The energy sector continues to experience a gigantic consolidation wave, which is causing master limited partnerships (MLPs) to drop like flies. Valero Energy (VLO 0.86%) is behind the latest disappearing act in the space after it agreed to buy out its MLP Valero Energy Partners (NYSE: VLP). In doing so, it's abandoning a vehicle that has proven to be valuable in driving growth for its rivals, which could put it at a disadvantage.
Putting a quick end to the experiment
Valero Energy launched Valero Energy Partners in late 2013, joining its refining rivals in creating an income-producing vehicle that would steadily buy its parent's midstream assets. Since that time, Valero has regularly sold its logistics assets to its MLP, which gave it the cash to buy back more stock and fund expansion projects. Meanwhile, Valero Energy Partners used those acquisitions to fuel fast-paced distribution growth, boosting its payout by 159% since its formation.
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But instead of continuing to sell down its midstream assets to Valero Energy Partners, Valero Energy has decided to buy out its MLP. It's paying $42.25 per unit in cash, which is a 12.4% premium to the MLP's trading price over the last 30 days. Overall, it will pay $950 million to purchase the rest of the units of Valero Energy Partners that it doesn't already own, buying back full control over its logistics assets.
Never getting past step one
Aside from one small third-party acquisition, Valero Energy hasn't deviated from its strategy for growing Valero Energy Partners, which has consisted of dropping down a few of its logistics assets to that entity each year. That's in contrast with the notable strategy shifts taken by fellow refiners Marathon Petroleum (MPC 0.70%) and Phillips 66 (PSX 0.91%) with their MLPs in recent years.
Marathon's MLP, MPLX (MPLX 1.17%), made a rather stunning course change in 2015 when it acquired natural gas processing company MarkWest Energy in a $15.6 billion deal to create the fourth largest MLP at the time. That transaction significantly diversified MPLX's revenue stream while adding a new growth platform. In 2018, the MLP invested around $2 billion to grow that gathering and processing business, which has given it the resources to increase its distribution by 10%. Meanwhile, MPLX has recently taken the next step of its evolution by participating in the development of some long-haul oil and gas pipelines, which will give it more fuel to continue growing its payout in the coming years.
Phillips 66's MLP, Phillips 66 Partners (PSXP), has also shifted gears in recent years toward funding more organic expansion projects, which carry higher returns on investment than drop-down acquisitions. The company has been taking on larger projects in the past year, including leading the development of the Gray Oak Pipeline, which will move oil from the Permian Basin to the Gulf Coast. It's also building a new unit at one of Phillips 66's refineries to increase the production of higher-octane blend components, constructing pipelines for natural gas liquids, and developing an oil export terminal with Marathon Petroleum. This shift has freed up Phillips 66 from having to invest in these midstream projects on its balance sheet, leaving it with more internally generated cash flow to buy back stock.
A failure to pivot could cost Valero in the long run
Valero Energy has opted to join a growing number of energy companies in giving up on their MLPs. That move, however, could put it at a competitive disadvantage to rival refiners like Phillips 66 and Marathon Petroleum, which have both shifted their strategy by using their MLPs as funding vehicles for organic growth projects. That has enabled both companies to further diversify into the midstream sector without investing that capital on their balance sheet. It's a move that should help those refiners produce steadier earnings going forward, which could give their stocks the fuel to outperform Valero's.
