Last quarter was another one of those run-of-the-mill results from Magellan Midstream Partners (MMP). New assets coming online led to incremental gains we have come to expect from Magellan over the past several years. Over the next few years, it's looking more and more likely that management is going to step on the gas when it comes to growth. Not only does it have a large suite of potential assets in the hopper, but management is also making inroads to secure funding for those assets already.
Here's a selection of quotes from the company's most recent conference call that explains management's moves to get this growth plan off the ground, as well as where the opportunities lie in the oil and gas transportation business today.
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Increasing funding options
One of the reasons Magellan Midstream Partners has been a better long-term investment among master limited partnerships is it has been able to avoid diluting shareholder value through equity issuance. According to CFO Aaron Milford, the company may start to deploy that funding option more in the future:
[W]e continue to make progress in establishing an [at the market] equity program to use as another tool for funding future growth. But with current leverage at approximately 3.4X, we do not anticipate using this program immediately once formally established. This program will essentially help us manage our leverage in a manner that is consistent with our 4X targeted maximum leverage ratio as we continue to make investments and grow.
At-the-market equity programs are designed such that the company can issue equity on any given day and take advantage of current stock prices, whereas more formal equity issuances are announced in advance and at sold at fixed prices that may be below current market value. For a company that budgets for new projects several quarters in advance, this can be a more effective way to raise equity.
When asked why the company is pursuing this equity issuance capability when management has said it doesn't need to do it right now, CEO Michael Mears replied that it's in anticipation of several big-ticket projects that could get the green light rather soon:
[I]f you look at our current spending, it would suggest that we don't need to do this. But as I've mentioned, we are looking at significant expansion of our Pasadena terminal, which could be anywhere from $500 million to $1 billion of capital opportunity. We're looking at expanding our Seabrook Logistics terminal. We're looking at building a new pipe to Dallas refined products. We're looking to build a new crude oil pipe to Corpus [Christi] out of the Permian. If all of those things happen or even half of those things happen, it's unlikely that we will want to -- that we could finance that all with debt and stay below 4X debt-to-EBITDA ratio. So we want to be prepared if those happen to fund with equity, if needed. And that's why we're putting the program in place.
One of the downsides of the Permian Basin black gold rush is that midstream companies like Magellan need to push through big projects probably faster than they would want to and stretch their budgets as a result. By having this equity funding arrow in its quiver, it will be able to keep debt within a range to maintain its investment grade credit rating.
Putting more capital to work in the Permian
Magellan is mostly known for its refined petroleum product pipeline and terminal network. That's to be expected, since refined products make up more than 60% of gross operating margin. When it comes to growth, though, Magellan's crude oil pipeline network has been the center of attention. It recently finished its Saddlehorn pipeline that delivers oil from Carr, Colo., to Cushing, Okla. Now, according to CEO Michael Mears, it wants to leverage its asset base in the Permian Basin:
As you may recall, we also announced plans to expand the capacity of BridgeTex from 300,000 barrels a day to 400,000 barrels per day, and that incremental capacity is expected to be operational by the end of the second quarter.
In addition, we are currently evaluating a further expansion of BridgeTex up to its maximum capacity of 475,000 barrels a day, which we believe could be achieved by the construction of additional pumping capacity.
That first expansion cost only a couple of million, so it was a very high-return project. Mears later said that the expansion to 475,000 barrels per day will be more expensive because it will probably involve more pumping stations.
Getting gun-shy when it comes to acquisitions
As is the case with just about every midstream company nowadays, the topic of acquisitions came up. In the past, Magellan was an active acquirer, but it hasn't made a deal since 2015. According to Mears, the reasons it stopped acquiring assets a few years ago -- the price was too high -- still applies.
[I]n the past, we've discussed our desire to extend our value chain to include gathering assets that could direct barrels to our long-haul pipelines in the Permian Basin, and that interest remains. There have been a number of assets marketed recently, which we believe were attractive assets toward accomplishing this goal. We have analyzed and valued these assets at terms that we believe are reasonable and in the best long-term interest to Magellan's investors. We have not been able to execute on these acquisition opportunities since the market-clearing valuations have been higher than we are comfortable with. Our preferred growth strategy continues to be construction of new assets, which generally provides better returns.
Magellan isn't the only one with this view on asset prices. Enterprise Products Partners CEO Jim Teague said something similar this past quarter. Today, building new is much cheaper than acquiring existing assets is, especially in the Permian, where valuations are off the charts.
Crude oil is more complicated than many think
We still import a lot of crude, but crude oil production is growing fast. So the logical conclusion is that we will replace those import barrels with domestic crude. While we are likely to see some imports displaced by domestic production, that isn't the whole story. According to Mears, there are lots of other factors to consider here, and that's why Magellan is examining projects to build crude oil pipelines and export terminals in the Corpus Christi region in Texas:
[A] significant portion of the growth in the Permian Basin is expected to be very light crude oil. And very light crude oil and the condensates, particularly coming out of the Delaware Basin, really are not well designed for the Houston refining market. They're more likely to be split at a condensate splitter or put on the water for export. So if that's the primary focus of increased production -- I'm not saying that that's all the production growth in the basin. There's still going to be production growth that wants to go to Houston, but there's significant pipeline capacity in Houston. There's significant -- and I shouldn't say just Houston, I mean, the eastern Gulf Coast market. There's significant available capacity on many of those pipes that are there today, but Corpus Christi doesn't have the same pipeline infrastructure headed to it. And if a significant portion of this growth is going to be barrels that really don't have an interest to the Houston-area refiners and has a primary interest to be exported, that's what's going to drive these barrels to Corpus Christi. So that's why we and all the other players are focused on Corpus as the next destination for our pipeline.
There certainly isn't a lack of options for investment projects in the Gulf Coast region. A potential Corpus Christi terminal would give Magellan a third export facility in the Gulf and is likely to make it a major player in how crude oil moves around South Texas for many years to come.
