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Sunoco Logistics Partners, L.P. (NYSE:SXL)

Q2 2013 Earnings Conference Call

August 08, 2013, 08:30 AM, ET

Executives

Michael J. Hennigan - President & CEO

Analysts

Steve Sherowski - Goldman Sachs

Bradley Olsen - Tudor Pickering Holt

Mathew Phillips - Clarkson Capital Markets

Ross Payne - Wells Fargo

Operator

Welcome to Sunoco Logistics Q2, 2013 Earnings Conference Call. All lines have been placed in a listen-only mode until the question-and-answer session. Today’s call is being recorded. If anyone has any objections you may disconnect at this time.

I would now like to turn the call over to Mr. Mike Hennigan, President and CEO. You may begin.

Michael J. Hennigan

Thank you Ameya. Good morning everyone. Welcome to Sunoco Logistics Partners conference call to discuss our second quarter 2013 results. I am Mike Hennigan, President and Chief Executive Officer for the General Partner. Joining me today is Pete Gvazdauskas, Vice President of Finance and also on the call are Martin Salinas and Mackie McCrea.

In the course of our remarks and in the subsequent Q&A, we’ll be referring to slides that have been posted on our website entitled Second Quarter 2013 Earnings Conference Call and we may be making some forward-looking statements. In that regard for the purpose of facilitating the discussion, I refer you to slide number two.

With regard to our results we are pleased to report record quarterly EBITDA of $244 million and distributable cash flow of $184 million for our Partnership. Through the first six months of 2013, we have generated $480 million of EBITDA and $379 million of distributable cash flow driven by the strength of our crude oil pipeline business and boosted by favorable market conditions for our lease, acquisition and marketing business.

Our crude oil pipeline business led our results in the second quarter as we are further seeing the development of our expansion projects in West Texas with Longview Access coming on line and the initial start-up of our Permian Express Phase I project.

Our crude oil acquisition and marketing business also had a strong quarter as market conditions continue to be favorable with a wide WTI Midland to LLS spread in excess of $15 per barrel. However the spread was lower than the first quarter spread which was in excess of $25 per barrel. The spread has continued to decline during the third quarter and the forward-market suggests a spread of approximately $5 a barrel for the second half of the year.

Our terminals business had a very strong quarter with our New Orleans terminal seeing increased volumes as a result of the oil flow to the Gulf Coast and our butane seeing the seasonal activity in the second quarter.

Overall we are very pleased with our record quarter and now let me give you an update on some of our major organic growth projects. Our Permian Express Phase I project which provides crude oil transportation service originating in Wichita Falls, Texas culminating in the Gulf Coast markets reached its initial 90,000 barrels per day capacity in June. Full capacity of 150,000 barrels per day is expected by late 2013 or early 2014. We continue to develop Permian Express Phase II which would increase the takeaway capacity out of the Permian Basin by 2,000 barrels per day and would be available to our Nederland Terminal and provide further market access to the Gulf Coast as well as access to the mid-continent markets.

We have had considerable market interest and continue to develop details of this project. Based on the increased interest from the market we expect to launch the open season for this project shortly. We remain bullish on Permian production volumes. Latest [prior] estimates are about 200,000 barrels per day of annual crude production growth from this robust West Texas region.

In the NGL area we begin the landfill for Mariner West in July. This project which will deliver ethane to the Sarnia marketplace is expected to be operational at about 20,000 barrels per day in September and ramp up to about 50,000 barrels a day by the end of the first quarter 2014. Mariner East with a capacity of approximately 70,000 barrels per day is expected to be able to deliver propane by the second half of 2014 and both ethane and propane by mid-2015.

As you are aware propane is already being exported from the Marcus Hook terminal today as the Northeast is long and will continue to go longer NGLs as the Marcellus and Utica develop further. We believe that Northeast NGL hub at Marcus Hook which is capable of handling a broad array of NGL products and is located less than 300 miles from the Marcellus is very attractive to producers and local and overseas consumers alike.

Mariner East Phase II is in development as the production in Marcellus and Utica continues to grow necessitating additional NGL takeaway capacity needed in the Basin. We continue to be bullish on this project as the reduction curves for the Marcellus Utica NGL production continue to move up with time. The latest estimates are for about 800,000 barrels per day of NGL production by the 2015-2016 timeframe, pretty significant numbers.

Mariner South, a joint project within our family of partnerships to export propane and butane from our Nederland terminal in the Gulf Coast will be operational by Q1 of 2015. This is the first example of a great synergy it was developed by being part of the energy transfer family and we look forward to additional opportunities in the future.

On the crude side we are pleased to have completed another successful open season for a project called the Eaglebine Express. This project will convert a portion of our existing refined product MagTex pipeline in the crude service and reverse the flow from Hearne, Texas area back to our Nederland Access terminal. There is a definite market need to provide outlet capacity for the Eaglebine and Woodbine crude areas. And this pipeline helps to deliver crude oil to key markets on the Gulf Coast.

We also launched an open season for crude pipeline projects entitled Granite Wash Extension which could connect the Granite Wash production area in Northern Texas and Oklahoma to our pipeline system which will deliver crude oil to the Gulf Coast and Mid-Continent markets. This open season will last until mid-September. Our open season project will provide fee-based income under long-term commitments. The cash flow from these projects will allow us to continue to generate ratable EBITDA even though we expect our margin related earnings to decline as crude differentials contract.

The WTI-LLS spread has come in significantly in the third quarter compared to the first half of the year making these ratable projects even more important to our long-term plan to reward our unit holders. From a capital standpoint we’ve guided for approximately $700 million of organic capital in 2013 and we spent approximately $300 million through the first half of the year as we continue to implement our growth strategy.

On our distribution we’ve announced an increased to $2.40 per common unit on an annualized basis which represents our third consecutive 5% increase quarter-over-quarter and our 33rd consecutive increase overall. This also represents a 28% year-over-year increase compared to the second quarter of 2012. We also expect to continue 5% quarter-over-quarter increases in 2013 and expect to give our investors over 20% growth again this year as we continue to implement our growth strategy.

We continue to grow our blue bar earnings and remain committed to distributing these earnings as our project materialize. As we discussed in the past our long term business model of 80% blue bar and 20% red bar would generate an approximately 1.25 times coverage ratio. To the extent our red bar coverage is a higher percentage than we will do cash flexibility as a source of equity for funding future growth.

We also continued our tremendous balance sheet capacity to fund our ongoing expansion capital program. Our debt-to-EBITDA ratio was 2.4 times as of June 30th. As we continue to implement our plan we remain committed to sustainable competitive distribution growth. We are confident our strategy is on track and we are committed to growing our cash flows over the near and long term.

With that I will ask the moderator to open lines up for any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions). And our first question comes from Steve Sherowski with Goldman Sachs. Go ahead.

Steve Sherowski - Goldman Sachs

Hi good morning. There is another project announced last night to take Northeast NGLs to the Gulf Coast. Just with that in mind could you give us an update or further update on Mariner East and generally what you are hearing from producers and how they are thinking about sending NGLs to the East Coast versus Gulf Coast?

Michael J. Hennigan

Hey good morning Steve. On Mariner East we still believe we have the next best takeaway project for NGLs. And what’s going on there in the market is there is a debate as to whether barrels should move down to the Gulf Coast versus export from the East Coast. And as you know there are several projects that want to take NGLs down to the Gulf Coast along with the recent announcement that came out yesterday. At the end of the day our belief and we continue to believe this is that the U.S. is along all the NGL slate.

I mean propane has been exported from the Gulf Coast than the East Coast out of our Marcus Hook terminal today. So that’s not in debate. Butane, in our view we will start exporting very shortly and ethane is clearly long as the pricing in the market has collapsed as a result of being too long ethane today.

So the question comes down to is do you believe that the Gulf Coast will be the best market for the NGLs. We don’t. We believe that these barrels need to be exported. At the end of the day we think that the market will stay long even though there is some robust expansions planned on the Gulf Coast our belief that the Marcellus, Utica NGL production as well as all the other shale plays will produce more NGLs than the demand will be able to satisfy.

So we still continue to believe that we have next best takeaway project, exports are the key and our facility in our view has the shortest transit time from the frac centers in the Marcellus, Utica. We are going to have world class ship loading capability and a deep water ship channel that is not bottlenecked in any way. So at the end of the day we still believe that we have the best solution. We think the market has interest there and as soon as we think there is enough interest we will launch an open season for Mariner East too.

Steve Sherowski - Goldman Sachs

Okay. Thanks for that. And if I could just have a quick follow-up just based on where crude oil spreads are today, how should we think about your marketing margins going forward? I mean is there a base line margin that we should take into account or consider when we are doing our models?

Michael J. Hennigan

Yeah Steve that’s obviously the toughest question we all try and circle around. Bottom line is we have known for some time that we expected those margins to contract. We have known that spread was to come in. What’s happening in the marketplace right now in our view is a little bit of an anomaly and the contractual margin is a little over done.

The production out of Canada has dropped off a little bit with some problems. You got [waiting] in the Midwest converting, taking sweet crude. So right today in the short term Cushing short somewhere around 300,000 barrels a day give or take. So we are drawing inventory WTI is backwarded as a result. We don’t think it’s a lasting equilibrium. The forward market for 2014, 2015 et cetera has WTI Brent in the $7-$8 range. We think that that’s even a best case scenario.

So it wouldn’t surprise us that WTI Brent is going to come back out in to the $9-$10 range longer term. But short-term we are kind of in a mode where Cushing is short the West Texas project have started up. The material coming out of Canada has been reduced. [Waiting] is converting. So all of that kind of brings Cushing short. That all occur for a couple months and then it will convert back.

So I think you are going to continue to see volatility. Throughout this year we saw some amazing margin movement, greater than $25 in the first quarter when Midland was constrained. Over $15 in the second quarter and now you are seeing some numbers down in the roughly around the $4-$5 range.

So we will have to see just like everybody to see where this market plays out. Volatility is key. You are seeing a lot of different grades moving, a lot of different markets. WTI always gets most talked about just because it’s the market rates but there is a lot of activity in the Houston market and Longview, up in the mid-continent. So I think it’s still going to be pretty dynamic volatile system and like we have been saying for a long time, we don't count on the wide spreads, we put that in our red bar earnings and we will capture earnings if they are available and if they are not we will concentrate on our blue bar projects like we have been talking about for the last several calls.

Steve Sherowski - Goldman Sachs

Thanks. I appreciate the insight that’s it from me.

Michael J. Hennigan

Okay, thanks Steve.

Operator

Our next question comes from Bradley Olsen from Tudor Pickering. Go ahead.

Bradley Olsen - Tudor Pickering Holt

Hey, good morning Mike. Good morning, Pete.

Michael J. Hennigan

Good morning, Brad.

Bradley Olsen - Tudor Pickering Holt

Question about the crude oil pipeline results that you posted, obviously very strong results and certainly some of that has to do with the projects that have come online and moved some of the red bar to the blue bar so to speak but it does seem like with 30% kind of year-over-year growth in pipeline EBITDA, 40% quarter-over-quarter and reported volume growth of 300,000 barrels a day, that’s well beyond the 150,000 or 160,000 barrels a day or so that’s come online with Permian Express and West Texas Gulf Expansion.

Can you provide any color around what else might have made up that that big step up?

Michael J. Hennigan

Sure, Brad. It’s a good question. You hit it on the head. A good chunk of it is our West Texas startup in Longview in the Houston and then PE1 started up in the second quarter finally getting to 90 by June. The part that you are missing is if you look at our Nederland volumes we have seen a big kick up there as well. We have a pipeline that supports the Motiva Terminal down in Port Arthur and as you are aware the refinery has been in an expansion mode in picking up volumes going there.

So we picked up quite a bit of volume on that system as well. That shows up in our crude pipeline system because it is a dedicated pipeline that goes from Nederland over to Motiva's refinery. So that’s the other chunk that I think you were missing.

Bradley Olsen - Tudor Pickering Holt

Okay, great. And so is it fair to say that those pipeline results will probably move up a bit more sequentially as we get full quarter credit from those new projects?

Michael J. Hennigan

Yeah I think that’s fair to say. As you know Brad we don't give a lot of forward guidance. We are happy that we got the projects on line that we expected to in the second quarter of 2013 on the crude side. You know the next step up that you will see from us the crude side is our Eaglebine project will be in 2014. We have announced that, that's successful and then we are hopeful that Granite Wash which we're in process now in open season we hope that that will be a 2014 project as well. But I think you are right you are saying in the 2013 crude projects coming on line.

Bradley Olsen - Tudor Pickering Holt

Okay, great. And terminal results also look pretty strong. I mean flattish year-over-year but I guess my question comes down to with the steep backwardation that we have seen in the market, do you see higher utilization with trawler capacity or with pipelines moving product around your terminals? Does the backwardation lead to higher returns from storage which boosts revenue at all?

Michael J. Hennigan

You know Brad I am not a real big believer that the market structure changes a lot of people’s activity. I mean obviously you know backwardation get the inventory out and people will be doing that to some extent but at the end of the day it promotes our activity. We've rented tanks, whether they are full or not full is up to the individual customer. So I don't think you are going to see an appreciable change in our earnings as a result of the structure.

I think you said it very well obviously backwardation will force people to move product out [Cantango] obviously incent people to have it stay. But as far as our earnings I don’t think you are going to see a lot. What I think you are seeing in the market though is if your Nederland volumes are up. I mean the flow continues to go down to the Gulf Coast. We are very pleased that our Nederland terminal has tremendous connectivity to the markets.

We are seeing activity coming down from Permian now , where Shell's [Toho] line is reversed itself from Houston into our Nederland terminal. Motiva as I mentioned is expanding their refinery runs. We are seeing a tremendous amount of water borne activity both barging and shipping out in Nederland.

So we are very pleased that we have a terrific asset there and I think we are going to continue to see more and more activity coming to that asset. We are bullish, the assets growth potential but more from the standpoint of that the production that’s coming out of the Permian which we continue to be very bullish on.

As you heard me say in our prepared comments we think Permian is going to continue to grow at 200,000 barrels per day. I mean Eagle Ford is going to continue to grow. So I don’t think it's the market structure phenomena as much as it just total growth and bullishness on domestic U.S. production.

And we plan to see Nederland continue to grow. I think it’s the largest crude terminal in the U.S. you know 22 million barrels and growing. It's fully subscribed and we are looking to grow the terminal.

The only other comment relative to your question on terminals is, we do have our butane blending business in that. So you’ll see some seasonal results there. Obviously we see stronger results in the second quarter and then that business kind of goes off, dormant for the third quarter and then it will come back again in the up fall and winter.

Bradley Olsen - Tudor Pickering Holt

Okay, great and just one more question mostly around Nederland but also kind of a general market question. Given the strength in LLS, I mean you talked about some of the growth dynamics out of the Permian and out of the Eagle Ford. And I guess you know it’s somewhat of a puzzle for me why given that while we are seeing all of this phenomenal growth out of the Eagle Ford and Permian seems to really be ramping up now.

We have some of the most expensive light crude in the world sitting just a couple of hundred miles away in St. James at the LLS pricing hub. And have you seen increased activity of marketers or producers trying to move their East Texas crude either by barge or by pipeline over to LLS. And is there a project that you think SXL could participate in that could help bring LLS back down in line with some of the other North American light crude grades?

Michael J. Hennigan

Hey Brad I think you hit it on the head. Obviously the producers are trying to get to the highest market; the traders are trying to get over to that market. So yes we are definitely seeing a lot more activity trying to get over to the LLS market.

Our Nederland facility has seen a real large jump in water borne activity. Both barges coming in from [Corpus] and from Houston as the flow continues east. So we have barge activity coming into the terminal. We have barge activity going out of the terminal, trying to make its way over to St. James et cetera. So the markets are very efficient and there are going to continue to try and capture that arbitrage. So I think that’s going to continue to occur.

Relative to projects that get over there I think there is a lot of activity within our family of partnerships. There is a project that in open season right now called Trunkline which will also benefit marketers that want to get down to the Gulf Coast market.

So we are anxious to see how that project plays out in the next couple of weeks or whatever. So I think there is going to continue to be a lot of pipeline projects that are attractive for both producers and consumers. The market will continue to be volatile like I said earlier. Short term I think we are in little bit of an anomaly as these West Texas projects started up. Our project and long horn there is a pull out of West Texas and away from Cushing, at a time when the barrels coming from the North.

So Cushing's short at the moment. I think that will equilibrate. As I mentioned Permian we continue to be very bullish. We are hoping to launch our Permian express Phase 2 project real shortly. It appears to us that the market’s going to need continued infrastructure and we hope to be a part of that.

Bradley Olsen - Tudor Pickering Holt

Great thanks a lot guys.

Michael J. Hennigan

You are welcome Brad.

Operator

Next question comes from Mathew Philips with Clarkson. Go ahead.

Mathew Phillips - Clarkson Capital Markets

Good morning everyone.

Michael J. Hennigan

Good morning, Matt.

Mathew Phillips - Clarkson Capital Markets

I was wondering if you all could change and tackle a little bit back to NGLs. I was wondering if you can talk about the ethane demand of the Sarnia region. I mean obviously the options for ethane are bit more limited than propane and do you see, is there enough utilization, enough flack in the system up there to take more Marcellus ethane? I mean could you see a potential expansion in Mariner West or do you think that’s unlikely?

Michael J. Hennigan

No, I think it is very likely. I think what’s happening there is the Sarnia crackers there is a couple of there. I mean if the first Phase they want to get Mariner West on. We’re filling the pipe as like we speak and we will be having it come online shortly here and then ramping up to the full capacity in early 2014.

So I think that is the first step. As I mentioned earlier our view is you’re going to see 800,000 maybe to 1 million type of NGL production in this 2015, ’16,’17 timeframe. So I do believe that they’ve crackers up in Sarnia. We’re going to look at expanding further once they get online. I think you can talk them about that but I think they are studying that as we speak. At the same time the European market has become more aware obviously [inaudible] is first mover working with Range to secure exports out of the Marcellus to go to Europe.

So we’re still pretty bullish, the Marcellus-Utica area. The NGL production has been tremendous, it will be ramping up. The tougher part for our project is for people to look out in time to be able to see out of couple of years and recognize does the market condition at least in our mind warrant more exploring than they do going down to the Gulf.

Couple of years ago I think people believed that the Gulf Coast expansion would bring the supply demand for ethane in balance. We just happen to not believe that. We believe there will be expansions on the Gulf Coast but they’re not coming online till the 2017 plus timeframe and our expectation is that supply will still outstrip that.

So we’re still bullish on our project. We think we still have the next best takeaway. We’re not a believer that white grade to the Gulf is the best solution and we continue to work with the producers along that path. Right today Mariner West is still not in full start up, Mariner East hasn’t come on yet. So not a whole lot of ethane has moved. The market does need that. As you know the BTU content of the gas is up against the limit. So ethane does need to move.

So I think the market needs to see the first phases come on and then assess whether they believe bringing barrels down to the Gulf Coast is a smart move. Our belief is we’re going to incur some economics to get them down there and still have to export from the Gulf.

Mathew Phillips - Clarkson Capital Markets

Great, that makes sense. And I know on your last call you’ve mentioned that rents were mostly immaterial or at least balanced out the effects on the [inaudible] is that still true regarding the updated rate from this week?

Michael J. Hennigan

Yeah that’s true Mat. Our system is such that we’re pretty much neutral on rents. Obviously we’ve been watching the market and how robust it's gotten and then the announcement has brought it back down a little bit. But it’s not a material event for us. We are an obligated party in some regards but we also have some length in other regards. So we come out about balance on rents.

Mathew Phillips - Clarkson Capital Markets

Okay, great. Thank you. That’s all for me.

Michael J. Hennigan

Okay you’re welcome.

Operator

Our next question comes from Ross Payne with Wells Fargo. You may go ahead.

Ross Payne - Wells Fargo

Good morning. You continue to maintain one of the best balance sheets in the space staying ahead of the curve with balance sheet flexibility. Do you feel this has benefited you well and do you expect to maintain these kind of metrics and this kind of flexibility in the future? Thanks.

Michael J. Hennigan

Yeah Ross obviously we are very pleased with the strength of our balance sheet. Part of that strength has been by what we call red bar earnings. We’re still very comfortable taking our leverage up. We would love to see some more opportunities for us that would enable us. I’ve said on other calls obviously we have debt capacity in our balance sheet. But we would also love to find some opportunities where we could go out and issue equity. I mean the market is robust and we continue to look for opportunities that work for us. We love to use our balance sheet capacity. We would love to find something that would make sense for us.

As you’ve seen to-date we have not found something that we thought would warrant us doing that but boy we would sure love to find something that would work for us where we could increase our leverage and take advantage of the strong financial position we are or even go the point where we would issue equity from the standpoint of finding something that made sense for us.

Ross Payne - Wells Fargo

Thank you.

Michael J. Hennigan

You are welcome Ross.

Operator

Next question comes from Allen Rice with [Sarbane Trust].

Unidentified analyst

My question has been answered. Thank you.

Michael J. Hennigan

Okay, sure.

Operator

And that was our last question sir.

Michael J. Hennigan

Okay, I want to thank everybody for joining us this morning. As usual Pete will be available for follow-up questions and thank you for your interest in the company.

Operator

This concludes today's conference. You may now disconnect at this time.

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