A Rich Pipeline

 | Jun 11, 2014 | 12:00 PM EDT  | Comments
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While it may seem very hard to believe, the US will soon be producing more of some grades of oil than it consumes. Some are now begging the question of what will happen to the so-called "shale revolution" once there are no more waterborne imports to displace. After all, US oil consumption peaked in 2008 and there is a congressional ban on crude oil exports. The chart below shows that the US will, indeed, have a surplus of 900,000 barrels per day of condensate and light, sweet crude.

 

This estimate includes predictions of refinery capacity additions and assumed flat crude oil demand in the US.

Where's all that extra light, sweet crude going to go? We don't know yet, but if congress does not lift the crude export ban, and if refineries do not sufficiently expand capacity (chances are there will be some expansion, but not enough), WTI crude could be in for a rocky ride. If prices drop steeply, chances are they won't be down for long: producers will likely react to much lower prices by pulling back production. This would, of course, effectively end the "shale oil revolution" as we know it.

The biggest beneficiaries to this volatility are midstream and downstream names. Plains All American Energy Partners (PAA) is a midstream name that will benefit in either environment.  Plains is a pipeline focused mostly on the transportation of domestically-produced crude oil from wellhead to refinery; the majority of its revenue comes from this. The most important geography for Plains is the Permian Basin, where the BridgeTex pipeline moves Permian crude to the Gulf Coast. 

 

 

Last year, Plains grew distributable cash flow, or DCF, by just over 10%. Plains should be able to continue this trend, whether domestic oil prices stay constructive or plummet due to excess capacity.

If prices stay around where they are now, Plains will continue to build out its pipeline infrastructure thanks to continued high demand. DCF growth will continue to be linear. This scenario is likely if congress lifts the export ban and if the global market is healthy enough to absorb the excess capacity. Acquisitions in this scenario would be hard to come by, so most of Plains' growth would come from organic projects.

If, however, we do see 900,000 excess barrels of light sweet crude and condensate, and the result is a steep drop in oil prices, Plains will still be ideally positioned, but for different reasons. Consider this: price differentials between domestic and global oil will widen. This is usually a bullish sign for pipelines. There will, in the short term at least, be far more supply needing to go through pipelines than pipeline space available. Plains will not build new pipelines, but will be able to use its strong balance sheet to acquire.

Plains All American is an oil pipeline that will do well, come rain or shine. With a DCF coverage ratio consistently above 1.1 times, Plains is one of the more conservative pipeline partnerships. With a yield of under 4.4%, now may not be the ideal time to pick up units of PAA, but it is certainly worth doing so on a pullback. 

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