Magellan Midstream Partners LP (MMP) Michael N. Mears on Q2 2016 Results - Earnings Call Transcript

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Magellan Midstream Partners LP (NYSE:MMP)

Q2 2016 Earnings Call

August 02, 2016 1:30 pm ET

Executives

Michael N. Mears - Chairman, President & Chief Executive Officer

Aaron L. Milford - Chief Financial Officer & Senior Vice President

Analysts

Faisel H. Khan - Citigroup Global Markets, Inc. (Broker)

Hilary Cauley - Ladenburg Thalmann & Co., Inc. (Broker)

Jeremy B. Tonet - JPMorgan Securities LLC

Shneur Z. Gershuni - UBS Securities LLC

John Edwards - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Elvira Scotto - RBC Capital Markets LLC

Jerren A. Holder - Goldman Sachs & Co.

Jeff Birnbaum - Wunderlich Securities, Inc.

Operator

Good day, and welcome to the Magellan Midstream Partners Second Quarter 2016 Earnings Results Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Mike Mears, Chief Executive Officer. Please go ahead, sir.

Michael N. Mears - Chairman, President & Chief Executive Officer

Okay. Well, hello, and thank you for joining us today to discuss Magellan's second quarter financial results. Before we get started, I'll remind you that management will be making forward-looking statements as defined by the SEC. Such statements are based on our current judgments regarding some of the factors that could impact the future performance of Magellan. You should review the risk factors and other information discussed in our filings with the SEC, and form your own opinions about Magellan's future performance.

Since we last spoke, a number of positive events have occurred for Magellan. First, we began commercial operations in early July for our new pipeline to deliver refined products to the Little Rock market. Market interest for our Little Rock pipeline remains strong and we continue to be very optimistic that demand for this system will exceed the minimum commitments received for this project.

We also announced our plans to build a new Marine Terminal in Pasadena, Texas, to handle refined products for a customer under a long-term commitment. The initial phase of this terminal includes approximately 1 million barrels of storage on nearly 200 acres of land and a ship dock. The capital cost for this project is expected to be $335 million, and will be operational in early 2019.

For this initial phase, we expect to realize by the 12 times EBITDA multiple, which includes all of the upfront costs such as the land purchase and pipeline infrastructure that will benefit all future phases. If we are successful in building this facility to its maximum capability with up to 10 million barrels of storage in five docks, the total capital invested would be approximately $1 billion and it will generate an estimated eight times EBITDA multiple.

As you recall, we're generally targeting an eight times multiple projects, but are willing to accept a lower return for a strategic project with significant upside potential, which is exactly what this first phase of the Pasadena Marine Terminal represents. We are currently in active negotiations with a number of parties to expand a new Pasadena terminal and are optimistic that we will be able to build the facility out to its full potential.

Now, shifting to earnings, as you saw this morning, Magellan continues our steady financial performance again this quarter despite the challenging backdrop within the energy industry.

I'll now turn the call over to our CFO, Aaron Milford, to review Magellan's second quarter financial results in more detail. Then I'll be back to discuss our outlook for the rest of the year and review the status of a few of our other large expansion projects before opening the call for your questions.

Aaron?

Aaron L. Milford - Chief Financial Officer & Senior Vice President

Thank you, Mike. Today, I will be making references to certain non-GAAP financial metrics, including operating margin and distributable cash flow. As usual, we've included exhibits to our earnings release that reconcile these metrics to their nearest GAAP measure.

We reported net income of $187.9 million earlier this morning, which was higher than the $177.4 million reported for the second quarter of 2015. Excluding the impact of out-of-period NYMEX activity in the current quarter, adjusted earnings per unit of $0.82 exceeded our guidance of $0.72 provided back in May. Distributable cash flow was $221 million for the second quarter, representing a slight decline from the $222.8 million reported for the second quarter of 2015.

I will now move on to discuss the operating margin performance of each of our business segments. Our refined products segment generated $177.3 million of operating margin in the second quarter of 2016, which was $29.1 million higher than the same period in 2015.

Transportation and terminals revenue was $247.8 million for the quarter, which was $9.5 million higher than the comparable quarter in 2015. This higher revenue is attributable to total transportation volumes increasing by approximately 4%, and the current quarter benefiting from the 4.6% tariff rate increase that occurred last July.

Gasoline volumes were nearly 6% higher than the same quarter last year in response to lower prices, while our diesel volumes were essentially flat compared to the previous year quarter. Reported product margin increased $12.9 million compared to the last year. The quarter benefited from higher volumes and reduced losses associated with our NYMEX positions. Ignoring the mark-to-market impacts of out-of-period NYMEX positions, our cash margins were slightly less than the second quarter of last year.

As mentioned in our previous calls, while our commodity-related activities are not generating the same level of cash flow as they did prior to the current commodity price environment, they are performing slightly better than expected in 2016. As we look forward, we have hedged or realized approximately 90% of our expected volumes for all of 2016. We have also hedged the vast majority of our blending volumes for the spring of 2017. The margins we've been able to lock in for the spring are below those realized this year on average, but are not significantly different from currently available spot margins and remain consistent with our expectations.

RIN costs are also a hot topic currently and, like many in our industry, we've been negatively impacted by the rising cost of RINs. As a butane blender, we are an obligated party required to comply with the Renewable Fuel Standard, which in our case requires us to purchase RINs. We have already purchased the RINs we need for the remainder of 2016 and most of what we anticipate needing for 2017.

Operating expenses for our refined products segment were $6.6 million lower than the second quarter of 2015 due to lower environmental accruals in the current year quarter, as well as higher value product overages resulting from higher commodity prices.

For our crude segment, operating margin of $96.9 million was $10 million lower compared to the second quarter of last year. The primary driver behind this period-over-period change was reduced earnings from our equity investments, including BridgeTex, which were $9.2 million lower than the second quarter of 2015. BridgeTex volumes of approximately 210,000 barrels per day were 20% lower as shippers are only shipping their minimum requirement.

Transportation and terminals revenue of $101.3 million was also down slightly from last year. Recall that last year's quarter benefited by approximately $6.5 million from a customer making a termination payment to exit a contract early.

While the current quarter benefited from higher volumes on Longhorn, which were almost 270,000 barrels per day, and increased revenue from additional leased storage, these were not enough to overcome the one-time benefit that occurred last year. For the balance of the year, we expect the Longhorn volumes will decline as shippers take advantage of historical credits that were earned by shipping more than their past minimum requirements and are due to expire if unused. For the year, volume should meet our expectations with potentially lower volumes in the second half of the year, offsetting higher volumes realized during the first half of this year.

Further, like last year's quarter, you'll notice that overall crude volumes detailed in our attached exhibits decreased period-over-period, while average rate per barrel increased period-over-period. This increased average rate and lower volumes were a function of our customers changing their nomination behavior to utilize long-haul tariffs available to them rather than nominating barrels to an interim point, such as East Houston, and then having the barrels re-nominated to their ultimate destination.

From a physical standpoint, in terms of barrels handled on our distribution system, our business remains virtually unchanged given the last mile nature of this system. Also, from a total revenue perspective, we're practically indifferent as to the tariff path nominated by our customers due to the comparatively low rates on our Houston Distribution System.

Operating expenses for the crude oil segment were $1.7 million lower compared to last year as a result of lower power costs. Finally, you will also notice that negative product margin in the quarter that impacted crude segment margin by about $1 million; this margin is impacted by changes in NYMEX contracts used to hedge a small inventory position we've been holding.

Lastly, our Marine segment's operating margin of $28.9 million was down $1.3 million compared to last year's quarter. Revenues were down approximately $1.4 million due to lower revenues received for ancillary customer activity. Leased storage revenue was basically unchanged with higher average rates offsetting slightly lower utilization. The lower utilization in the quarter was mainly related to tanks that we've taken out of service in order to convert them to crude oil service. Product margin for the segment was $0.6 million favorable to the previous year quarter due to timing of transmix sales, and operating expenses were slightly higher than last year due to timing of maintenance work.

Now, moving to other net income variances to last year's quarter, our G&A expenses decreased by $3.4 million primarily due to lower equity-based compensation expenses; depreciation and amortization expense increased $2.9 million compared to the 2015 period due to expansion capital projects placed into service; and, our net interest expense increased $4 million due to interest on higher debt balances being partially offset by higher capitalized interest related to project spending.

Other income and expense decreased by $4.6 million due to a smaller non-cash gain recognized in the quarter related to the change in the differential between spot and forward prices on the fair value hedges we have in place related to our crude oil tank bottoms. Finally, net income was favorably impacted by an additional $1.2 million gain on the exchange of our Osage interest reported in the first quarter of this year. This additional gain is derived from a final working capital payment, and brings our total gain recognized on the exchange to $28.1 million.

Through the first half of the year, we continued to see results consistent with our expectations and our business remains fundamentally healthy.

I will now move to a brief discussion regarding our balance sheet and liquidity position. We had $3.8 billion of debt outstanding at June 30, 2016, which includes $23.9 million of commercial paper outstanding, with no borrowings outstanding on any of our credit facilities. Our weighted average interest rate for the first six months of 2016 was 4.8%. We also ended the quarter with $34.3 million of cash on hand. As of the end of the second quarter, our debt to EBITDA ratio was approximately 3.1 times on a pro forma basis.

We continue to enjoy a strong balance sheet and strong distribution coverage. As we stated in the past, we remain committed to a maximum leverage ratio of four times debt to EBITDA and expect our leverage ratio to increase throughout the year as we continue to spend growth capital, but it will stay below our maximum target.

I'll now turn the call back over to Mike to discuss guidance for 2016, as well as the status of our growth projects.

Michael N. Mears - Chairman, President & Chief Executive Officer

Thanks, Aaron. Based on our financial results to date and outlook for the remainder of the year, we reaffirm our 2016 DCF guidance of $910 million. Although, our second quarter EPU exceeded our guidance by $0.10 per unit, some of these favorable items are due to the timing of certain operational expenses. I know a number of you have enquired about the unscheduled refined products pipeline shutdowns that we experienced beginning in June, these pipeline segments were located in Kansas and Texas and both were related to river washouts that occurred due to significant rainfall events.

Fortunately, there were no environmental issues related to these washout events and our team worked around the clock to ensure the pipes were repaired in a timely manner, while minimizing product outages in the markets we serve. One way we kept up with market demand was by reversing the flow of our pipeline system to move barrels from Oklahoma to Texas to help relieve the reduced supply situation in Northern and Western Texas. While situations like these are extremely challenging, we hope you can appreciate they also highlight the versatility of our refined products pipeline system with its immense connectivity and operational flexibility.

One impact you'll see from these weather-related incidents is an increase in maintenance capital in our DCF guidance. For the year, we now expect $100 million in maintenance capital, compared to previous guidance of $90 million. The increase is directly attributable to repair work needed for these washout events in Texas and Kansas. Again, we reaffirm our $910 million annual DCF guidance for 2016 and remain committed to our goal of increasing cash distributions by 10% in 2016 and at least 8% in 2017, all while maintaining distribution coverage of 1.2 times.

Moving on to our expansion projects, we already mentioned the recent startup of our Little Rock pipeline and the launch of our new Marine Terminal in Pasadena. We also began linefill activities on the Saddlehorn pipeline last week, and if all goes as planned, we expect to be delivering crude oil from Platteville, Colorado to Cushing by the end of August.

The construction process has gone smoothly so far with cost less than expected. In fact, the estimate for our share of spending is now $230 million, which is $30 million lower than previously expected. Construction still continues for the extension up to Carr with pipeline installation occurring as we speak. Based on our construction timeline, we still expect the Carr to Platteville segment to be operational by the end of 2016.

And finally, construction is nearing completion for our Corpus Christi Condensate Splitter. Due to some weather-related delays, we expect to commission and start up the splitter in September with actual commercial operations to begin late in the fourth quarter of 2016. Our cost estimate is now approximately $300 million compared to our previous guidance of $270 million. Even with the higher spending, we still expect an average six times EBITDA multiple from this project.

Our latest growth spending estimates are now $850 million in 2016, $250 million in 2017 and $200 million in 2018 to complete the construction projects that are currently underway. These spending estimates are $350 million higher than the last guidance we provided, primarily due to the addition of our new Pasadena Marine Terminal and a number of smaller projects, such as additional crude oil storage at our East Houston terminal.

Based on strong demand for crude oil storage in the Houston Gulf Coast region, we have launched projects to build a total of 2.7 million barrels of crude oil storage at East Houston, with new tankage expected to begin coming online as early as next month, through the end of 2017.

Even though, we are moving forward on our new Pasadena terminal, we continue to evaluate well in excess of $500 million of other potential organic growth opportunities, with significant opportunities in all areas of our business. As we've discussed, more near-term opportunities include additional build-out of the Pasadena terminal, as well as further development of our Seabrook Logistics joint venture.

We announced a few months ago, that we've signed a letter of intent with our Seabrook Logistics partner, and continue to work on finalizing binding agreements. We will provide more detail on the scope of the Seabrook expansion and its contribution to our capital spending plans, when these agreements have been finalized. These opportunities represent just a few of the long list of potential projects we are considering at this time.

Concerning the acquisition market, there are a number of attractive assets currently being marketed. As always, we remain active in analyzing these opportunities and we'll do our best to negotiate offers we believe are reasonable, and will benefit Magellan investors over the long-term.

That concludes my prepared remarks. And so, now, we'll turn the call over for your questions.

Question-and-Answer Session

Operator

And we'll go ahead and take our first question from Faisel Khan with Citigroup. Please go ahead. Your line is open.

Faisel H. Khan - Citigroup Global Markets, Inc. (Broker)

Hi, good afternoon. It's Faisel at Citigroup. Just going back to your comment on RINs, I think in your Analyst Day, you talked about sort of the cost of RINs in 2015 being about I think $10 million to $15 million. Just wanted to understand I mean cost, I think the RIN prices have probably almost doubled since then, so just want to make sure of that linear equation. And this year, is that headwind $20 million to $30 million or how you're looking at that?

Aaron L. Milford - Chief Financial Officer & Senior Vice President

We look at it right now with the increases that we have seen in RINs that $15 million that you referenced would turn into $20 million.

Faisel H. Khan - Citigroup Global Markets, Inc. (Broker)

Okay. And is there a way to mitigate the cost because since you own the terminals, I understand you leased those terminals out to your customers, but is there – as some of those contracts roll off, can you sort of retain some of that terminal capacity to blend gasoline or are you obligated to continue to let that contract roll to your customer?

Michael N. Mears - Chairman, President & Chief Executive Officer

Well, the way that RINs are actually generated, is at the point where you blend ethanol into gasoline and the blender – the party that's actually doing that then owns the RIN. We're not in the marketing business, I mean one consequence of doing that is when you have blended gasoline you need to market either at the wholesale level or the retail level. We are not in that business, we don't have any plans to be in that business, right now. So, there's little we can do, short of that, to mitigate those costs. We have done a couple of minor projects that involve some biodiesel blending that probably aren't material enough to drop that cost down, but those sorts of things we've done around the edges, but to materially – directly impact, we'd have to change our business model and we don't at this point have any plans to do that.

Faisel H. Khan - Citigroup Global Markets, Inc. (Broker)

Okay. And just on the oil pipelines, you've talked about how, I guess, one of your joint venture pipelines, you received some headwind in terms of now shippers are – you're not seeing any spot volumes in that pipe, or what are you seeing in the rest of your oil pipeline network, are you seeing all the volumes sort of migrate towards MVCs or are you now sort of, are you also seeing them migrate below MVCs?

Michael N. Mears - Chairman, President & Chief Executive Officer

Well, with regards to – the general answer to that is we're seeing the volumes migrate to the MVCs. I mean, if you look at the differentials, you've got, in many cases, product price differentials that are below the cost to ship, which is driven to that fact, because people are acquiring barrels to meet their MVCs. And that's generally what we're seeing on our committed pipes right now.

Faisel H. Khan - Citigroup Global Markets, Inc. (Broker)

Okay. We aren't seeing the volumes trend below the MVCs?

Michael N. Mears - Chairman, President & Chief Executive Officer

We've seen it on Double Eagle to a small extent, but we have not seen it for any length of time on BridgeTex and Longhorn. In fact, they're trending right at the MVCs. I would say though on Longhorn, we are expecting our actual performance to be below the MVCs for the rest of this year that factored into our guidance. And that's simply because shippers have credits from over-shipping from previous periods that they are now using, but we would expect it to go back to the MVC level once those credits are used up.

Faisel H. Khan - Citigroup Global Markets, Inc. (Broker)

Got it. And last question from me, just that the linefill on Saddlehorn, you said you were done with that and just what's the amount of linefill in that pipeline? I'd suspect somewhere around 3 million barrels, but I just wanted to make sure and understand what the number could be?

Michael N. Mears - Chairman, President & Chief Executive Officer

No, it's probably closer to 1 million barrels. And it's not done yet. We just started it last week. We expect it to be done by the end of the month and then put the line into commercial service.

Faisel H. Khan - Citigroup Global Markets, Inc. (Broker)

Okay, great. Thanks for the time.

Operator

Thank you. And we'll go ahead and take our next question from Richard Verdi with Ladenburg Thalmann. Please go ahead. Your line is open.

Hilary Cauley - Ladenburg Thalmann & Co., Inc. (Broker)

Hi. This is actually Hilary Cauley on for Rich Verdi. My first question for you guys is touching on the Marine storage with a little bit lower utilization rates. And I know you said most of that was due to the Galena Park, I was just wondering if there are any other driving factors that we could expect to continue into the next quarter?

Michael N. Mears - Chairman, President & Chief Executive Officer

There really aren't any material changes on our Marine storage. All of it or the vast majority of it is contracted. Usually when you see variations quarter-to-quarter on utilization, it's due to tanks being out of service for maintenance.

Hilary Cauley - Ladenburg Thalmann & Co., Inc. (Broker)

Okay.

Michael N. Mears - Chairman, President & Chief Executive Officer

And in this case, it was unusually high because we are converting a large volume of storage at Galena Park to crude oil, and so that's what drove that variance.

Hilary Cauley - Ladenburg Thalmann & Co., Inc. (Broker)

Okay, great. Thanks. And then, just real quick, if you guys could provide an update on the credit profile of your counterparties. I know, previously you said the only issue really had been with BridgeTex, and just wondering if that's still the case?

Aaron L. Milford - Chief Financial Officer & Senior Vice President

Yes, we've talked about that fairly extensively in the first quarter and nothing has really changed for us. We're still in great shape; our customers, generally speaking, are very solid. So, there is nothing that has changed from our previous comments.

Hilary Cauley - Ladenburg Thalmann & Co., Inc. (Broker)

Okay.

Michael N. Mears - Chairman, President & Chief Executive Officer

I think we've previously discussed that we have one shipper on BridgeTex that is a credit concern. They have not been shipping. We don't anticipate them to ship and they are not in any of our forward forecast, nor have they been in any of our results so far this year.

Hilary Cauley - Ladenburg Thalmann & Co., Inc. (Broker)

Right. All right, great. Thanks. That's all from me.

Operator

Thank you. And our next question comes from Jeremy Bonnet (sic) [Tonet] with JPMorgan. Please go ahead. Your line is open.

Jeremy B. Tonet - JPMorgan Securities LLC

Hi, it's Jeremy Tonet, here.

Aaron L. Milford - Chief Financial Officer & Senior Vice President

Hi, Jeremy.

Jeremy B. Tonet - JPMorgan Securities LLC

Good afternoon.

Michael N. Mears - Chairman, President & Chief Executive Officer

Good afternoon.

Jeremy B. Tonet - JPMorgan Securities LLC

I was just wondering with regards to the competitive landscape for Permian crude oil takeaway, if you could just dive in a bit more as far as how you see that kind of developing over the next few years in – a lot of people talk about overcapacity, so I was just wondering if you could refresh us on your thoughts there?

Michael N. Mears - Chairman, President & Chief Executive Officer

Well, clearly, when you look forward in the Permian basin, there is the potential for there to be overcapacity. And it's not in a chronic overcapacity situation, as we speak, but it certainly could be in the future if some of the projects that are proposed are actually built. So, with regards to what the competitive landscape is going to be, it's going to be competitive. I mean, I don't know what more to say about that. I've said a number of times, I would not envision an all-out tariff war, so to speak, in those markets, but I think you'll see a differentiation based on service, there'll be differentiations based on capabilities on both ends of the pipe to segregate barrels, capabilities to offer Marine access at the terminus of the pipes.

All those things will tend to differentiate the various operators. I think the most likely scenario, if you're in an overbuilt situation, is that you'll have all of the pipelines operating at less than capacity. I don't think you'll have a situation where a pipeline will be full and another pipeline will be empty. So, you'll have underutilization spread across the assets. That being said, you certainly could paint a scenario, depending on various production forecasts, where that period of overcapacity is not long-lived, that if you have a recovery in oil prices as everyone is projecting in 2017 and 2018 and production starts to ramp back up, then you could certainly, based on a number of forecasts I have seen, in 2019 or 2020, not have an overcapacity situation.

So, that's kind of how we're looking at it right now. We think we've got assets that are very well-positioned. We have capacity available on BridgeTex today that we're marketing. We are doing things in the Houston area with regards to our Marine facilities and storage at East Houston, and segregating and putting in capabilities to segregate products on our pipe so that we are in a strong position to be competitive going forward. So that's kind of my high level view of the market in the next few years.

Jeremy B. Tonet - JPMorgan Securities LLC

That all makes sense. And just to follow-up on that, as far as your contract cover is concerned, are you guys pretty close to kind of the baseline there? I mean, it seems like you have a good amount of protection as far as what your contracts are.

Michael N. Mears - Chairman, President & Chief Executive Officer

Well, we do – I mean, BridgeTex has long-term contracts. They are extending out quite a few years into the future. Our Longhorn pipeline has contracts that are expiring within the next couple of years. We continue to believe that Longhorn is a very efficient path from the Permian to the Gulf. We are continuing to have discussions with our shippers and other parties about use of the system after those contracts expire. We do not anticipate that – any significant reductions in volume. Certainly, if you were in a very competitive market, there would be some pressure on volumes. As I mentioned, Longhorn is full today. I think if we are in an overbuilt situation, you are going to see pipelines that are – that that unused capacity will be spread out. So there is some potential that Longhorn won't be full.

However, trying to estimate what that level will be, at this point in time, is difficult to do. I can tell you that the market likes the service that Longhorn provides today and as I said, we're doing things today such as putting in the ability to segregate condensate on Longhorn, and we are putting in flexibility in the Gulf for Marine access off of Longhorn movements. And so, we're doing the things at this point in time to keep that system competitive, even beyond the life of the contracts.

Jeremy B. Tonet - JPMorgan Securities LLC

That's all helpful. That's it from me. Thank you.

Operator

Thank you. And our next question comes from Shneur Gershuni with UBS. Please go ahead. Your line is open.

Shneur Z. Gershuni - UBS Securities LLC

Hi. Good afternoon, guys. I was wondering if I can follow up to your response to Jeremy a little bit. There you kind of hedged talking about the potential negative in the Permian Basin, the potential positive in the basement. What is your base case? I mean, we hear, Pioneer last week talking about 5 million barrels of production, which would be well in excess of where capacity can potentially be envisioned. I mean, do you really expect there to be an issue re-contracting or do you actually expect a tight market when you consider that production never came off in the Permian and rigs have already started to come back? I was wondering if you can sort of talk in the context of, what you're really actually planning for versus kind of giving the bear and bull case?

Michael N. Mears - Chairman, President & Chief Executive Officer

Well, first of all, we're not in a business of projecting oil prices and we're not necessarily the best advocate for where production will be. I can tell you, though, when we think about our base case, I mean, our expectation is that in the 2018 to 2020 timeframe, that it's going to be a very competitive market that short of a dramatic increase in price in the next year, which is possible, but short of that happening, if we see more of a gradual recovery, then there is going to be a period of time where it's going to be competitive.

We don't think, long-term, it's a problem. I mean, we believe the thesis that crude oil prices will rebound to generate the kind of production in with a level of production in the Permian that's not going to have an overcapacity situation on pipe takeaway. But our working assumption is that there is going to be a year or two years of overcapacity in the market. And what the magnitude of that will be is unknown, how much it will impact our volumes is unknown. I think there is a reasonable chance that we will keep Longhorn full through that period, through the things we're doing. But, trying to predict that two years out is difficult to do. So, that's probably the best answer I can give you with regards to what our base case is.

Shneur Z. Gershuni - UBS Securities LLC

Is there another basin that has better return profiles than the Permian that would help compete the Permian for a production increase because that sounds kind of bearish when you think about the pull of crude in the U.S. in general?

Michael N. Mears - Chairman, President & Chief Executive Officer

No, there's not. Not at all. First of all, I mean we're a conservative company when it comes to forecasting going forward. Everything on paper looks great for the Permian, and there's probably the majority of analysts, who are projecting production growth in the Permian that would suggest you don't have a long-term problem. And we agree with that. But, what sounds like I'm hedging my bets here is, we're at $40 crude today. If we're at $40 crude a year from now or $40 crude two years from now, then I think we're going to have an overcapacity situation. No one is predicting that, but then again I don't want to say it's not possible. So, if we're at $60 crude a year from now, then I think the magnitude and the length of time that you have in overcapacity situation is mitigated substantially, but unless, I don't want to sit here and say there's absolutely not going to be a problem, because production will catch up, because I don't know that. I mean, if you can tell me what the price of crude will be a year from now or two years from now, I can give you a better guess, that's why it sounds like I am hedging my bets.

We don't feel like we've got a long-term problem. At worst, we've got a short-term problem, and as I said earlier, we're not confident the short-term problem is material. I mean, we believe, we've got the tools to keep Longhorn, if not full, close to full.

Shneur Z. Gershuni - UBS Securities LLC

Okay. It's fair enough. And for a couple of questions, in terms of the Saddlehorn to start with, if I remember your comments correctly, you said, there's a very little, if any, benefit this year and then it shows up next year. Is that more of just the structure of the JV, that you sort of it's on the lagged payment or is that equity method accounting? I was just wondering if you can sort of walk through sort of how that will play itself out from an earnings perspective?

Michael N. Mears - Chairman, President & Chief Executive Officer

Well, our comments had to with DCF. I mean, the earnings will show up, as we start earning it through the JV, but from a DCF standpoint, we don't report DCF from a JV, until we actually get a cash distribution from the JV. And so, we would not expect that we would get one until early next year. Being a startup JV, we would anticipate, we're going to retain cash, build up some working capital and then roll into kind of a typical quarterly distribution process and if we do that then we're not going to actually get a cash distribution until next year, which is when we'd report it in DCF. But it makes – but earnings will – it will – what it earns in 2016 will show up in earnings in 2016.

Shneur Z. Gershuni - UBS Securities LLC

Okay. A couple of more quick questions here. Early shift to winter gasoline by refiners, is that something that you can take advantage of on your butane business or that's pretty much hedged up and delivers when it delivers?

Michael N. Mears - Chairman, President & Chief Executive Officer

Well, there is little opportunity for us because there is little opportunity for us to store any winter gasoline at this point in time. I mean, we're pretty full. There may be some opportunities we're looking at the store, but they are pretty small. The way we operate our pipeline system, it will make it very difficult for us to start taking winter gasoline early in any material amount.

Shneur Z. Gershuni - UBS Securities LLC

Okay. And then finally, with the splitter coming online, do you expect or have any sense whether your contracted counterparties are going to actually run volumes through it just kind of given where product inventories are or do you expect just to receive the MVC payment? I was wondering you can just sort of give us a color on how you think it will be utilized.

Michael N. Mears - Chairman, President & Chief Executive Officer

At this point in time, we have every reason to believe that our counterparty is preparing and planning on using the facility when we start out.

Shneur Z. Gershuni - UBS Securities LLC

Okay, great. Thank you very much, guys. Appreciate the color.

Operator

Thank you. And we'll go ahead and take our next question from John Edwards with Credit Suisse. Please go ahead. Your line is open.

John Edwards - Credit Suisse Securities (USA) LLC (Broker)

Yes. Hi. Mike, just to clarify, I think it was Shneur's question, just on the declines in Longhorn, the impact of those, it sounds like in answering that, you're not really seeing any negative impact, you're pretty much running full and you are expecting to more or less stay at that level. Is that correct?

Michael N. Mears - Chairman, President & Chief Executive Officer

Are you talking about the rest of this year or are you talking about...

John Edwards - Credit Suisse Securities (USA) LLC (Broker)

The rest of this year. I mean, I think you were indicating that you were seeing some slight declines and...

Michael N. Mears - Chairman, President & Chief Executive Officer

Right.

John Edwards - Credit Suisse Securities (USA) LLC (Broker)

... going further out, I think you're all but full, are you seeing any slight impact there and if so, can you quantify that?

Michael N. Mears - Chairman, President & Chief Executive Officer

Yes, our expectation for this year, which is built into our forecast is we would be running less than 100% capacity and that is simply because our shippers – certain of our shippers have built that previous credits that will expire at the end of the year and they need to use those before they expire and so they will be using a credit instead of actually shipping a barrel. When I say that, though, I mean the reduction is not dramatic. I mean when we're talking...

John Edwards - Credit Suisse Securities (USA) LLC (Broker)

Okay.

Michael N. Mears - Chairman, President & Chief Executive Officer

...in the neighborhood of 260,000 barrels a day is our expected throughput. So, it's down somewhat from the level we've been at. But it's not falling off a cliff by any matter and that is a short-term phenomena while they use their credits. And again, they're interested in using their credits right now because the differentials don't really support shipping barrels. And so, it's to their advantage to use a credit rather than ship a barrel, if they have a credit. All of that's already factored into our guidance.

John Edwards - Credit Suisse Securities (USA) LLC (Broker)

Okay. That helps. And then, you are indicating that, on some of the volumes running at or maybe a little bit below MVCs and, do you quantify, can't remember if you quantified deficiency payments, I think you said it – if you did say, I think you said it was fairly small, but if you could just remind us on that?

Michael N. Mears - Chairman, President & Chief Executive Officer

Well, we do collect the deficiency payments. They typically don't flow through earnings right away, and we have historically not included deficiency payments in our DCF. And one reason is because they haven't been material in the past. If they reach the level of materiality, that's an open discussion for us, that we haven't landed on us, whether we report those in DCF or not.

As I've said, I mean we have collected deficiency payments in the past that we have not reported in DCF. When they are recognized income, which is either when they're used or when they expire, we would roll those into DCF. But right now, we've got a backlog, we have a backlog of deficiency payments that have not shown up in earnings, and they have not shown up in DCF. And that number may grow until – that's an issue we have internally as to whether we report that or not. I know some of our peers who report their deficiency payments in their DCF, we have not. Historically, our guidance so far this year does not include any deficiency payments in our guidance, but that's something we're going to be reviewing.

John Edwards - Credit Suisse Securities (USA) LLC (Broker)

Okay. So, they – have deficiency payments – have they reached the level of materiality, yet, or not, or I guess, maybe later in the year, do you expect it to, perhaps?

Michael N. Mears - Chairman, President & Chief Executive Officer

I'd say they haven't quite reached the level of materiality, but they potentially could.

John Edwards - Credit Suisse Securities (USA) LLC (Broker)

Okay. All right, fair enough. And then, on the – I mean, you indicated you've got well north of $500 million of projects, so, I mean, from the last quarter, I mean, is it about the same, a little higher, a little lower? How would you just sort of characterize, directionally, your opportunity set?

Michael N. Mears - Chairman, President & Chief Executive Officer

It's about the same as we've had before. I mean, we've been talking about these two large projects, our crude Marine facility and our refined products Marine facility, for some time. Those projects – we've announced the Marine facility – I'll tell you, both of those projects have, as I've mentioned in my comments, considerable additional upside that's a significant portion of our backlog, but I can also tell you that there's numerous projects in that backlog and some that are very material in size. So I would say the overall quantity and quality of our backlog has not changed.

John Edwards - Credit Suisse Securities (USA) LLC (Broker)

Okay. It sounds like you're quite pleased. Would it be fair to say you're quite pleased with the opportunity set that you're looking at?

Michael N. Mears - Chairman, President & Chief Executive Officer

We are. That's correct.

John Edwards - Credit Suisse Securities (USA) LLC (Broker)

Okay. All right. That's it from me. Thank you so much.

Michael N. Mears - Chairman, President & Chief Executive Officer

Thank you.

Operator

And we'll go ahead and take our next question from Elvira Scotto with RBC Capital Markets. Please go ahead. Your line is open.

Elvira Scotto - RBC Capital Markets LLC

Hi. Good afternoon. I think on the Pasadena Marine Terminal that you talked about, I think you said that it's expandable up to 10 million barrels. How have discussions been going with other potential customers? What's the reception been? And when do you actually have to start construction on this project?

Michael N. Mears - Chairman, President & Chief Executive Officer

Well, we are – and we're actively in the engineering process right now and the permitting process. I mean, actually turning dirt? I don't know. It's probably nine months or a year away before we actually start turning dirt out there. I mean, to be fair, this property doesn't have any development on it. We literally acquired the land the day before we announced the deal. And so – now, that doesn't mean we haven't been doing extensive engineering and prep work, but the fact that it's going to be early 2019 before this is finished indicates that we've got a lot of permitting work to do. And there are no docks at this facility today. And so, going from ground zero to having a new dock and all the infrastructure behind it takes time for permitting and design, also.

Obviously, we would expect as we contract the additional phases that those hopefully would go quicker from their start point. Obviously, if we contracted them right now, it would take the same amount of time; but we're doing considerable prep work such that when we do the additional phases, the incremental capital will be, to use the phrase, on a per unit basis will be a lot less, which is going to drive that multiple down. But we need to do a lot of that prep work upfront, including the connection of a large diameter pipe to our Galena Park facility to bring the supply in here.

So that's kind of the answer on the construction. As far as the question on discussions with other parties, we're in discussions with multiple parties right now and the interest is high.

Elvira Scotto - RBC Capital Markets LLC

Great. And I think you said, I mean, this could be very sizable, $1 billion if you were building all 10 million barrels. How do you think about financing this?

Michael N. Mears - Chairman, President & Chief Executive Officer

Well, we'll finance that as we go along, and maybe I'll let Aaron address that.

Aaron L. Milford - Chief Financial Officer & Senior Vice President

Sure. So we're committed to a strong balance sheet and nothing is going to change. As we continue to grow, we're going to capitalize our business in a prudent way just like we've done in the past. So, nothing is going to change. We've told everybody what we're committed to on a leverage basis, that's not changing. So we'll capitalize the business prudently going forward.

Elvira Scotto - RBC Capital Markets LLC

Okay. Just switching over to the expansion of the – the potential expansion of the Seabrook JV, would that be similar to Pasadena in that the multiple would move lower if you expand it up to 4 million barrels?

Michael N. Mears - Chairman, President & Chief Executive Officer

Well, it's going to start out probably the same – in a similar fashion. If you'll recall, what we're doing at Seabrook right now is kind of a, for lack of a better word, an isolated project. I mean, we have a long-term contract to build storage and connect it through a third-party pipe for importing barrels. What we haven't done is connect it to our distribution system. And so one of the elements of the expansion would be to build the pipeline connections to our distribution system, so that we can move barrels from all of the origin points we're connected to on a distribution system into the facility and also be able to move barrels out of the facility back into our distribution system. So, the upfront costs for the Seabrook expansion, initially it's going to have to bear that pipeline cost, but then it's going to be in the same situation that Pasadena is that as we build it out, that multiple should come down.

Elvira Scotto - RBC Capital Markets LLC

Got it. And have you provided any book ends around CapEx if you could go up to 4 million barrels and build the pipes, et cetera?

Michael N. Mears - Chairman, President & Chief Executive Officer

We haven't. We're going to wait until we get all the final documents executed before we provide those details. And I will say, I know we announced the letter of intent back in May, I think it was this project is still very active. We are right in the heart of negotiating definitive agreements and so hopefully we can have something to talk about in the near future. And as always, I qualify those statements by saying, a deal is not done until it's done, and so that's why we're cautious. Even though we're making good progress on definitive agreements, never want to call a project completely done until they're signed.

Elvira Scotto - RBC Capital Markets LLC

Great, thanks. And then just the last one from me, do you have any update on the South Texas refined product pipeline, the one from Corpus Christi to Brownsville?

Michael N. Mears - Chairman, President & Chief Executive Officer

I don't have any update on it other than we're continuing to actively work on it.

Elvira Scotto - RBC Capital Markets LLC

Great. Thank you very much.

Michael N. Mears - Chairman, President & Chief Executive Officer

Thank you.

Operator

Thank you. And our next question comes from Jerren Holder with Goldman Sachs. Please go ahead. Your line is open.

Jerren A. Holder - Goldman Sachs & Co.

Hi. Good morning. Just starting off with the costs in Saddlehorn, can you tell us what drove the cost lower relative to the initial forecast? And if that results in an improved multiple to you guys or potentially lower tariffs to your customers?

Michael N. Mears - Chairman, President & Chief Executive Officer

I mean the short answer is, it's just a combination of labor and materials. And we also typically put contingencies in there for unforeseen issues and we didn't have very many unforeseen issues. So, that's why our cost was lower. And yes, we've quoted the multiple on Saddlehorn just at the committed levels at about a nine times EBITDA multiple and with just lower costs, that's more like an eight times EBITDA multiple.

Jerren A. Holder - Goldman Sachs & Co.

Thanks. And then, maybe switching across to some of your debts, I know you guys issued some term debt in February, but we've seen other investment-grade companies raise debt recently at much more attractive rates. How are you guys thinking about refinancing or pre-financing or anything like that, just given how some of the investment-grade debt markets are at the moment?

Aaron L. Milford - Chief Financial Officer & Senior Vice President

Yes. We continue to stay on top of the market and so – we're typically not a big pre-issuer, but we've got our debt coming due here in October. The way we approach the markets is in a very opportunistic way. We try and maintain the liquidity in our bank facilities, which you can see are undrawn, to allow us to sort of time and pick what we think are good times to go to market and function in terms of the quality of the market at the time, but also what our spending need are. We try and flange (51:14) those up as best as we can, so that we don't have a lot of negative carry. So, we're aware of the markets that are out there, but we'll continue to behave as we have in the past.

Jerren A. Holder - Goldman Sachs & Co.

Okay, great. Thank you.

Operator

Thank you. And our next question comes from Jeff Birnbaum with Wunderlich. Please go ahead. Your line is open.

Jeff Birnbaum - Wunderlich Securities, Inc.

Afternoon, everyone. Pretty much all my questions have been asked and answered at this point. Just one quick one from me, with products markets, as oversupplies as I've seen here and some refiners talking about run cuts in the back half of the year, are you expecting any changes or softness in shipments in the second half?

And then, I was just kind of curious, how long you're thinking these inventories might last and maybe to what extent if then you're seeing any benefit from that, as you negotiate to add product storage? Thanks.

Michael N. Mears - Chairman, President & Chief Executive Officer

So, certainly, it's a market that's very interested in adding product storage along our pipeline system. And so, we are doing that as we speak, we are also negotiating additional contracts for product storage, so that is something that continues to grow on our system. With regards to predicting where the inventory is going to go, it's difficult for us to do that. Again, that's driven by the individual refiners and what they choose to do with regards to cutting runs and how they're reacting to the abundance of supply in the market, and the abundance of the inventory in the market.

But on your first question, the short answer is, I mean at the end of the day we're a demand-driven system. So what's most important to us over the long-term is the demand through the system, inventory fluctuations or things we have to manage, they don't really drive our income. And the way we're managing that is continuing to look at storage and continue to add new markets for Mid-Continent refiners, such as Little Rock, such as reverse – being able to reverse our system into Texas to relieve some of the oversupply and we're continuing to do that. There's a number of projects, we're looking out right now, to continue to expand the reach of our system to help solve that problem over the long-term, and obviously it's not a problem you can solve easily in the short-term. But – well, I think that's it. Hopefully that answers your question.

Jeff Birnbaum - Wunderlich Securities, Inc.

Yes. It does. Thanks, Mike.

Operator

Thank you. And our next question comes from Lin Chen (54:18) with (54:19). Please go ahead. Your line is open.

Unknown Speaker

Okay. Thank you very much for taking my question. I just want to clarify that I think, I began to use that cost of Saddlehorn is going to be $30 million less than the original planned cost. Is the $30 million just your cost or the total cost of the pipeline or just the Saddlehorn or the joint venture between Saddlehorn and also Grand Mesa?

Michael N. Mears - Chairman, President & Chief Executive Officer

Well, the $30 million is our cost, but that's a product as a fact that the overall project is less. So, all the other participants in the project are going to have lower cost also.

Unknown Speaker

Okay. So $30 million cost is just your portion of that?

Michael N. Mears - Chairman, President & Chief Executive Officer

Correct.

Unknown Speaker

Okay, great. Thank you very much.

Operator

Thank you. And it does appear we have no further questions at this time. I will hand it back over to Mr. Mike Mears for any additional or closing remarks.

Michael N. Mears - Chairman, President & Chief Executive Officer

Well, thank you very much, for your time today. Overall, we are pleased with the performance of our business so far this year and the progress we're making on our growth projects. And we appreciate your continued support at Magellan. So, have a good afternoon.

Operator

And that does conclude today's program. We'd like to thank you for your participation. Have a wonderful day, and you may disconnect at any time.

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