Trunkline Conversion v 2.0

This is a continuation of an earlier article on the conversion of Trunkline. According to Energy Transfer’s (“ETE and ETP”) November 14, 2012 Analyst Day presentation, the company’s much anticipated Trunkline conversion will begin at Tuscola, IL and also connect with the Mid West’s major pipeline hub in Patoka, IL. The Trunkline conversion will follow Trunkline’s path and will pass by the Lake Charles (2.0+ million Bpd) refinery market on its way to terminate at company’s terminal at Nederland, TX. ETP also plans to build a lateral from Trunkline to service the St. James refinery market (2.1 million Bpd). Laterals to individual refineries within each market are likely to be built only as refiners commit to pipeline capacity on the conversion.

Management stated on its Q3:2012 earnings call that it expects the pipeline’s capacity to be 400,000-600,000 Bpd. Management also expects the pipeline’s initial capacity will be closer to the lower end of the range, but will ultimately be determined by level of shipper interest.

With an expected total project cost estimated to be ~$1.5 billion, management expects to obtain FERC approval for the abandonment of some of Trunkline’s gas service in Q2:2013, and that the conversion will be in service by mid-2014. Management began this process by filing an application for abandonment with the FERC in July 2012.

Given the project’s cost and an 8.0x EBITDA multiple, we conservatively expect this project could begin to contribute $45 million of EBITDA per quarter, beginning in Q3:2014. As the project ramps from 400,000 Bpd to its full capacity of 600,000 Bpd, we expect this project’s EBITDA contribution could ramp to $65 million per quarter.

With the closing of ETP’s acquisition of Sunoco and Sunoco Logistics’ (“SXL”) General Partner in October, 2012, we expect this crude oil pipeline conversion could be a dropdown candidate for ETP and SXL. Once the abandonment has been approved, the most capital efficient way of financing this conversion would be for ETP Holdco to sell SXL the rights to the Trunkline Conversion in return for cash. We believe SXL’s low leverage (~2.0x LTM EBITDA), its rapidly increasing cash flow, and its high distribution coverage ratio could allow SXL to finance this pipeline conversion without raising any additional equity, while keeping its leverage ratio below 4.0x.

Based on SXL’s Q3:2012 IDR Waterfall, we expect this project could initially increase quarterly distributions per common unit by $0.18 per unit, and that SXL’s IDR could increase by 90% to over $38 million per quarter. Given that SXL’s common unit distribution ($0.5175/unit) is very close to the top tier ($0.5275/unit) of SXL’s IDR Waterfall, we expect this project to be a big cash flow contributor to SXL’s General Partner, ETP.

Closing of SUN Acquisition to Put Near Term Pressure on ETP Units?

Yesterday, Energy Transfer Partners (“ETP”) announced the cash consideration option for its pending purchase of Sunoco (“SUN”) was oversubscribed. According to the preliminary results of the elections made by SUN shareholders regarding the form of consideration to be received, almost 74 percent of SUN shareholders selected that choice.

Among other factors, it is possible this will likely lead to some near term pressure on ETP units as those holders of SUN shares which received, but did not want, ETP units sell the unwanted units as quickly as possible. We believe SUN shareholders behavior could unfold as follows:

• Unit Only Election. Out of a total of almost 105 million shares of SUN, only 4.2% of SUN owners elected to receive only units. These SUN shareholders will receive 1.049 ETP units and no cash for each SUN share, and this election was worth $44.27/SUN share based on Monday’s closing price. Once the deal closes on Friday, these holders will hold ~4.7 million units of ETP, and these holders are likely to hold onto their ETP units.
• Standard Election. 2.6% of SUN shareholders elected to receive the standard election of $25 cash and 0.5245 ETP units for each share of SUN. This election was worth $47.13 per SUN share based on Monday’s closing price, and these shareholders will receive ~1.4 million ETP units. Like the unit only group, once the deal closes on Friday, these holders are likely to hold onto their units.
• No Election. 19.2% of SUN shareholders made no election and will receive the standard election of $25 of cash and 0.5245 ETP units each SUN share they hold. Like the Standard Election, this election was worth $47.13 per SUN share based on Monday’s closing price. These shareholders will receive ~10.6 million ETP units. Like the Standard Election group, once the deal closes on Friday, these holders are likely to hold onto their ETP units.
• Cash Only Election. 73.9% of SUN shareholders elected to try to maximize their return and receive cash only. Unfortunately for these shareholders, while this would have been $50 of cash had this deal not been subject to proration, proration will adjust their compensation to be $26.44 of cash (more cash than the standard election as some SUN shareholders elected to take no cash) and 0.4944 ETP units for each SUN share. This election was worth $47.40 per SUN share based on Monday’s closing price. For any number of reasons (ex. Selling to lock in gains, selling because they are not mandated to hold MLP units, etc.), these holders are likely to try to sell their ETP units as quickly as possible. Total units given to holders who made the Cash Only Election are expected to be ~38.3 million units.
  • Prior to closing this deal, ETP had a total of ~245 million common units and ~55 million ETP units will be issued as consideration in this deal.
  • ETP’s recent trading volume has averaged ~1.5 million shares per day.
  • SUN shareholders who are able to short are likely to begin to short ETP units prior to the deal closing to get ahead of any selling pressure.

Note: Had ETP units been trading above $47.66 on Monday, the final Election day, the profit maximizing choice on Monday would have been the Unit Only Election.

Getting Oil Out of the Bakken…

As the Bakken’s oil production growth continues to exceed expectations, oil production is now expected to eventually double or even triple to 1.2 – 2.0 million Bpd. The Bakken’s rapid growth is, however, being constrained by an inability to cheaply and efficiently move the oil out of the region. To this end, we thought we’d take a look at some of the infrastructure alternatives, and see if there might be an intriguing opportunities. Generally, lighter crude oils such as those produced by the Bakken have the greatest demand in the east in  PADDs I and II. This is because many of the PADD I and Ohio refineries have less ability to process heavier oils, as measured by their lower Nelson Complexity Ratings. Generally, heavier oils will go south to the PADD III refineries on the USGC which have been upgraded to process heavier oils.

There are two main ways to transport oil out of the Bakken: (1) by train, and (2) by pipeline.

Currently, because the Dakotas were never a historically prolific oil producing region, oil pipeline capacity out of the Bakken is limited to Enbridge’s (“ENB”) 200,000 Bpd pipeline, and many shippers have had to resort to shipping their oil to the USGC, or even the USEC, by rail. However, there are at least three pipeline systems under construction, and by 2015, pipeline capacity is expected to carry nearly all of the oil production from the Bakken.

Rail vs Pipeline Costs

One might ask why rail, as the incumbent carrier, wouldn’t be able to keep its current share of oil transportation customers. The answer is cost. Transporting oil by rail is dramatically more expensive than transporting oil by pipeline. Though much more expensive than a pipeline on a per barrel basis, rail has one big advantage. Many rail systems are already in place and need a minimal amount of capital upgrades to begin transporting oil. That said, as the $10 differential between the rail cost to St. James and the pipeline cost to the USGC shows, once up and running, pipelines are a much cheaper, more efficient, and more reliable way of transporting oil. However, pipelines are expensive to build, and take a fair amount of time to get permitted and into service.

The $14/Barrel differential in rail pricing to USEC vs to pipeline pricing to Petoka, IL creates opportunity to bring oil into Ohio and to the USEC. Petoka is about the farthest east that one can transport Bakken oil by pipeline. As was mentioned above, the the lack of heavy oil processing capability makes the Ohio and the PADD I/east coast refinery markets an appealing 1.5 million Bpd opportunity for Bakken oil. This said, once up and producing in the next three to seven years, the oil production from the Utica could satisfy 300k of this demand. Nevertheless, a 1.2 million Bpd market should be more than sufficient to support the construction of a pipeline to the east coast from the Midwest.

Bakken to the Midwest

To get oil to the USEC and to Ohio, transiting through Cushing, OK seems unnecessary, adding additional distance and cost to the trip. That said, skipping Cushing will eliminate OneOK (“OKE”) and TransCanada’s (“TRP”) Keystone XL pipelines as potential carriers out of the Bakken. Skipping OKE and Keystone XL will leave ENB as the main pipeline alternative out of the Bakken.

If one takes either OKE’s or Keystone XL’s pipeline from the Bakken to Cushing, to get east, one will need to use ENB’s Ozark Pipeline to Wood River, IL or BP’s pipeline to get to Whiting, IL. Using either of these two alternatives does not seem like a cost effective alternative to using one of ENB’s pipelines the whole way from the Bakken. ENB’s mainline can get crude from the Bakken to Toledo, OH, or to either Chicago or Patoka, IL.

The High Prairie Pipeline, a yet to be built pipeline out of the Bakken is currently fighting with ENB to interconnect with ENB’s mainline at Clearbrook, MN. Another option for High Praire to move its crude south and/or east might be to interconnect with the Koch (Minnesota/Koch) pipeline system. Koch’s Minnesota Pipeline begins at Clearbrook, MN, and then interconnects with the Koch Pipeline in St. Paul, MN. The Koch Pipeline terminates at Wood River, IL. Because there are a lot of historical relationships between High Prairie’s management team and Koch, many members of High Prairie’s management team used to work at Koch, we feel like this could be a easier and better alternative than interconnecting with ENB.

Possible East Coast Pipeline Partners:

As oil production in the Utica ramps up, it is likely that local refiners in Ohio (Marathon, Husky, BP/Husky, and PBF) will absorb most of the 300k Bpd of light oil produced by this formation.This however, does not mean that there isn’t a need for pipeline infrastructure to get oil from Ohio to the PADD I refineries, most of which seem to be clustered in and around the  Philadelphia area. This pipeline need will play to companies who already service some or all of these refineries for either crude delivery or refined product take away capacity and to those companies who can aggregate disparate pipeline networks and rights of way. We see some possible players as being the following:

• Marathon Petroleum (“MPC”)
  • Has rights of way, and crude and refined products pipeline connections to terminals and refineries in Ohio.
  • Marathon Pipeline connects Petoka, IL to Marathon’s refineries in Ohio.
  • Does not have pipeline connectivity east of Ohio.
• Sunoco (“SUN/SXL”)
  • Has rights of way and pipeline connections from many of the Philadelphia area refineries to markets in Pennsylvania, Ohio, and Michigan.
  • Also controls the Inland Pipeline, a refined products pipeline which connects three refineries to eastern Ohio and western Pennsylvania markets.
  • Could be possible to use rights of way and underutilized/unused pipe to get crude from either Toledo or one of Inland’s Ohio refineries to Philadelphia.
• Buckeye (“BPL”)
  • Has rights of way and refined products connections to terminals and refineries in Pennsylvania, Ohio, New York, and New Jersey.
• Enterprise Products (“EPD”)
  

• EPD owns the interstate ATEX pipeline.
• Though it crosses Indiana, Ohio, and Pennsylvania, ATEX is primarily a NGL pipeline and does appear to connect to refineries.

Conclusion

ENB seems poised to be the dominant transporter of crude, not only from Canada, but also out of the Bakken. However, a good counter balance would seem to be a combination of the MPC pipeline network and either the SUN/SXL or BPL pipeline network. This combination would create a pipeline network which serves a thirsty but under-served region with 1.5+ million Bpd of light oil demand.

Marathon Petroleum’s Pipes… A Value Creating Opportunity?

The Background section of Sunoco’s proxy statement for its acquisition by Energy Transfer Partners (“ETP”) mentions that “Company A,” a large petroleum refiner, marketer, and transporter, was also interested in a merger with Sunoco (“SUN”). The universe of possibilities for Company A’s true identity is rather limited, and includes companies such as:

1. Delek (“DK”)
2. Marathon Petroleum (“MPC”)
3. Murphy Oil (“MUR”)
4. Phillips 66 (“PSX”)
5. Tesoro (“TSO”)
6. Western Refining (“WNR”)
7. Valero (“VLO”)

Chevron (“CVX”) and ExxonMobil (“XOM”) could also be included in this list, but these giants have been focusing more of their efforts and capital on their upstream businesses.

Though refiners with some marketing and logistics assets, DK, TSO, VLO, and WNR would seem to have little to offer in the way of operational synergies due to their regional focuses on either the southwest or west.

This leaves PSX and MPC. With 10,000 marketing locations and 15,000 miles of pipeline, Sunoco’s assets 5,000 marketing locations and nearly 8,000 miles of pipeline would seem to fit nicely with those of PSX. However, PSX seems to be focusing more of its efforts and capital on its Chemicals and Midstream businesses as they offer higher returns than Refining and Marketing. This leaves MPC as being the last potential “Company A” for Sunoco.

With highly cyclical results and market prescribed EV/EBITDA multiples in the 3-5x range, it is not surprising that a refiner such as MPC would be limited in the premium it could pay for an acquisition, as the proxy suggests. And thus, it is not surprising that a company with much more stability in its results, and with an EV/EBITDA in the 10-12x range, would win the auction for SUN. This however, does not mean that some of SUN’s assets would not be a good fit and offer good synergy opportunities for a company such as MPC. In fact, MPC was correct to be interested in SUN, and a correctly structured deal for some, rather than all, of SUN’s assets may offer a company such as MPC the opportunity to monetize some of its highly value, non core, assets (ex. pipelines) for which the market gives it little valuation credit, while continuing to add heft to one of its core business (ex. retail).

With Pipeline EBITDA accounting for just 4.5% of MPC’s total EBITDA, and Refining and Marketing EBITDA accounting for 87.3% of MPC’s total EBITDA, it certainly seems as if MPC’s pipeline assets can be viewed as non-core. When one compares the valuation premium which the market puts on many pipelines, (12x EBITDA) relative to to refiners (3-5x EBITDA) and convenience store operators (6-8x EBITDA), the argument for doing something to monetize the value of MPC’s pipelines becomes that much more obvious, and it seems that even MPC’s management has realized that its pipeline business is hidden within MPC as a whole. To this end, MPC has made the effort to highlight its pipeline business by filing to take taking part of it public through an MLP structure.

Another possible way to realize the value of MPC’s pipelines while bolstering a core business might be a swap of MPC’s pipelines for SUN’s retail business.

Because MPC’s Pipeline business and SUN’s retail business, generate relatively the same amount of EBITDA, a transaction of this type would allow MPC to keep its EBITDA relatively flat by bulking up its second largest business, while crystallizing some of its pipeline’s valuation premium by picking up either cash or SUN/ETP units as consideration. Under this scenario, where the assets would be exchanged at market multiples, MPC would trade ownership of its pipeline business for SUN’s retail business plus $1 Billion of consideration. This consideration could take the form of either cash or shares/units in SUN/ETP.

MPC Pros

• Asset exchange could be done on a tax-free basis. As a tax paying entity, prudent tax planning is likely to be important to MPC too avoid value leakage. If a reverse Morris Trust structure is used, it is likely this MPC and SUN could exchange their assets (and additional consideration) in a tax-free manner.
• Improve an under-performer. Relative to MPC’s Speedway branded retail presence, SUN’s retail outlets are under-performers. It is likely MPC’s retail management team could improve the operation of SUN’s retail assets and bring their performance more in like with Speedway’s.
  • Speedway’s Light Product Margin Per Store Per Month is nearly $8,000 better than its peer group average, including SUN’s retail business
  • Speedway’s Merchandise Margin per Store Per Month is nearly $21,000 better than its peer group average, including SUN’s retail business
• Move away from wholesale and spot gasoline markets. Based on current refinery gasoline yields, MPC sells ~60% of the gasoline produced at its refineries to assured markets (ex controlled retail chains and long term wholesalers). A greater retail presence would allow MPC to sell a greater portion of its gasoline production to the higher margin assured market vs the wholesale or spot markets.

MPC Cons

• Less Control. On the face of things, selling its pipelines would give Marathon less control over the operations and strategic direction said pipelines. However, MPC will have long-term contracts to use these pipelines. In fact, in anticipation of the spinoff of its pipelines into an MLP, MPC has already entered into long-term contracts with its pipeline subsidiary.
  • MPC’s pipelines are already common carrier and as such, open to all users under tariffed rates.
  • Contracts will allow MPC to continue to use the pipelines.
• Leakage in Value Creation. Pipelines are often not operated in an optimally commercial manner when they are captive to an E&P company or a refiner vs a 3rd party. If MPC’s pipelines are sold/exchanged, MPC may be able to capture some of the upside/growth derived by a 3rd party owner if it takes units rather than cash as consideration.
  • Taking units may also help MPC to keep some control over its pipelines, and MPC may even be able to get board representation in the pipeline’s acquirer.

SUN/ETP Pros

• Retail Divestiture. ETP has indicated it would eventually sell SUN’s retail business. In addition to being not logistics oriented, there are some questions about whether or not the retail assets would be MLP qualifying.
• Synergies Between Pipeline Networks. A Combination of the MPC and SUN pipeline networks is likely to result in numerous synergies as new crude oil pipelines and refined product pipelines will be able to share rights of way with existing pipelines. The combined networks could create a best in class crude oil and refined products pipeline network which service most of the refineries and major markets in the North East and Ohio River Valley.
  • A combined network and their rights of way would simplify the construction of a crude oil pipeline which could more easily get crude oil from the Bakken to the stranded refineries on the east coast.

ETP Cons

• Possible High Pipeline Valuation. MPC does not appear to be an eager seller of its pipelines, and this may lead to having to pay a higher than desired price/valuation
• Complicated Organization. ETP restructuring could make it more difficult to realize operational synergies with Sunoco Logistics pipelines.

Other Possible Impediments

• Possible Anti Trust on Retail/Marketing. In the US, there are over 115,000 convenience stores which sell fuel, with 59,000+ convenience stores in the Midwest and south-east. A combination of the SUN and MPC retail businesses would total ~10,000 stores, not an overwhelming proportion of the total convenience store market.
  • PSX currently has ~10,000 stores on its own. A combined MPC/SUN retail would come close to rivaling PSX’s retail presence.
• Possible Anti Trust on Pipelines. There could be some antitrust concerns as two liquid pipeline systems are brought together. However, there is minimal overlap of services between the two networks.
  • SUN’s pipeline system in North East is predominantly a refined products pipeline network
  •  Any overlap SUN and MPC may have would seem to be for refined products in northern Ohio. However, SUN’s pipeline is an east to west pipeline while MPC’s pipelines are mostly south to north.

PDVSA Refinery Fire, A Catalyst for Non-Core Divestitures?

Last month’s tragic explosion at PDVSA’s massive (940,000 Bpd) Amuay refinery in Venezuela could serve as a catalyst for PDVSA to divest itself of some non-strategic assets. This fire will not only exert near term financial pressure on PDVSA as it is forced to purchase of refined product to satisfy local demand, but also medium term pressure as it tries to balance the need to spend capital to maintain current output, while also supporting Venezuela’s massive social programs.

US Pipelines Non-Core?

With most US interstate pipelines being common carrier, where the pipeline must offer its services to the general public under tariffed rates, PDVSA’s two US refineries only gain a minimal strategic advantage by owning non-controlling interests in crude oil and refined products pipelines. Though they are able to financially benefit from a pipeline’s profitability, lowering the effective rate they pay to use the pipelines, ownership of a non-controlling interest often offers a minority owner little influence on day-to-day operations. Minority owners may only have a blocking right on major decisions such as a change in a pipeline’s usage or direction.

To that end, should PDVSA divest itself of its minority interests in four US pipelines, it is likely that PDVSA’s two major US refineries will be able to receive the same level of service while freeing up capital.

PDVS’s US Pipelines

Inland Pipeline (refined products) – PDVSA owns a 16.2% interest in the Inland Pipeline. Sunoco Logistics (“SXL”), with a 83.8% ownership, owns a controlling interest in Inland, and SXL is also the operator of the Inland Pipeline. Inland is the owner of 350 miles of active refined products pipelines in Ohio. The pipeline connects three refineries in Ohio to terminals and major markets in Ohio. Based on the last sale of an interest in Inland in May 2011, the pipeline was valued at $118 million.

West Shore Pipeline (refined products) – PDVSA owns an 18.4% interest in the West Shore Pipeline. With a 34.6% ownership, Buckeye (“BPL”) is the operator of the West Shore Pipeline. The other owners of West Shore include ExxonMobile (“XOM”; 11% ownership), Shell (“RDS.A”; 18.9%), and Sunoco Logistics (17.1%). West Shore owns and operates approximately 650 miles of common carrier refined products pipelines that originate in Chicago, Illinois and which service delivery points from Chicago to Wisconsin. Based on the last sale of an interest in West Shore in July 2010, the pipeline was valued at $125 million.

West Texas Gulf (crude oil) – PDVSA owns 11.4% of the West Texas Gulf Pipeline. The other owners of West Texas Gulf are Sunoco Logistics (60.3%) and Chevron (“CVX”; 28.3%). West Texas Gulf owns and operates approximately 600 miles of common carrier crude oil pipelines which originates from the West Texas oil fields at Colorado City and the Sunoco Logistics’ Nederland terminal, and extends to Longview, Texas where deliveries are made to several pipelines, including Mid-Valley. Based on the last sale of an interest in West Texas Gulf in August 2010, the pipeline was valued at $352 million.

Wolverine Pipeline (refined products) – PDVSA owns 9.5% of the Wolverine Pipeline. The other owners of the Wolverine pipeline are ExxonMobile (36.2%), Marathon (“MPC”, 5.6%), Shell (17.2%), and Sunoco Logistics (31.5%). Wolverine operates 700+ miles of active refined product pipeline in three states, connecting Chicago refineries to terminals in Michigan and Northwest Indiana and moving product west to east. Wolverine transports over 300,000 BPD of refined products.

It is important to note, many pipeline partnership agreements give existing owners a Right of First Refusal or a Last Look on the sale of an interest in a pipeline. Though it may be possible to structure a sale to circumvent the ROFRs or LLs, these structures often limit the universe of potential buyers of a minority in a pipeline to a pipeline’s existing owners. Because the universe of potential buyers may be limited, the sale of a minority interest in a pipeline may generate a less than desired amount of upside for the seller.

Note: Most of PDVSA’s assets in the US are held through its Citgo subsidiary.

Who Has Infrastructure in the Utica and Marcellus?

With an estimated 5.5 billion barrels of potential oil reserves, the Utica could come close to rivaling the Bakken and Eagle Ford formations in terms of potential oil production. If it does, the Utica’s light shale oil could become a potential windfall for PADD I and Canadian refineries who are not engineered to process the cheaper but heavier grades of crude which are produced in Canada, Mexico, Venezuela or Saudi Arabia, and which are dependent on more expensive seaborne imports of light crude from West and North Africa, and from the North Sea.

With nearly 1.2 million Bpd of demand which is currently being fulfilled entirely by seaborne imports of light sweet crude because of a lack of physical infrastructure to move crude from the US Gulf Coast and Mid-Continent regions to the East Coast, it would seem PADD I refiners could be one of the readiest (and easiest) customers for oil produced in the Utica. Though slightly farther away, Canada’s Eastern refineries, with their 1.2 million Bpd of demand, also lack the infrastructure necessary to access crude from Alberta and the Mid Continent, and as a result, are forced to import crude. Given the opportunity, these refiners, and their 1.2 million bpd of demand, could also be ready consumers of oil from the Utica. Finally, some eastern PADD II refiners could also be ready customers for Utica oil, but many of the major PADD II refiners are retooling to be able to use the cheaper and ever increasing volumes of heavier crudes which are being produced in Canada. This retooling could increase PADD II heavy crude demand by 470,000 bpd, while freeing up 430,000 bpd of light crude, to the benefit of PADD I and Eastern Canadian Refiners.

Though the Utica Shale lies under most of New York, Pennsylvania, Ohio, and West Virginia and extends under adjacent parts of Ontario and Quebec in Canada and Kentucky, Maryland, Tennessee, and Virginia in the United States, the Utica’s oil window is expected to largely lie under eastern Ohio. Exploration and development of the Utica has just started, but early results in Harrison and Carroll County, Ohio have been encouraging,  and as a result, it might be time to begin to think about how to get the oil from the wells to a refinery. To that end, we thought we would explore the north-eastern assets of some of the larger petro-logistics companies.

Though Ohio was once a prolific oil producer, spawning the construction of the the eighth largest refining capacity in the US, Ohio’s oil and gas production is not what it once was. While its refining infrastructure has endured, its petro-logistics infrastructure could use some revitallization.

There are generally three main ways to move crude oil and refined products. Though pipelines have recently had some spill issues, they are generally much safer and more efficient than trains, trucks and barges when transporting fuel long distances. That said, before a critical mass of oil wells are developed, trucks are often the best way to aggregate production from dispersed wells, and trains are often the easiest way to ship production before more permanent infrastructure can be built. The following are some of the companies which have existing crude oil and refined products infrastructure in the Utica. These assets, together with their associated rights of way, could serve as a solid foundation upon which to rebuild the infrastructure needed to bring crude east from Ohio to PADD I refiners:

• Buckeye Partners (“BPL”) – With a history tracing its roots back to 1886, when The Buckeye Pipe Line Company was incorporated as a subsidiary of the Standard Oil Company, BPL has over 6,000 miles of pipeline. Additionally, BPL owns ~100 liquid petroleum products terminals with an aggregate storage capacity of ~64 million barrels, and operates/maintains ~2,800 miles of pipeline for major oil and chemical companies.
  • Pennsylvania/New Jersey/New York Pipelines – BPL serves refined petroleum product demand in major population centers in Pennsylvania, New York and New Jersey through ~925 miles of pipeline. Refined petroleum products are received at Linden, NJ from 17 major source points, including two refineries, six connecting pipelines, and nine storage and terminalling facilities. Products are then transported through two lines from Linden to Macungie, PA. From Macungie, the pipeline continues west to Pittsburgh, PA and north through eastern Pennsylvania into New York. Products received at Linden are also transported to Newark Airport, to JFK Airport, to LaGuardia Airport and to refined petroleum products terminals at Long Island City, NJ and Inwood, NY.
    • BPL also has a pipeline system which extends from Paulsboro, NJ to Malvern, PA. From Malvern, a pipeline segment delivers refined petroleum products to locations in upstate New York, while another segment delivers products to central Pennsylvania. Two shorter pipeline segments connect the Paulsboro refinery to the Colonial pipeline system and the Philadelphia International Airport.
    • The Laurel pipeline system transports refined petroleum products through a 350-mile pipeline extending westward from four refineries and a connection to the Colonial pipeline system in the Philadelphia area to Pittsburgh.
  • Ohio/Indiana/IllinoisMichigan/Missouri Pipelines – BPL transports refined petroleum products in northern Illinois, central Indiana, eastern Michigan, western and northern Ohio, and western Pennsylvania through ~2,100 miles of pipeline. A number of receiving lines and delivery lines connect to a central corridor which runs from Lima, OH through Toledo, OH to Detroit, MI. Refined petroleum products are received at a refinery and other pipeline connection points near Toledo, Lima, Detroit, and East Chicago, IN. Major market areas served include Peoria, IL; Huntington/Fort Wayne, Indianapolis and South Bend, IN; Bay City, Detroit and Flint, MI; Cleveland, Columbus, Lima and Toledo, OH; and Pittsburgh.
  • Midwest Pipelines – In the midwest, BPL also owns eight refined petroleum products pipelines whose aggregate mileage total ~1,250 miles. Refined petroleum products are received from the Wood River, IL refinery and are transported to Chicago, to BPL terminals in St. Louis, MO, to the Lambert-St. Louis Airport, to receiving points across Illinois and Indiana, and to BPL’s pipeline in Lima. Petroleum products are also transported from East St. Louis, IL to East Chicago with delivery points in Illinois and Indiana, and from East Chicago to Kankakee, IL.

• Crosstex Energy, LLC (“XTEX”) – Though substantially smaller than some of its brethren, XTEX has begun to establish a presence in the Utica through its acquisition of Clearfield Energy. Through this acquisition, XTEX now has assets which handle ~300,000 barrels per month of crude and condensate in Ohio, Kentucky and West Virginia. These assets include:
  • A 4,500-barrel-per-hour crude oil barge-loading terminal on the Ohio River
  • A 28,000 bpd crude oil rail-loading terminal on the Ohio Central Railroad network. XTEX expects to expand this facility to a 56,000 bpd  facility by year-end 2012.
  • 200 miles of crude oil pipelines in Ohio and West Virginia
  • More than 500,000 barrels of above ground storage
  • Six brine water disposal wells, with two additional wells under development
  • An extensive truck fleet with a handling capacity of 35,000 bpd
  • XTEX also acquired more than 2,500 miles of unused right of way for future expansions.

Though they do not have nearly the economies of scale which come with more permanent infrastructure such as a pipeline or even rail, trucks and barges are often the easiest way to aggregate initial oil production until more permanent infrastructure can be constructed.

• Marathon Petroleum (“MPC”) – With its beginning as The Ohio Oil Company, before being absorbed into the Standard oil Trust, MPC, through Marathon Pipe Line LLC (MPL), manages one of the largest petroleum pipeline networks in Ohio. In aggregate, MPL owns, leases, or has ownership interests in ~8,300 miles of pipeline spread across 52 systems in 12 states. Below is a partial list of MPC’s pipeline interests:

Pipelines which are owned and operated by refiners and/or E&P companies are often underutilized and are not operated to their peak commercial potential. As a result, they can often benefit from being owned and managed by more focused third party.

• Sunoco Logistics (“SXL”) – Sunoco got its start in 1886 as one of Standard Oil’s first substantial competitors. In the northeast, SXL has the following assets:
  • Included in SXL’s Crude Oil Pipeline System is a 91% interest in the Mid Valley Pipeline Company, a crude oil pipeline which consists of a ~1,000 mile pipeline originating in Longview, TX, passing through Louisiana, Arkansas, Mississippi, Tennessee, Kentucky and Ohio, before terminating in Samaria, MI. This pipeline provides crude oil to a number of refineries, primarily in the midwestern United States.
    • In addition, SXL owns a ~100 miles of crude oil pipeline that runs from Marysville, MI to Toledo, OH, and a truck injection point for local production at Marysville.
  • The SXL Refined Products Pipeline System consists of ~2,500 miles of refined products pipelines which transport refined products from refineries in the northeast, midwest and southwest United States to markets in New York, New Jersey, Pennsylvania, Ohio, Michigan, Texas and Canada. The refined products transported in these pipelines include multiple grades of gasoline, middle distillates (such as heating oil, diesel and jet fuel) and LPGs (such as propane and butane).
    • Included in SXL’s Refined Products Pipeline system is an 84% interest in Inland Corporation, a pipeline system SXL operates that connects three refineries in Ohio to terminals to major markets in Ohio. SXL  also operates, and owns a 2/3s interest in the Harbor Pipeline, which transports products from the Philadelphia area to the Linden/Newark, New Jersey area.

• Williams Partners (“WPZ”) – Though its infrastructure is mostly natural gas and NGL oriented, WPZ has been building up its presence in the Marcellus and Utica through step out acquisitions around its Transco interstate natural gas pipeline. Since 2010, WMB has made the following acquisitions to form a foundation for its Marcellus and Utica business:
  • Cabot Midstream Assets – In December 2010, WPZ spent $150 million to purchase Cabot Oil & Gas’s midstream assets in Susquhana, PA. These assets included 75 miles of gathering systems and a 25 year dedicated gathering agreement covering 138,000 net acres.
  • Laser Gathering System – In December 2011, WPZ spent $750 million to purchase the Laser North East Gathering system. These assets included 33 miles of 16 inch gathering systems in north eastern Pennsylvania, and 10 miles of gathering pipeline southern New York. This acquisition was supported by existing long-term gathering agreements with acreage dedications and volume commitments.  As gas production in the Marcellus increases, the Laser system is expected to 1.3 bcfd of natural gas.
  • Caiman Eastern – In April 2012, WPZ spent $2.4 billion to acquire Caiman Eastern Midstream, LLC. This acquisition establishes WMB’s Ohio Valley Midstream business and provides WPZ with a significant footprint with strong growth potential in the natural gas liquids-rich portion of the Marcellus Shale in northern West Virginia, eastern Ohio, and south-western Pennsylvania. This business is anchored by long-term contracts, including gathering dedications totaling 236,000 acres from 10 producers. Additionally, there are processing commitments in place for 100 mcfd of gas and work is under way to expand the existing physical assets, which include a gathering system and a processing facility. Finally, construction is underway on NGL fractionation and additional processing facilities, and the company is also considering the construction of natural gas liquid (NGL) pipelines.
  • Caiman II Investment – Caiman II’s area of focus will be the natural gas liquid- and oil-rich areas of the Utica Shale in Ohio and northwest Pennsylvania. Together with EnCap Flatrock Midstream of San Antonio, Highstar Capital of New York, and Caiman management WPZ anticipates that Cainman II will invest ~$800 million to develop natural gas, natural gas liquid and crude oil gathering and processing infrastructure. WPZ’s anticipated share of the $800 million in potential development is could total up to $380 million over the next several years.

Infrastructure SOS in the North East

Yesterday’s announcement of Carlyle’s (CG) acquisition of a majority interest in Sunoco’s (SUN) 330,000 barrel per day Philadelphia refinery and last month’s acquisition of Philips 66’s 185,000 bpd Trainer refinery by Delta Airlines highlight the need to revamp and repurpose some of the energy infrastructure in the North East.

Both of these facilities had been put on the chopping block in large part because of their reliance on imported crude oil as their base feedstock. Because the infrastructure (and until recently, the supply) has been unavailable for East Coast refiners to access domestic (ex Bakken) or Canadian crude oil production, the wide spread between imported crude oil and domestic crude oil has caused East Coast refineries to be unprofitable. Sunoco has stated it has lost over $1 Billion in its refinery business in the past three years.

The Bakken Crude Advantage

Bakken crude oil is currently priced at a discount of about $7 to $10 a barrel to benchmark West Texas Intermediate (WTI) crude oil. As of late, WTI crude oil has traded at a $12-15 discount to Brent crude oil, the benchmark for most crude produced in the Atlantic. Railroad freight charges to transport a barrel of oil from North Dakota, where the majority of Bakken crude oil is produced, to the East Coast are about $12-$15 per barrel. Transatlantic shipment of crude is currently about  $4.50-$7 per barrel. Doing a back of the envelope calculation, shipping Bakken crude via rail to Philadelphia would allow a refinery to benefit from a $11 per barrel decrease in input costs.

As a near term way to capture this input cost differential, part of Carlyle’s investment in Sunoco’s refinery will be the construction of a high speed train unloading facility at the refinery. This facility is expected to be completed by the end of this year, and will give the refinery the ability to off load up to 140,000 barrels of oil per day (~42% of the refinery’s capacity) of North American crude oil.

Rail is Suboptimal

Though certainly a good short-term solution, the shipment of crude oil from North Dakota to Philadelphia via train is not an optimal medium or long-term solution for the following reasons:

(1) Once in place, pipelines will always be more economic than trains. Shipping by rail costs $12-15 per barrel. This compares with an estimated $4-8 per barrel from Chicago or Toledo to Philadelphia or possibly $7-$11 from North Dakota to Philadelphia.

(2) Pipelines will always be more reliable than trains, especially trains that have to transit through Chicago. Trains carrying oil from the North Dakota to Philadelphia will always have to travel through Chicago, where over 1,200 trains transit per day. Though three additional unit trains per day would not seem to be a huge amount of incremental usage, it is widely known that Chicago’s train infrastructure is at its limits and trains are often subject to delays. If all three Delaware Valley refineries (Carlyle, Delta, and PBF/Blackstone) refineries all have the same idea and try to import crude from North Dakota, these three refineries could create a demand for up to 650,000 bpd of crude oil. This would necessitate the use of up to 14 unit trains (or 1,400 cars) per day. In addition to increasing Chicago’s burden, the impact of 14 unit trains on Philadelphia’s rail infrastructure is not likely to be insignificant.

(3) It is likely that pipeline companies will be able to leverage existing infrastructure to provide pipeline access from the North Dakota to Philadelphia.

• Enbridge (ENB) is one of the largest oil pipeline companies in North America with a large amount of pipeline capacity coming from Canada, through North Dakota to a hub in Chicago. ENB is currently increasing the capacity of its routes to Chicago and from Chicago to Toledo. These expansions which will add an incremental 150,000 bpd of capacity are likely to be operational by 2014.
• Sunoco Logistics (SXL), Buckeye Partners (BPL), and Marathon Petroleum (MPC) all seem to have assets which could be used as part of the final leg of pipeline transport of crude oil from Chicago (or Toledo) to Philadelphia.
• Sunoco Logistics (SXL) – Owns the last mile of piping and out of the Sunoco refinery which is being sold to Carlyle; Because of the close proximity or Delta’s refinery to the Carlyle refinery, SXL also would seem to own pipe within a few miles of Phillips 66 refinery which was sold to Delta; SXL also has an extensive pipeline network in New Jersey, Ohio, Michigan, and Illinois.
• Buckeye (BPL) – BPL has an extensive pipeline network in Ohio, New Jersey Indiana, Illinois, and Michigan.
• Marathon Petroleum (MPC) – MPC is an independent refiner with extensive pipeline assets in Ohio, Indiana, Illinois, Kentucky, and Michigan. MPC’s refineries would also benefit from pipeline access to Bakken and Canadian crude.

Bakken Alternatives

• Canadian Crude Oil A pipeline connection Enbridge or Keystone’s pipelines or to an Illinois pipeline hub in Chicago, Wood River, or Patoka would also give a shipper access to Canadian crudes once Keystone XL and Enbridge expansions come on line in 2014 and 2015.
• Utica Shale. Possible play on the oiliness of the Utica Shale. Though in a much earlier stage of development than the Bakken or the Marcellus shale formations, the Utica shale formation in Ohio, Pennsylvania and West Virginia is expected to be very prolific. Early drilling results from Anadarko and Chesapeake have been very promising. The possible medium term emergence of the more local source of oil in the Utica may prevent the development of a pipeline all of the way from Philadelphia to Chicago. It would probably not preclude the development of a pipeline to a meet me point in Ohio (ex Toledo, canton, or Lima).
• Marcellus Shale. Though the Marcellus formation is very close to Philadelphia, it is not very rich in oil. However, the refinery’s close proximity to the inexpensive gas from the Marcellus should be of benefit. Though the refinery had previously been using oil to power its production processes, it is likely that the refinery will switch to locally sourced natural gas to power its production processes. With a cost of less than ¼ of oil, on an energy equivalent basis, the refinery’s access to locally sourced gas is also likely to be beneficial to the refinery’s profitability. Further, locally sourced gas is also likely be an inexpensive source of hydrogen for use in the refinery’s newly announced hydrocracker. Depending in the size of the hydrocracker and the new hydrogen plant, the facility could use locally sourced, and low priced natural gas to get up to a 30% unit volume expansion on its feed stocks. Where one barrel of feed stock would normally yield one barrel of distliates, hydrogen cracking could increase the yield such that the refinery could produce up to 1.3 barrels of middle distillates such as gasoline, diesel, or jet fuel per barrel of feed stock.

Why didn’t their original owners make these changes?

• Until recently, North American, and specifically Bakken crude oil production was rather limited. In January 2010, the Bakken produced 165,000 bpd of crude oil. In April, 2012, Bakken production increased to 545,000 bpd of, a CAGR of over 65%. Some pundits expect Bakken crude oil production to increase to 800,000 to 900,000 bpd by 2025, with one of the biggest constraints on production being the ability to easily get the oil and gas to market.
• This transition in is likely to take time, and until the supporting infrastructure is fully developed, likely to continue to generate losses. As such, a transition like this is best done in private, without the scrutiny and earnings drag which comes with being a part of a public company.

Sunoco/Energy Transfer Partners and Marathon Petroleum, a Match Made in Heaven?

On April 30, 2012, Energy Transfer Partners (“ETP”) announced its intention to acquire Sunoco (“SUN”). SUN has spent the last few years rationalizing its business lines and has slimmed it self down to two main businesses: (1) Retail Gasoline Service Stations and (2) Oil and Products Pipelines.

Though consistently profitable, ETP has stated that SUN’s retail business is noncore, and as it works to simplify its story, it is likely ETP will look to monetize SUN’s retail business.

Though there are a number of possible buyers (ex. Alimentation Couche-Tard Inc., Casey’s, Pantry, Susser, Valero, etc.) for SUN’s retail business, a deal with Marathon Petroleum (“MPC”) would seem to be optimal for both SUN/ETP and MPC. In this potential SUN/ETP and MPC transaction, SUN/ETP would swap its retail business for MPC’s pipeline business.

 Benefits for MPC

• Increases MPC’s retail presence and decreases its exposure to wholesale gasoline sales
  • MPC has been acquiring retail outlets
• Ability to monetize a non core asset at premium valuation
  • Pipeline contributed ~4.1% of MPC’s EBITDA
  • Pipelines trade at 10-12x EBITDA vs 2.75x-4x for refiners and 6-8x for retailers
  • MPC has been shedding/selling/closing pipeline miles; MPC is definitely not growing its pipeline miles
  • As a captive pipeline business, it is likely that MPC is not utilizing its pipeline network in a commercially optimal fashion
• A tax free monetization of MPC’s pipeline assets might be possible
  • Reverse Morris Trust opportunity
• Synergy Opportunities
  • SUN retail locations seem to underperform those of MPC’s when measured by: Light Product Sales, Light Produce Margin, Merchandise Sales, and Merchandise Margin
  • Retail gasoline margins higher than wholesale gasoline margins
  • Ability to amortize marketing dollars over larger footprint

Cons for MPC

• Doubles size of retail business
  • More revenue volatility associated with gasoline prices and retail sales vs. pipelines
  • Possible anit-trust concerns, but combined retail businesses would have less than 9% national market share
• Decreases exposure to stable pipeline business
  • EBITDA ranged from $213-244MM in 2008-2012
• Marathon might view pipelines as being strategic
  • Can sign long term usage contracts with SUN/ETP which will preserve most of their rights on the pipelines, or keep stub ownership

 Benefits for SUN/ETP

• Decreased exposure to non-core asset
  • Possible issues around MLP qualified nature of retail assets’ cash flow
• Increased breadth and scope of growing oil, refined products and NGL pipelines in the midwest and northeast
• Tax free monetization of retail assets
  • Reverse Morris Trust opportunity
• Synergy Opportunity
  • Highly likely that MPC’s pipelines have not been operated in an optimally commercial fashion

Cons for SUN/ETP

• Even though the MPC’s pipeline business and SUN’s retail business generate similar levels of EBITDA, it is likely SUN will need to contribute $500MM to $1B of cash to bridge the valuation gap because pipelines trade at 10-12x EBITDA and retail businesses trade at 6-8x EBITDA
  • SUN can swap its retail assets for less than 100% (60-75%) ownership of MPC’s pipeline assets

• Dilutive equity might need to be raised to bridge the valuation gap
  • If SUN’s retail business is being contributed on an unlevered basis, the debt SUN (or MPC) would have to raise to bridge the $500MM to $1B is reasonable at only 2-4x MPC’s pipeline EBITDA