Pipeline companies have been cashing in on the oil production boom in the Permian Basin. Those that had excess capacity on their systems have been able to take advantage of the region's infrastructure issues to make a mint moving oil out of the area.
However, those good times appear to be winding down, and it appears that 2020 will be a much less lucrative year for pipeline companies focused on the region.
In the right place at the right time
Oil pipeline master limited partnerships Plains All American Pipeline (NASDAQ:PAA) and Magellan Midstream Partners (NYSE:MMP) have been among the biggest beneficiaries of the Permian Basin's pipeline shortage. They were able to cash in on rising pipeline valuations last year to sell a 50% stake in their BridgeTex system for $1.438 billion, giving them cash to invest in expansion projects. In addition, they've been able to fill up the capacity on their existing systems, enabling them to make more money than expected.
In Magellan's case, it initially anticipated that it would generate $1.14 billion of cash this year, which would be enough to grow its high-yielding payout by 5% while covering it by a comfortable 1.2 times. The company, however, noted: "Due to the volatility in the pricing differential between the Permian Basin and Houston that encourages spot shipments on the Longhorn and BridgeTex pipelines, current guidance assumes spot shipments occur on both pipelines during the first quarter of 2019 only. If spot shipments continued throughout the remainder of the year, the partnership's DCF could be up to $1.2 billion for 2019."
That's exactly what has happened. Market conditions have been so strong that the company is on track to haul in $1.26 billion in cash this year, which is enough to cover its payout by 1.35 times.
Plains All American, meanwhile, has also benefited from the strong market conditions. It has increased its guidance each quarter and now expects to produce $2.07 billion in cash this year, 15.8% above 2018's level.
All good things must come to an end
Plains All American, however, doesn't expect 2020 to be quite as strong. The company's CEO, Willie Chiang, discussed on the third-quarter call what he sees ahead. He noted that the MLP expects to generate between $2.55 billion and $2.6 billion of adjusted EBITDA next year, well below the $3.075 billion it's on track to produce in 2019. He noted that the company's fee-based transportation and facilities segments are on pace to grow their EBITDA by about $100 million next year. However, he pointed out that this number "includes offsetting an estimated $85 million of expected impacts from the competitive environment" because the company won't benefit from lucrative spot shipments on pipelines like BridgeTex. In addition, the company expects to produce only $50 million to $100 million in adjusted EBITDA out of its more market condition-sensitive supply and logistics business. That's a huge drop from the $670 million the segment is on track to haul in this year.
Magellan Midstream, likewise, sees tougher times ahead in 2020. CEO Mike Mears stated on the third-quarter call that the company is entering "a period of increased competitive pressure for long-haul crude oil pipelines in the Permian Basin." That means it won't be earning as much on its Permian pipelines.
Two issues are at play here. First, production growth in the region will slow considerably in 2020. After increasing by 1 million barrels per day (BPD) in 2018 and another 800,000 BPD this year, Plains All American only "expect[s] Permian production to grow on average approximately 500,000 BPD" in 2020, according to Chiang. That's "about 100,000 BPD on average less than our prior estimate as we have further calibrated the anticipated impact of producer capital discipline on drilling and completion activity."
The other issue is one of their own making, as pipeline companies have been building new capacity as quickly as they can. Plains All American, for example, recently finished up its Cactus II pipeline, which will be able to transport 670,000 BPD. It's one of three long-haul Permian oil pipelines that will enter service in the coming months. With so much new capacity coming online, these pipelines are taking volumes away from legacy systems, which is affecting their earnings.
Down but not out
While 2020 won't be as good as 2019 for Permian pipeline companies, the sector is still relatively well insulated from changes in market conditions within the energy sector. That's because most sell the bulk of their capacity under long-term, fixed-priced contracts. As a result, there's a high floor under their cash flow. That will enable them to continue paying out lucrative distributions to their investors in the next year, which is why they still make ideal stocks for dividend investors to consider buying for the long haul.