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Permian Basin bottleneck clouds pipeline companies' strong financial results

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Permian Basin bottleneck clouds pipeline companies' strong financial results

With bottlenecks appearing earlier than expected, insufficient takeaway capacity in high-production shale plays headlined the concerns that overshadowed oil and gas pipeline companies' improved financial results for the first quarter.

Only one of a selection of 10 large North American oil and gas transport firms recorded decreases in adjusted EBITDA and distributable cash flow in the quarter, while most others reported double-digit-percentage increases as midstream industry fundamentals extended their recovery. The transportation of oil and associated gas from the Permian Basin, however, weighed on analysts and executives as producers take about a $10 discount to get barrels from Midland, Texas, to Cushing, Okla. That discount could grow while drillers wait for more capacity to come online in the third quarter of 2019.

"We were relatively surprised at the infrequency of questions on midstream conference calls regarding Permian marketing strategies as any constraints will ultimately impact throughput at the midstream level," analysts at the energy investment bank Tudor Pickering Holt & Co. wrote in a May 11 note to clients. "With plenty of processing additions expected in coming quarters but natural gas takeaway lines largely full, [the] question remains on where incremental residue gas will be directed."

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In the early years of the shale revolution, midstream companies were eager to commit to long-haul pipes that would lock in guaranteed revenue through long-term, fee-based contracts. But after a commodity price downturn hit pipeline master limited partnerships hard in 2015 and effectively closed public equity markets, the sector as a whole scaled back on growth projects. With high leverage and stock market under-performance plaguing balance sheets as the future of the MLP structure hangs in the balance, management teams are reluctant to pour cash into expensive endeavors.

Trucking has emerged as a temporary solution for Plains All American Pipeline LP, whose 2018 guidance was based on takeaway constrains beginning in the second half of 2018 and the first half of 2019, but CEO Greg Armstrong acknowledged that keeping customers happy comes at a cost.

"Some of these things that we're doing right now ... we may not be making much in terms of incremental value to us right now by moving that barrel around these bottlenecks," he said May 8. "What we're doing is providing service to a customer that says, 'We told you we would move your barrel' and it will, and it's a long-term relationship. ... At the end of the day, it's about the certainty of ... moving that barrel from the wellhead to the best market on a routine basis."

Even Plains, however, posted a 16% increase in adjusted EBITDA and a 47% rise in distributable cash flow less than a year after announcing a 45% distribution cut and plans to reduce leverage to $9.7 billion from $11.15 billion.

"There were few signs of stress this quarter, as operators either delivered on 1Q expectations or signaled strong 2Q growth," midstream analysts at Guggenheim Partners LLC said in a May 15 note to clients.

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First-quarter operational stability also belied the fallout from the Federal Energy Regulatory Commission's March 15 ruling to no longer allow oil and gas pipeline MLPs to recover an income tax allowance in cost-of-service rates, a decision based in part on the 2017 federal corporate tax rate reduction.

The bellwether Alerian MLP Index plummeted in the two weeks following FERC's decision, but partnerships with minimal exposure to cost-of-service rates saw their share prices recover while peers like Enbridge Energy Partners LP and TC PipeLines LP face buyouts and distribution cuts over the expected impacts from the federal regulatory agency's policy change.

The Alerian Index dropped 11% on a total-return basis, including distributions, during the first quarter. The price of West Texas Intermediate crude, meanwhile, rose 7.5%, illustrating further that the former link between the key index and oil prices is broken as disenchanted unit holders and the prohibitive cost of capital fuel negative sentiment about MLPs.