Many questions remain unanswered regarding the collapse of Boardwalk Pipeline Partners (NYSE:BWP). A few weeks ago, the stock fell nearly 50% on heavy volume after the company lowered its distribution by a massive 81% to $0.10 per unit per quarter. This was clearly an unmitigated disaster as Boardwalk Pipeline Partners was before widely seen as a "safe" investment due to the fee-based nature of its income. The purpose of this article is to find out exactly what factor(s) forced Boardwalk Pipeline Partners to lower its distribution so suddenly.
What caused Boardwalk Pipeline Partners to lower its distribution?
It shocked many that Boardwalk Pipeline Partners lowered its distribution so significantly, especially considering its distributable cash flow, or DCF, generation. For 2014, the company is projecting DCF of about $400M, well above the expected annual distribution payments of about $90M.
Given that the current distribution is barely 25% of 2014 DCF, clearly the company will be using its cash flows for other reasons.
From its press releases the company gives us the following causes for its lowered distribution:
A need to lower debt from about 4.6x to below a long-term target of 4.0x EBITDA
A need for internally generated cash flows to fund certain critical expansion projects, namely the planned Bluegrass pipeline
The future expiration and resetting of certain favorable midstream natural gas contracts to lower rates
While the first two points are rather self-explanatory, point three is probably the most complex and relevant to the issue.
During its conference call, Boardwalk Pipeline Partners was rather mum on details regarding its future contracts, only really mentioning certain "market headwinds" caused by the new sources of natural gas, namely in the Marcellus and Utica shale formations.
Boardwalk Pipeline Partners recently filed 10-K contains many answers to our questions.
However, compared to the conference call, Boardwalk Pipeline Partners' recently filed 10-K really does provide some valuable insights into why the company needed to lower its payout.
In particular, the updated risk factors regarding "transportation services" and "storage and PAL services" are very much worth a read. Below are these sections in full.
A key market driver that influences the rates and terms of our transportation contracts is the current and anticipated basis differentials - generally meaning the difference in the price of natural gas at receipt and delivery points on our natural gas pipelines - which influence how much customers are willing to pay to transport gas between those points. Basis differentials can be affected by, among other things, the availability and supply of natural gas, the proximity of supply areas to end use markets, competition from other pipelines, including pipelines under development, available transportation and storage capacity, storage inventories, regulatory developments, weather and general market demand in markets served by our pipeline systems. As a result of the new sources of supply and related pipeline infrastructure discussed above, basis differentials on our pipeline systems have narrowed significantly in recent years, reducing the transportation rates and other contract terms we can negotiate with our customers for available transportation capacity and for contracts due for renewal for our firm transportation services. The narrowing of basis differentials has also adversely affected the rates we are able to charge for our interruptible and short-term firm transportation services.
Each year, a portion of our firm natural gas transportation contracts expire and need to be renewed or replaced. For the reasons discussed above and elsewhere in this Report, in recent periods we have renewed many expiring contracts at lower rates and for shorter terms than in the past, which has materially adversely impacted our transportation revenues. We expect this trend to continue and therefore may not be able to sell our available capacity, extend expiring contracts with existing customers or obtain replacement contracts at attractive rates or for the same term as the expiring contracts, which would continue to adversely affect our business.
In 2008 and 2009, we placed into service a number of large new pipelines and expansions of our system, including our East Texas Pipeline, Southeast Expansion, Gulf Crossing Pipeline, and Fayetteville and Greenville Laterals. These projects were supported by firm transportation agreements with anchor shippers, typically having a term of ten years and pricing and other terms negotiated based on then current market conditions, which included wider basis spreads and, correspondingly, higher transportation rates than those prevailing in the current market. As a result, in 2018 and 2019, we will have significantly more contract expirations than other years. We cannot predict what market conditions will prevail at the time such contracts expire and what pricing and other terms may be available in the marketplace for renewal or replacement of such contracts. If we are unable to renew or replace these and other expiring contracts when they expire, or if the terms of any such renewal or replacement contracts are not as favorable as the expiring agreements, our revenues and cash flows could be materially adversely affected.
Storage and PAL Services:
We own and operate substantial natural gas storage facilities. The market for the storage and PAL services that we offer is also impacted by the factors discussed above, as well as natural gas price differentials between time periods, such as winter to summer (time period price spreads), and the volatility in time period price spreads. Recently, the market conditions described above have caused time period price spreads to narrow considerably and price volatility of natural gas to decline significantly, reducing the rates we can charge for our storage and PAL services and adversely impacting the value of these services. These market conditions, together with regulatory changes in the financial services industry, have also caused a number of gas marketers, which have traditionally been large consumers of our storage and PAL services, to exit the market, further impacting the market for those services.
We expect the conditions described above to continue in 2014 and cannot give assurances they will not continue beyond 2014. These market factors and conditions adversely impact our revenues, earnings before interest, taxes, depreciation and amortization (EBITDA) and distributable cash flow and could impact us on a long-term basis.
For natural gas transportation, the company is seeing much narrower natural gas differentials, which has the direct result of lowering rates as well as future contract terms. Indeed, these factors have had a materially adverse impact on transportation revenues for the company this year.
Much of Boardwalk Pipeline Partners current transportation contracts were put into place in 2008 and 2009 at very attractive levels. However, these only have a term length of 10 years. As soon as these roll off in 2018 and 2019, the company will need to adjust them, factoring in current weak natural gas differentials.
In other words, as soon as these existing contracts expire, the company will basically have to settle for lower rates or not have that capacity on its systems. Once again, this is expected to have a materially adverse impact on both cash flow and revenues.
Storage and PAL Services
Here again, Boardwalk Pipeline Partners is seeing narrowing natural gas differentials crush its profits. The company has been forced to lower its storage rates due to this price volatility, adversely impacting the value of these services.
In addition, the company noted that certain regulatory changes have caused gas marketers to exit the market. This is a major blow as they have traditionally been large consumers of storage space when trying to capture the spread between natural gas prices.
The end result for Boardwalk Pipeline Partners' storage segment is that 2014 revenues, EBITDA and DCF will be much weaker than in prior years. In addition, the company cannot guarantee that these factors will abate beyond 2014.
Will other pipeline MLPs face similar troubles?
With Boardwalk Pipeline Partners having its problems, some have wondered if lower rates will impact other midstream MLPs. In particular, El Paso Pipeline Partners (NYSE:EPB) has been repeatedly mentioned as the next MLP blowup.
However, as I noted in a recent article, this scenario seems highly unlikely. Boardwalk Pipeline Partners problems are largely specific to it as its asset base is concentrated in areas where natural gas has long been in decline. The Fayetteville and Hayneville shale plays are some of the oldest natural gas production in the country, with new production only viable at prices well over $5.00 per MCF.
As for El Paso, it is part of the much larger Kinder Morgan, Kinder Morgan Energy Partners (NYSE:KMP) and Kinder Morgan Inc (NYSE:KMI), family of companies. Kinder Morgan has noted that it will support El Paso, dropping down several of its legacy assets which will have an accretive effect to its DCF.
El Paso is seeing some rates reset lower in 2014. However, this was due to recent rate case settlements approved by the Federal Energy Regulatory Commission (FERC) that have resulted in lower rates on the Southern Natural Gas ("SNG") and Wyoming Interstate Company ("WIC") pipeline systems. As a result, El Paso's distribution growth will be limited in 2014, but no reduction is currently in the cards.
Do note that not all midstream MLPs are the same, with each having their own strengths and weaknesses. While higher energy prices are usually better, this is not always the case. In general, these companies prefer strong volume growth as well as large price differentials between regions.
As can be clearly seen, Boardwalk Pipeline Partners is seeing much worsening fundamentals for both its natural gas transportation and storage segments. This is a major issue for the company as essentially 95% of its TTM operating revenues comes from these two segments.
With this new information now in hand, it becomes very obvious as to why Boardwalk Pipeline Partners needed to lower its distribution. Basically, its revenues, cash flows and DCF will be falling off a cliff in 2018/2019 when existing contracts expire.
Even when looking forward, Boardwalk Pipeline Partners is not expecting the situation to improve, The company is expecting that it may not be able sell capacity and or extend expiring contracts at attractive rates which will hurt future cash flows and revenues.
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Disclosure: I am long KMI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.