In this video, Motley Fool energy analyst Joel South discusses the inherent risks associated with the stock of Energy Transfer Partners (NYSE: ETP) and how it could affect the company going forward.
While these risks are company-specific, they can also be extrapolated to a lot of other producers as well.
When it comes to ETP the first risk involves the commodity price risk. Unlike Plains All American Pipeline (NASDAQ:PAA) or Kinder Morgan (NYSE: KMP) whose contracts are mostly fee-based, ETP takes possession of the contract. So if natural gas prices start to drop, the company's EBITDA also falls. For every 10-cent drop, the company stands to lose about $70 million to $75 million in EBITDA.
On the bright side, ETP is trying to address this issue. Its merger with Sunoco last year helps, because a lot of its pipelines are fee-based. They have spent $3 billion on projects since the end of 2010.
Nevertheless ETP still has a lot of its contracts set for the near term where they can really be hit on the commodity price risk.
The second risk involves the huge debt situation. MOPs are supposed to return a lot of their cash flow to shareholders or unitholders and finance their expansion through debt.
If a company has mostly fee-based contracts, cash flows are more guaranteed, which, in turn, improves its credit rating. When that's not the case, it results in the company paying a higher cost of capital.
The third risk is one that's quite common among midstream companies -- the environmental risks. There is always a risk of an oil spill. As we saw in the case Enbridge (NYSE:ENB), they had 877,000 gallons spilled in the Kalamazoo river, which really hurt the company.
Such occurrences gives the industry a bad name and as a result, people shy away from such investments.
The second part of the environmental issue is that if an oil spill like this were to happen, natural gas production would have to be switched off because of the way its extracted. That's obviously going to be a macro issue, which will affect the midstream sector as a whole.