If You Think Oil Will Recover, Consider Atlas Pipeline

Atlas Pipeline Partners (APL) and Atlas Pipeline Holdings (AHD) have declined significantly recently over concerns about the margins at APL's processing plants. 

A large percent of APL's income comes from the sale of natural gas liquids that the company strips out of the natural gas that flows through its pipelines.  At APL's processing plants unprocessed natural gas goes in and APL then burns a small amount of the natural gas to pull out the higher value natural gas liquids.   APL then sells the natural gas liquids and has to pay for the amount of natural gas that has been burned up in the process. 

The problem APL has been facing recently is a rapid decline in the value of the natural gas liquids that it is selling.  The price of natural gas liquids is highly correlated with the price of oil.  As a result, as the price of oil falls APL's processing margins will decline.  Since hurricane Ike, the price of natural gas liquids has fallen even further than the oil price as many refineries have reduced their purchases of natural gas liquids as a fair number of them are undergoing repairs.  Refineries are significant for the natural gas liquid market as they represent somewhere around 75% of the market's total.

When tracking APL's processing margins you need to look at two factors, the NGL-crude ratio and the price of crude.  I generally place the NGL-crude ratio at around 55%, which is a bit low by historical standards but a bit higher than the ratio currently.  As the impact of hurricane Ike wanes, I expect the NGL-crude ratio to improve back to around 55%. 

The following table gives an example of what sort of distributions to expect at different oil prices.

Average Oil price	Annual APL Distribution	Annual AHD Distribution
$85	$3.96	$2.04
$70	$3.20	$1.60
$60	$3.00	$1.30

There are a few points worth making about this table.  First, APL is hedged but only partially.  In hindsight, APL picked a poor time to repurchase its crude oil hedges earlier this year, in doing so the company has worsened APL's exposure to dropping oil and NGL prices.  On the way up crude outperformed NGLs and as a result APL's short derivative position were costing the firm a fair amount of money. 

Another point worth mentioning is that AHD's distribution holds up well when APL's annual distribution rate drops from $3.96 to $3.20.  This is because of how the IDR adjustment associated with the Anadarko purchase was structured.  At $3.96 per year, APL is paying $9.3M per quarter on its IDRs.  At $3.20 APL is paying $7M.  This is because the IDR adjustment canceled the IDRs between $7M to $12M per quarter. 

As a result, while APL is currently paying $9.3M per quarter it would have been paying $14.3M per quarter if not for the $5M per quarter IDR adjustment.  An annual rate of $3.20 at APL puts its IDR payment at $7M.  Below $7M per quarter, AHD's increased exposure is what you would expect.

If the price of oil averages below $85 for Q4, I would expect a cut in distributions at APL and AHD.  When the oil price recovers you can expect APL & AHD to recover to the level of their past glory.  Given time, AHD should return to being one of the fastest growing GPs as detailed in this article.

Another point worth mentioning is an issue Citigroup raised in a recent downgrade of APL.  Citigroup believes that APL could be in danger of violating the terms of a credit agreement if the price of oil averages below $60 for "an extended period of time."  This makes little sense to me, as even at $50 oil APL and AHD will continue to generate significant amounts of free cash flow.  MLPs are required by their credit agreements to maintain hedges with those companies in their lending group to stabilize cash flows and any significant modification to those hedges would need to be run by creditors before it could happen. 

Even in a worst-case scenario, there is nothing preventing APL from maintaining a distribution significantly below its level of free cash flow and APL's partial hedge position should stabilize cash flow at a level that is capable of keeping its creditors happy.  Unlike some MLPs, APL has more than enough capacity available on its credit lines to fund its business and all planned expansions.  I expect management at APL to correct Citigroup on its credit agreement thesis at the next conference call.

Finally, Pioneer Natural Resources’ (PXD) option to acquire 14.5% of Midkiff-Benedum expires at the end of this year.  APL's guidance is based on PXD exercising its option.  However, in the current environment I wonder if PXD may choose not to exercise its option.  PXD may instead be able to acquire assets at better multiples from other parties rather than by acquiring another 14.5% interest in Midkiff-Benedum at multiples determined before the credit crisis began. 

The best case scenario is for PXD to decline to exercise its option, as a result, guidance will likely need to be revised upwards.  The worst case scenario is that PXD exercises its option and that APL receives $150M to shore up its balance sheet as a result.

In the short term, I see reasons to be bullish on oil.  Longer term I think the fundamentals of the oil market will support significantly higher prices, once the economy recovers.  If you think that oil prices will recover, then you may want to be a buyer of APL or AHD at these levels.

Disclosure: None

Comments

[Oil Man:]

I bought APL ,my first MLP purchase, recently. Great article and explanation of the processing of gas liquids. I am confident that APL will continue prospering and the price of oil and gas liquids will recover.

2008 Oct 31 07:02 AM

[Ferdinand E...:]

A very interesting article. Very informative.

2008 Oct 31 04:45 PM

[Itsonlymoney:]

Thank you for the information. Could you also unravel the confusing ownership structure of APL and AHD?

2008 Nov 01 12:21 PM

[RWRocksOn:]

try this investor presentation slide show:

library.corporate-ir.n...

Rog


On Nov 01 12:21 PM Itsonlymoney wrote:

> Thank you for the information. Could you also unravel the confusing
> ownership structure of APL and AHD?

2008 Nov 02 03:23 PM