What happened
Shares of oil and gas pipeline and processing company Targa Resources (TRGP -2.68%) declined 19.3% in December, according to S&P Global Market Intelligence. This recent slide is on top of the prior month's slide, which also coincided with a significant drop in oil prices.
Check out the latest Targa Resources earnings call transcript.
So what
Typically, companies in the pipeline, processing, and logistics portion of the oil and gas business structure their business in a way such that they are mostly insulated from commodity prices. This typically means fee-based revenue contracts with their customers, which sometimes even include things like minimum volume commitments. Contracts and business structures like this make revenue and cash flow relatively predictable and allow these businesses to return large amounts of cash to their investors through dividends -- or, in master limited partnership parlance, distributions. (Targa isn't a master limited partnership, but its business shares a lot of traits with MLPs.)
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Targa is a little different in that its revenue for its natural gas processing business comes much more from percentage-of-profit contracts. As of its most recent investor presentation, about one-third of the company's revenue comes from these percentage-of-profit contracts. This means that Targa is much more exposed to commodity prices than other companies in the business. Most of Targa's peers get 80% or more of their revenue from fixed-fee contracts.
Now what
Targa is slowly moving more and more of its business toward fixed-fee contracts by investing in other parts of oil and gas logistics such as long-haul pipelines. It spent about $2.4 billion in 2018 and expects to spend around $4.2 billion to complete its current slate of projects. That is a lot of cash for a $9 billion company, and it will likely need higher oil and gas prices to help cover its generous payout and some of its spending. If not, management may find it hard to gather the funds to complete this ambitious spending plan.
