Operating pipelines and processing plants make for a rather boring business. Yet these operations provide substantial income to the MLPs that typically own these assets. However, not all midstream assets are equal, which is why investors interested in Eagle Rock Energy Partners (NASDAQ: EROC) need to take a deeper look into the company's bedrock midstream operations to get a better understanding of these assets.
Midstream overview
Eagle Rock's midstream operations are concentrated in two core areas, the Panhandle and East Texas. Overall, the company has 8,134 miles of pipeline and 20 process plants:
Eagle Rock Energy Partners Investor Presentation
It's the Panhandle assets which offer a lot of potential growth. There are currently 68 active drilling rigs in the area and more than 550 wells have been permitted over the past six months. Because of this, Eagle Rock has been busy both acquiring and building its assets in the area. The biggest recent acquisition was a $227.5 million deal for BP's (BP +0.00%) Texas Panhandle Midstream System. The system, which won't be accretive to its distributable cash flow until 2014, added significant scale and important fixed-fee revenue. The deal was also important to BP, which was able to monetize a non-core asset, but was still able to use the asset as it signed a 20-year gathering agreement with Eagle Rock.
Eagle Rock was then able to leverage its extended footprint into a new fee-based gathering and processing agreement with Apache (APA +2.10%). This agreement, which is an expansion of a previous agreement, again adds important fee-based revenue from one of the most active drillers in the region. Meanwhile, Apache is able to get its growing natural gas production gathered and processed. Eagle Rock's ability to continue to leverage its assets to build out its platform is a key to rewarding investors over the long term.
Rocky ground
The issue when it comes to Eagle Rock's midstream business is that two-thirds of its income is subject to commodity price volatility. That means that its income, and therefore its distribution, could be hit when commodity prices sink. The good news is that thanks to those new contracts, Eagle Rock's midstream operations are strengthening:
Eagle Rock Energy Partners Investor Presentation
However, for perspective, top midstream operator Enterprise Products Partners (EPD +0.19%) derives 81% of its gross operating margin from fee-based activities. That means that substantially more of Enterprise's revenue and profits are rock solid which provides ample safety to its distribution. This is one reason why Enterprise has been able to raise its distribution for 36 strait quarters while Eagle Rock's payout is at risk of being cut.
More midstream operators are pushing for fixed-fee contracts to provide better stability. Another example of this is Atlas Pipeline Partners (NYSE: APL), which currently has just 36% fixed-fee contracts. However, it recently acquired a business which had 80% of its contracts as fixed fee, which pushes the pro forma business to 42% fixed. By the end of next year, Atlas expects to have 50% fixed-fee contracts, which will make its distribution more secure. Because income security is important to investors, it's good to see Eagle Rock move in this same direction of having more of its revenue tied to fixed-fee contracts, even if it still does have a long way to go.
Final Foolish thoughts
While Eagle Rock's operations are centered on areas with growth potential, way too much of its revenue is tied to volatile commodities. That can cause issues both with its debt and its distributable cash flow, meaning its high distribution might not be on solid ground.
