuss redeterminations for 2023 prices toward the end of this year. Should these conditions hold, and as I said earlier, we believe it's more likely than not that they will. We would reasonably expect to see prices increase another $10 to $15 per ton across all the tons we sell even after taking into account our multi-year arrangements that often contain caps on annual increases.

We remain very excited to restart our original Grainger production facility, and it's roughly 500,000 tons of annual production in the first quarter of 2023. Furthermore, our Granger expansion project representing an incremental 750,000 tons or so of annual production remains on schedule and on budget for first production in the third quarter of 2023. We continue to believe the expanded Granger facility and its incremental 1.2 million to 1.3 million tons per year will be the most significant addition of new natural baseload supply to the market for several years to come. Assuming prices remain at least where they are today or quite frankly, even if they pull back sub, we would expect that the Grainger project will exceed our original forecast for incremental segment margin once fully ramped and online.

On the cost side, we have a fair amount of tools already in place to be able to largely maintain our margins per ton sold. Approximately 75% of our existing contracts have a natural gas surcharge already in place, and we will move to 100% as contracts allow and are reopened. We have also hedged a significant amount of our fuel requirements for at least 2022 that aren't already covered by such contractual surcharges. 100% of our export sales have a bunker fuel surcharge.

Through ANSAC, we have a very high percentage of our dry bulk transportation costs contracted under favorable terms for the next year or so. And all of our competitors face the same increases we will ultimately face, all of which will ultimately be passed on to and paid by the retail consumer. Our historical refinery services business exceeded our expectations as the demand for our sulfur-based products was quite strong as copper and corrugated paper markets remain robust. Both our marine and onshore facilities and transportation segments continue to show improvements.

Market conditions in our marine transportation segment continued to improve across all classes of vessels as the volatility in crude oil and refined product imports creates opportunities. At the same time, there is continued tightening in overall supply and demand of both the blue and brown water fleets. We remain excited with the trajectory of our marine business and would expect market conditions to continue to improve throughout the remainder of 2022 and into 2023 as the industry deals with net tonnage retirements and rapidly inflating replacement costs. We continue to see -- expect to see increasing volumes at our onshore terminals and pipelines in both Texas and Louisiana over the remainder of the year as new volumes in the Gulf of Mexico from both King's Quay and Argos come online and need to be further transported to refineries and market demand centers along the Gulf Coast.

In addition, the new developments we announced this morning with an expected first oil in late 2024 and into 2025 will potentially add volume growth to these onshore assets in the years ahead. During the quarter, we were also successful in extending our agreements with our main customer in and around our Baton Rouge terminal. The agreements provide a framework for future activity, which further reinforces the integration of our assets into their future operations and plans. The robust outlook for Genesis over the remainder of the year remains unchanged as our businesses continue to demonstrate their resiliency.

New volumes in the Gulf of Mexico, combined with strong pricing in our soda ash business and a recovery in our Marine segment highlights the tremendous operating leverage we have to overall improving market conditions. As we sit here today, we would reasonably expect our 2022 financial performance to come in toward the high end of our previously announced segment margin and adjusted EBITDA guidance range of $620 million to $640 million and $565 million to $585 million, respectively. Even after the challenging first quarter in our offshore operations discussed earlier. Furthermore, our guidance does not include the gain and cash distribution proceeds from the sale of our interest in the Independence Hub platform as discussed earlier.

That $32 million gain will be additive to both segment margin and adjusted EBITDA in the second quarter of 2022 and will be included in our bank leverage ratio as calculated in accordance with our senior secured credit agreement. As a matter of fact, had we completed the sale of the Independence Hub platform by March 31, our calculated bank leverage ratio would have been 4.79 times or some three-tenths of a turn lower than what we recorded for the quarter. In any event, this gain will be included in our financial results next quarter and will stick with us for both covenant compliance and pricing purposes under our senior secured revolving facility through the first quarter of 2023. The management team and board of directors remain steadfast in our commitment to building long-term value for all of our stakeholders, and we believe the decisions we are making reflect this commitment and our confidence in Genesis moving forward.

I would once again like to recognize our entire workforce for their efforts and importantly, their unwavering commitment to safe and responsible operations. I'm proud to be associated with each and every one of you. With that, I'll turn it back to the moderator for questions.

Questions & Answers:

Operator

Thank you. [Operator instructions] Our first question comes from the line of Kyle May with Capital One Securities. Please proceed with your question.

Kyle May -- Capital One Securities -- Analyst

Hi. Good morning, everyone. 

Grant Sims -- Chief Executive Officer

Hi, Kyle.

Kyle May -- Capital One Securities -- Analyst

Grant, appreciate all the prepared remarks about the current state of the business. Maybe just to start things off, you indicated that Genesis is trending toward the high end of your guidance for the year. Just wondering if you can provide any additional insight into maybe which aspects of the business are performing better than expected and kind of where you see that outperformance shaking out?

Grant Sims -- Chief Executive Officer

Well, I think, clearly, the soda ash business massively outperformed our expectations in the first quarter. And I think that certainly, given our prepared remarks around our view of what pricing is for second quarter and the rest of the year based upon fundamentals in the worldwide marketplace that we would expect that to continue. I mean if you just look at -- if you just annualize the first quarter result, I think you get to $575 million or so. And again, let's make sure that we're -- it excludes the $32 million gain.

But as we continue to see the ramp in the Gulf of Mexico and get the operational mechanical hiccups behind us, I think that it's more likely than not as we -- when we visit with you from 90 days from now that will widen the range and increase the range as we proceed, but through the year. So I think that quite frankly, all of the businesses even after the operational mechanical hiccups in the first quarter in the offshore are exceeding our internal expectations, and we hope to be able to share that with everyone as we progress through 2022.

Kyle May -- Capital One Securities -- Analyst

That's helpful. And you also mentioned, I guess, looking more specifically at the offshore business that roughly the impact you noticed in the first quarter was about $8 million. So I think that would have put you closer to $80 million with the segment margin in the first quarter. How should we think about that cadence going forward through the balance of the year with the -- I mean, I guess, can you provide any more granular detail about the cadence with those new projects coming on?

Grant Sims -- Chief Executive Officer

Well, that's -- again, I think, Kyle, your analysis is correct that on a normalized basis prior to King's Quay and prior to Argos that we kind of anticipated about an $80 million a quarter run rate as a normalized basis. And then obviously, we cut that back a little bit in the third quarter to take into account the potential interruptions from weather-related events in the Gulf of Mexico. So with that, we have, as we said, on April 12, the Murphy achieved first oil. I think it's out in the public domain in their investor presentation and earnings release that the first two wells are doing about 30,000 barrels a day, 90% of which -- 89% of which is oil.

And remember we get all of that because we take all of the gas also, there's another well imminent to come on and then a number of wells in cadence to come on every 40 days -- 45 days or so. I think, again, based upon their public announcements this morning. So you can do a little bit of the cadence of arithmetic associated with that as it ramps up. And again, in the prepared remarks, we tried to explain the value chain of we get 100% on the Shenzi lateral and then it's split evenly between the sidemen CHOPS on the oil side, and then we get 100% of the gas through Anaconda and then 26% as it goes to shore and round terms on the Nautilus system.

So that's a very important ramp for us throughout the year, and we're very excited about it. And at this point, I think it's, I can't speak for Murphy, but it's meeting our expectations of the ramp. And then Argos, Argos has a lot of wells predrilled. The data first delivery is we're not 100% certain of.

That's a better question for BP, but we had -- given that they've predrilled all of the wells, I think that we would anticipate a very rapid ramp in that. And as we said, potentially even achieving design capacity within six months once first of every start, but that's a little bit of an amorphous date, and we'll see when it all kind of shakes out. And I would certainly think that by the second quarter call, we'll have a better idea of what the expected first date is and can give a little bit more granularity around that.

Kyle May -- Capital One Securities -- Analyst

OK, great. Appreciate the additional color there. I'll turn it back.

Operator

Thank you. Our next question comes from the line of TJ Schultz with RBC Capital Markets. Please proceed with your question.

TJ Schultz -- RBC Capital Markets -- Analyst

Great. They, Grant. For the CHOP expansion and SYNC pipeline, what's the cadence on the $500 million spend? And when does the take-or-pay begin?

Grant Sims -- Chief Executive Officer

The cadence is -- there'll be a little bit front-loaded in terms of when it's kind of a bimodal spend, TJ, because there will be a little bit of capital in the front end as you acquire the materials, but the installation itself will occur really toward the end of the construction period in the late '23, '24 type time frame. So it's not necessarily linear, but a little bit lumpy, a little bit more upfront, and a little bit back loaded. And the take or pays basically begin in the late '24 time frame. But under our credit agreement or our discussion with the banks, we get project completion credit relative to that amount of take-or-pay that we have.

So in other words, at the point that we spend 10% of the $500 million, we get 10% of the value of the take-or-pay coming in as pro forma EBITDA, so to speak, in terms of calculating our compliance and where we are on the pricing grid under the senior secured facility.

TJ Schultz -- RBC Capital Markets -- Analyst

OK, make sense. And then on soda ash, you mentioned the market is tighter than you expected given in part to the fact that China capacity was running, I think, 83%, 84% at the beginning of the year. So is the expectation that this continues to run lower than, call it the 90% range heading into your redeterminations and that's supporting the view on the $10 to $15 per ton improvement. I guess I'm just really looking for what's mainly driving the outlook on the market to remain tight.

Is it more supply contraction or is it a demand growth story? Thanks.

Grant Sims -- Chief Executive Officer

Yeah. I mean it's a little combination of both. And as we said, even with a slight reduction or a reduction in economic activity in the back half of the year, we think that it's really primarily a supply story that is extremely tight. Inventories have been depleted.

There's been a couple of force majeure events by some of the domestic producers in the first half of the first four or five months of the year that have again reduced available inventories. And so we think it's really primarily driven on a supply basis that things are extremely, extremely tight. And as a result, we believe that things are going to grind tighter and that these conditions will stay around. And really the $10 to $15 a ton in 2023, that reflects the fact that we have a number of multi-year contracts that "can't go up more than $5 or $10 in any annual redetermination period.

So I mean, if everything we're able to reprice to current market or spot market, then it would be an even more significant increase across all of our tons.

TJ Schultz -- RBC Capital Markets -- Analyst

OK, make sense. If I can squeeze one more in, just on marine really quickly. We did see like the refining cracks really materialize higher late in the first quarter. And there's clearly, as you noted, a lot of focus to move products into the East Coast.

So as we think about your fleet and the ability to capture this tighter market, should we expect some type of step-change higher in what the segment can contribute? Or was the first quarter a pretty good indication of a run rate there? Thanks.

Grant Sims -- Chief Executive Officer

Yeah, and that's a very good question. And I would say that at least internally, we're looking at the potential of a step change, and it really is being driven by the market dynamics in large part that you pointed out, are vis-a-vis Gulf Coast and Mid-Atlantic and especially New York Harbor on refined products has blown out given a lot of geopolitical events as well as the behavior of demand for transportation fuels out of Gulf Coast refineries to go to Latin America primarily is really opened up and dramatically increased the demand for oceangoing vessels capable of moving refined products from USGC to Mid-Atlantic. So we're clearly at 100% utilization. We are seeing rates that are above what we saw in 2015 on a day rate basis in that business.

And then -- so we anticipate that continuing, we don't see what's fundamentally going to change that for quite some time. I think that we're also seeing even demand within our inland fleet, again, because of the refinery utilization in PADD 3 and PADD 2, trying to take advantage of these crack spreads that the refineries are seeing we're -- as all practical matters, we're at or close to 100% on the -- on our inland fleet, we are seeing rates, do the arithmetic real quick, some 30% up over the spot rates up over the last three or four months. So I think, quite frankly, that marine could be very additive to helping us achieve and exceed the previously provided guidance.

TJ Schultz -- RBC Capital Markets -- Analyst

OK. Thanks, Grant.

Operator

Thank you. [Operator instructions] It seems there are no other questions at this time. I'll turn the floor back to Mr. Sims for any final comments.

Grant Sims -- Chief Executive Officer

Well, thanks very much. And again, thanks, everyone, for dialing in, and we look forward to visiting with you in another 90 days or so. So thanks very much.

Operator

[Operator signoff]

Duration: 35 minutes

Call participants:

Dwayne Morley -- Vice President, Investor Relations

Grant Sims -- Chief Executive Officer

Kyle May -- Capital One Securities -- Analyst

TJ Schultz -- RBC Capital Markets -- Analyst

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