This year's oil market downturn has claimed another victim. The latest casualty is the Midland-to-ECHO 4 crude oil pipeline (M2E4), which Enterprise Products Partners (NYSE:EPD) has canceled. While the decision will cost the master limited partnership some money, it has some notable longer-term financial benefits, namely that it will save $800 million in capital costs over the next couple of years. Those savings will put the energy company's high-yielding payout -- which is up to 10.3% at the moment -- on an even firmer long-term foundation.
A stalled out growth engine
Enterprise initially sanctioned the M2E4 project last October after securing enough long-term customer agreements to justify the investment. It was planning to build a 450,000 barrel a day pipeline from an oil storage facility in the Permian Basin to an even larger one along the U.S. Gulf Coast, which connected to several refineries in Texas and a network of marine export terminals. The company estimated that it would cost more than $800 million to build the pipeline, which it expected to finish by the first half of next year.
However, with oil prices tumbling earlier this year, Enterprise launched a thorough review of its expansion projects. As a result, it deferred and canceled some projects to better align its spending with customers' needs. While the industry initially thought it would require more oil pipeline capacity to support future growth, that space is no longer needed as early as first thought because of the impact COVID-19 has had on oil demand.
Finding a win-win solution
Instead of building the contractually secured M2E4 pipeline, which the industry doesn't need anytime soon, Enterprise and its customers worked out a "win-win" solution for everyone. The company agreed to reduce its customers' near-term volume commitments in exchange for extending the term of their agreements. That allowed the company to move some of the volumes earmarked for M2E4 to other systems that had available space and free up the capital it would have invested in the project for other uses. While the company already spent $45 million on the now-canceled pipeline, it will save $800 million of capital costs through 2022.
As a result, the company now only expects to spend $2.8 billion this year, $1.6 billion next year, and just $900 million in 2022. That's down from a range of $2.5 billion-$3 billion in 2020, $2.3 billion in 2021, and $1 billion in 2022.
One of the benefits of the capital savings from canceling M2E4 is that it will "accelerate Enterprise toward being discretionary free cash flow positive," according to CEO Jim Teague. That would enable the company to generate enough cash to cover its capital spending and dividend with room to spare. That, according to Teague, "would give us the flexibility to reduce debt and return additional capital to our partners, including through buybacks." Also implied in those comments is the potential for additional distribution increases. While the company did pause distribution growth earlier this year after 62 consecutive quarterly increases, it has boosted its payout for the last 21 years. Thus, with M2E4 canceled, the company will now have even more financial flexibility to potentially deliver that 22nd consecutive annual increase, which would keep it on track to eventually become a dividend aristocrat.
Trading some growth for more stability
While Enterprise Products Partners had secured enough customer contracts to move forward with M2E4, much has changed since they signed those agreements. Instead of building what would probably be an underutilized pipeline, Enterprise worked with its customers to improve the utilization of its existing assets and lengthen contract terms, which will save both money in the near term. By trading some growth for more stability, Enterprise will put its big-time payout on an even firmer foundation, further enhancing its appeal to income investors.