At BP Capital Fund Advisors, we believe a differentiating aspect of the TwinLine MLP fund is our investment approach, which emphasizes a preference for assets that sit closer to the end user along the midstream value chain. In practical terms, volume throughput on these demand centric assets is influenced more by incremental consumption trends or ‘demand-pull’ and less by upstream producer volume or ‘supply-push’, which can be heavily impacted by commodity price volatility. Benefiting from stable throughput, demand-pull oriented assets generally enjoy more consistent operating performance which tends to translate into greater stability in financial results, ultimately providing investors with the potential for a more reliable stream of cash distributions.
In recent years, price-induced demand growth here at home has provided a favorable growth tailwind for the midstream sector, creating infrastructure build-out opportunities to facilitate a broader use of lower cost feedstock and fuels by users in the U.S. Going forward, we see the trend continuing. Over the next several years, globally competitive, low cost U.S. energy will continue to drive a new wave of infrastructure build out, this time through export demand, providing yet another leg of growth for properly positioned midstream companies and MLPs.
In this white paper, we 1) provide a background to the export led price-induced demand trend currently in place in the U.S. 2) identify key demand projects and 3) highlight the specific midstream companies capitalizing on export demand driven infrastructure build out opportunities.
The Origin of Price Induced Demand: Abundance – ‘Our Cup Runneth Over’ U.S. upstream producers continue to push the envelope across every major shale basin in the U.S. The combination of cost efficiency improvements and well productivity gains have enabled U.S. operators to do more with less and expand volume to levels that at one time would have been unthinkable given the current pricing environment. As a consequence, rising production volumes have pushed U.S. storage inventory levels of crude oil, natural gas and natural gas liquids to levels at or near respective historical seasonal highs.
But wait there’s more – ‘Sitting DUC(s)’ In addition to current storage above ground, the U.S. oil and gas industry has drilled an extensive inventory of drilled but uncompleted wells or (DUCs), effectively creating a virtual underground store of production just sitting and waiting to be unlocked. While timing of development is uncertain, production additions generated through DUC completion stand to add significantly to the current U.S. supply volumes, ultimately providing ‘just in time’ production capacity, ready to satisfy short term demand needs should they arise.
U.S. Producers: Prisoners Dilemma and the real Winner Victims of their own success, U.S. producer led volume gains, bloated inventories and DUCs have weighed on commodity prices. In surprising fashion though, cost efficiencies continue to allow many E&P companies to maintain activity levels and margins even as prices have come down. The resulting combination of low cost, abundant resource has translated to a relative pricing advantage in the U.S. versus that which is available in foreign markets. Recognizing the profit opportunity in low cost U.S. supply, foreign consumers are increasing consumption through new and expanded projects providing access to U.S. energy.
Export led Demand-Pull Projects Most if not all categories of hydrocarbons unlocked from shale development are seeing greater export opportunities. Just in the past few years, globally competitive natural gas prices have prompted the development of liquefied natural gas (LNG) export projects as well as natural gas export pipelines to Mexico. Similarly, attractive natural gas liquid (NGL) feedstock pricing has incentivized the construction of ethane, propane and butane export facilities. Most recently, export demand for crude oil and refined products is necessitating the build out of export oriented infrastructure, namely pipelines, storage facilities and dock expansions.
While commodity pricing has provided challenges for industry producers, stable volume growth and tangible evidence of growing global demand have provided confirmation that export driven midstream investment fundamentals remain sound and may continue to support improving operational and financial results for many midstream and MLP companies in our universe. Let’s take a look at these growth projects and what they mean for U.S. volume growth.
Natural gas exports U.S. natural gas demand growth is being driven by two key export trends, 1) large scale LNG project development and 2) pipeline capacity expansion linking the U.S. to Mexico.
U.S. flips the script, LNG Importer to Exporter Once thought to be in short supply, natural gas infrastructure was built to import LNG during the first decade of 2000. By 2016, shale gas abundance and its competitive global pricing incentivized foreign demand enabling the U.S. to reverse course and become a net natural gas exporter. The U.S. now consistently, exports more than 1.5 billion cubic feet per day (bcf/d) of natural gas. To put this in context, the global LNG export market in 2016 was roughly 34.5 bcf/d.
At present, there are 5 separate LNG liquefaction projects currently under construction and scheduled to come online between now and the year 2020. Importantly, each of these projects is underpinned by long term LNG delivery contracts. In the chart below, we illustrate these projects and their respective projected capacities as guided by each project’s operator. Actual LNG export volumes are charted through April, 2017, and future volumes are projected based on contracted utilization rates, also provided by the project’s operators. As illustrated below, U.S. LNG volumes are set to grow dramatically from the April, 2017, rate of 1.7 bcf/d to nearly 7.5 bcf/d by 2020. Adding 5.6 bcf/d of LNG demand would require an additional call on U.S. production volume of roughly 7.3%.
Midstream companies benefiting from the expansion of LNG export capacity have been numerous. Primary winners are the operators of the projects themselves that have committed volume contracts with foreign buyers for periods as long as 20 years. As indicated above, this group includes Cheniere Energy (LNG, CQP, CQH), Dominion Energy (D), Kinder Morgan (KMI), and private company Freeport LNG. Secondary beneficiaries have included a variety of infrastructure providers that will connect liquefaction facilities with feed gas, sourced from the U.S. natural gas pipeline system.
Exports to Mexico – ‘Making a Run for the Border’ In a sweeping measure to facilitate a wider use of natural gas within Mexico, the country’s energy ministry announced a comprehensive five-year plan in 2015 to expand the network of pipelines providing gas to various end users. The Ministry’s proposal included the addition of 12 pipelines primarily to accommodate rising power demand and offset the impact of declining local supplies, but also to reduce dependence on LNG imports. Once finished, the pipeline buildout would increase existing connectivity to the U.S. through the addition of more than 3,200 miles of new pipeline through Mexico. Energy Information Administration (EIA).
As indicated below, we have charted U.S. to Mexico natural gas transportation capacity additions as well as current and projected rates of natural gas exports. Assuming newly built pipelines are at least filled 50% to capacity once in service (a very conservative assumption) April 2017, volume of 4.3 bcf/d would rise by nearly 3 bcf/d to 7.1 bcf/d by 2019. Adding 2.8 bcf/d of Mexican export demand would require an additional call on U.S. production volume of approximately 3.6%, assuming the April 2017 U.S. daily production rate of 76.8 bcf/d.
Midstream companies benefiting from the expansion of export pipeline expansion to Mexico are primarily those companies building and operating pipelines that will likely be moving contracted volumes from supply points in the U.S. to border crossings and beyond into Mexico. As indicated in the chart above, that would include, TransCanada Pipeline (TRP), Energy Transfer (ETE,ETP), Kinder Morgan (KMI), and Sempra Energy (SRE) through its Mexican division Ienovoa, and private company Howard Energy. Secondary beneficiaries include a variety of infrastructure providers that may connect export pipelines with natural gas, sourced from the U.S. natural gas pipeline system.
Natural Gas Liquids (NGLs) Growing in tandem with natural gas volumes, associated NGL production has risen rapidly, ultimately surpassing capacity for U.S. consumption. As a result, the composite price of an NGL barrel and the component purity products that comprise, have been depressed due to swollen storage inventories. Fortunately, just like natural gas, competitive pricing for NGLs, primarily ethane, propane and butane, is stimulating new demand here at home and abroad.
NGLs on the move – ‘One Word, Plastics!’ Ethane is used almost exclusively as a feedstock for petrochemical companies in the production of ethylene, a core component that goes into the manufacture of many plastics. Because U.S. ethane has become so cheap, both foreign and domestic petrochemical companies have initiated plans to build new manufacturing capacity here in the U.S. While the magnitude of domestic end-user demand growth is beyond the scope of this white paper, it is included in the chart below simply to put the magnitude of U.S. ethane demand growth into perspective.
As indicated in the chart below, two ethane export projects and seven ethane steam cracker plants are approved and set to come online through year end 2018. Projected capacities have been disclosed by each respective project or plant operator. Actual volumes are charted through April 2017, and future ethane demand is based on the EIA’s Short Term Energy Outlook from July 2017. As is evident below, ethane volumes are set to grow from the April 2017 rate of 1.1 million barrels per day (mmbbls/d) to nearly 1.6 mmbbls/d by year end 2018.
Beneficiaries of increasing petrochemical feedstock demand have been midstream providers providing the necessary infrastructure to link processed natural gas liquids with end user petrochemical facilities here and abroad. Those would include Enterprise Products Partners (EPD), and Energy Transfer Partners (ETE, ETP), MPLX (MPLX) and Oneok (OKE). Secondary beneficiaries would be the numerous midstream companies that extract and process NGLs from the natural gas production streams.
NGLs on the move – ‘LPG Exports Are Cookin’ Ethane isn’t the only NGL component product seeing growth out of the U.S. Liquified Petroleum Gas (LPG) volumes, comprised of propane and butane, have risen significantly over the last several years with rising natural gas volumes. Surplus LPG supply conditions have weighed on prices in the U.S. which in turn have incentivized price-induced export demand by foreign end users seeking cheaper alternatives.
As indicated in the chart below, U.S. LPG exports have risen dramatically. Since 2008, average annual LPG exports have risen more than 5 fold to over 1 mmbbls/d. With two additional export projects set to come online by year end 2018, volumes could potentially gain another 20%. Based on the EIA Short Term Energy Outlook issued during July, 2017, U.S. LPG exports could rise 150 mbbls/d by year end 2018.
Beneficiaries of increasing petrochemical feedstock demand have been midstream companies providing the necessary infrastructure to link processed natural gas liquids with end user petrochemical facilities here and abroad. Those include Enterprise Products Partners (EPD), Targa Resources (TRGP), Energy Transfer Partners (ETE,ETP), Occidental Petroleum (OXY), Conoco Phillips (COP), private company Sage Midstream and Pembina Pipeline (PBA). Secondary beneficiaries have been the numerous midstream processing companies that extract NGLs from the natural gas production streams.
Background to crude oil and refined product exports – With U.S. oil production nearly doubling over the last 7 years, U.S. end users have been challenged to find ways to absorb an abundance of supply. Complicating matters, shale derived crude grades have generally been more light and sweet in terms of quality, which has meant that even after reducing U.S. imports of similar quality, the U.S. has had limited ability to process these grades given the current configuration of the U.S. refining complex This challenge is widely known as the ‘blend wall’. A relief valve was opened however, when the U.S. lifted the crude oil export ban in December, 2015.
The Flood Gates are Open – Free from the constraints of the export ban, U.S. oil producers are now on a more equal footing with other energy commodity exporters and are able to move volumes to end users around the world. As with Natural gas and NGLs, local U.S. price advantages for refined products, namely gasoline and distillate, in addition to crude oil, are creating opportunities for U.S. companies to satisfy demand overseas.
Refined Products – Benefitting from cost advantaged feedstock, U.S. refiners have been expanding their production of gasoline and distillate to satisfy foreign demand. As, indicated in the chart below, volumes of gasoline and distillate have grown considerably. On a combined basis, since 2007, gasoline and distillate exports have risen nearly fourfold from 500 mbbls/d to over 1.9 mmbbls/d.
Companies benefiting from the expansion of refined product export capability have been numerous. Clearly refiners and refining logistics companies are benefiting from increased throughput volumes, but storage facility operators and export dock operators participate as well. Those midstream companies that have been primary beneficiaries of the refined product export trade are Enterprise Products, LP (EPD), Magellan Midstream Partners, LP (MMP) and Buckeye Partners, LP (BPL).
Crude oil export spikes after ban elimination As mentioned, the U.S. refining complex remains limited in its capacity to process light sweet grades of crude. Since U.S. shale development is resulting in crude volumes that have overwhelmed our capacity to refine them, end user demand from outside the U.S. will be required to clear U.S. market surpluses. Since the lifting of the crude export ban in 2015, price-induced export demand has driven export volume growth out of the U.S. Gulf Coast.
As indicated in the chart below, U.S. crude oil export volumes have risen dramatically since year end 2015, averaging over 578 mbbls/d. While this number may appear small in the global supply picture, volumes are anticipated to increase dramatically as anticipated U.S. volume growth increasingly requires export markets to clear imbalances here at home.
With much of the incremental crude oil growth coming from the Permian Basin in West Texas and New Mexico, pipeline operators are rushing to build and expand transportation lines connecting facilities at the nearest access points to export demand. The primary ports providing ship loading capacity along the gulf coast are the ports of Corpus Christ and the Houston Ship Channel. At present, several significant expansion projects are being undertaken to expand U.S. export at these key ports.
Primary beneficiaries of crude export trends have included Enterprise Products (EPD) which has significant dock and storage capacity at the Houston Ship Channel, Magellan Midstream Partners (MMP), which has significant storage capacity at both Corpus Christi, TX and the Houston Ship Channel as well as dockage at the Houston Ship Channel. Buckeye Partners, (BPL) which has storage and extensive dock capacity at Corpus Christi, and NuStar Energy (NS, NSH) which has Corpus Christi export capability.
Summary – The U.S. shale revolution has created an abundance of low cost crude oil, natural gas and natural gas liquids that are increasingly being sought by foreign end users seeking to capitalize on relatively attractive domestic pricing. To facilitate that consumption, the U.S. midstream sector is providing logistic solutions that provide a very real, tangible growth opportunity for a select group of midstream companies and MLPs.
We see natural gas throughput volumes rising significantly into the end of the decade with LNG and export pipelines to Mexico. Combined, with 5.6 bcf/d added through LNG and 2.8 bcf/d being added with exports to Mexico, U.S. gas production will be required to grow by 8.4 bcf/d by 2020 which would represent 11% growth from the current level of 76.8 bcf/d.
We see natural gas liquids throughput volumes also rising significantly over the next several years, with growth coming from ethane, butane and propane exports. Through year end 2018, ethane export volumes are expected to grow by 420 mbbls/d and LPG volumes are expected to grow by 146 mbbls/d, representing growth of 37.5% and 14.5% respectively.
Similarly, crude oil export volumes should continue to rise in tandem with growing U.S. shale oil production. While the volume ramp is difficult to predict given the variety of variables at play, (global pricing spreads, and localized supply and demand trends) it seems reasonable to assume volumes across the U.S. could continue to grow on recent trend. Since bottoming last August, U.S. lower 48 crude oil production has risen by nearly 1 mmbbls per day. If volumes were to grow at half that rate, it would be logical to assume that exports could rise by that same amount, implying 500 mbbls/d of U.S. oil export growth per year going forward.
From our perspective at BP Capital Fund Advisors, the trend toward globally competitive U.S. energy is creating an attractive opportunity for investors to once again participate in the buildout of U.S. energy infrastructure, this time emphasizing global export capability. In our view, this growth potential represents yet another leg to future sector expansion, ultimately providing strong visibility to midstream company returns, cash flow and distribution growth.
The views in this material are intended to assist readers in understanding certain investment methodology and do not constitute investment or tax advice. Please consult your tax advisor. The views in this material were those of the author as of the date of publication and may not reflect their view on the date this material is first published or any time thereafter.
Investors should consider the investment objective, risks, charges, and expenses of the BP Capital TwinLine Funds carefully before investing. A prospectus with this and other information about the Funds may be obtained by calling 1-855-40-BPCAP (1-855-402-7227). Please read the prospectus carefully before investing.
As with any mutual fund, it is possible to lose money by investing in the BP Capital TwinLine® Funds. An investment in either Fund is subject to other risks that are more fully described in the prospectus, including but not limited to risks in Master Limited Partnerships (“MLPs”) include, cash flow, fund structure risk and MLP tax risk plus regulatory risks. The prices of MLP units may fluctuate abruptly and trading volume may be low, making it difficult for the Funds to sell its units at a favorable price. Most MLPs do not pay U.S. federal income tax at the partnership level, but an adverse change in tax laws could result in MLPs being treated as corporations for federal income tax purposes, which could reduce or eliminate distributions paid by MLPs to the Funds.
An investment in the BP Capital TwinLine® MLP Fund is, also, subject to risks, include but are not limited to non-diversification, energy-related sector, small-cap and mid-cap stocks, initial public offerings, high-yield “junk” bonds, and derivatives. The Fund is treated as a regular corporation, or “C” corporation, for U.S. federal income tax purposes. Accordingly, unlike traditional open-end mutual funds, the Fund is subject to U.S. federal income tax on its taxable income at the graduated rates applicable to corporations (currently a maximum rate of 35%) as well as state and local income taxes. The Fund will not benefit from current favorable federal income tax rates on long-term capital gains, and Fund income and losses will not be passed on to shareholders. The BP Capital TwinLine® MLP Fund may, also, invest in MLPs that are taxed as “C” corporations.
Shares of the Funds are distributed by Foreside Fund Services, LLC, not affiliated with BP Capital.