Arc Logistics Partners: Near-Term Upside Catalysts, Longer-Term Questions

| About: Arc Logistics (ARCX)
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Arc Logistics Partners LP (NYSE: ARCX) went public on Nov. 5, raising about $114 million before fees.

The fledgling master limited partnership (MLP) owns 11 refined-product terminals that can store about 2.5 million barrels of petroleum products and three terminals in Alabama that can accommodate another 2.4 million barrels of crude oil and heavy refined products. These Gulf Coast assets include two rail transloading facilities that can handle about 23,000 barrels per day.

The weighted average term on the contracts covering this capacity hovers around three years, while the MLP's top 15 customers have an average of more than five years remaining on their agreements.

About 89 percent of Arc Logistics Partners' revenue comes from storage and throughput service fees, while take-or-pay agreements-where customers must pay a minimum fee regardless of whether they use their allotted capacity-predominate.

Management's forecast for the 12 months ending Sept. 30, 2014, calls for the MLP to generate about $13.9 million in distributable cash flow from its storage and terminals business-about $5 million shy of its annualized quarterly payout at the minimum quarterly distribution rate of $0.3875 per unit.

To make up for this shortfall, Arc Logistics Partners plans to use $73 million of the proceeds from its initial public offering (IPO) to purchase a 10.3 percent interest in Gulf LNG Holdings from GE Energy Financial Services, which, incidentally, owns a 58 percent interest in the MLP's sponsor and general partner, private-equity outfit Lightfoot Capital Partners LP.

Gulf LNG Holdings owns an LNG import terminal in Pascagoula, Miss., that has a nameplate capacity of 1.5 billion cubic feet per day and connects to the Gulfstream Pipeline, the Destin Pipeline and the Pascagoula Supply Line.

Although the facility's customers aren't delivering LNG cargos to the site because of the huge upsurge in U.S. natural-gas production, the two 20-year agreements covering this capacity include firm charges that guarantee payments regardless of throughput.

This graph breaks down the ownership of Gulf LNG Holdings after this transaction. Note that Kinder Morgan Inc. (NYSE: KMI) last fall announced plans to drop down its interest in this asset to El Paso Pipeline Partners LP (NYSE: EPB).

Source: Company Reports

Arc Logistics Partners estimates that its 10.3 percent interest in this LNG import terminal will generate $8.7 million in distributable cash flow over the 12 months ending Sept. 30, 2014, enabling the MLP to cover its targeted minimum distribution by 1.2 times.

However, the fledgling publicly traded partnership's prospectus also warns that this stream of cash flows could shrink if the LNG facility's operator invests this revenue to add export capabilities to the site.

Growth Prospects

Arc Logistics Partners' terminal and storage assets in the Midwest and on the East Coast serve as cost-effective delivery points between refineries and end-user markets of petroleum products; the majority of the organic growth opportunities on these assets would involve adding capacity to handle a wider range of products and enhancing blending capabilities.

Management also indicated that the firm would continue to pursue opportunistic third-party acquisitions to complement its existing assets in these regions.

However, the MLP's most compelling growth opportunity resides on the Gulf Coast, where an influx of North American crude-oil production should drive demand for storage and export capacity.

As we explain in Crude Realities: Price Volatility is Here to Stay, light-sweet crude oil from the nation's prolific shale oil and gas plays has flooded the region, creating huge profits for storage and terminal owners on the Texas Gulf Coast.

But Arc Logistics Partners could benefit from the next wave of crude oil to hit the Gulf Coast: bitumen produced from Canada's oil sands.

Planning or construction is under way on five large-scale rail terminals in western Canada that would increase cross-border rail shipments to more than 500,000 barrels of oil per day in 2015 from about 100,000 barrels per day this year.

These facilities would load unit trains of heated or insulated railcars that prevent the viscous bitumen from setting. These specialty cars reduce the volume of condensate or natural gasoline required to dilute the raw bitumen, making this transportation method more price competitive with imported volumes of Mexican and Venezuelan crude oil that Canadian producers hope to displace. Some commentators have even suggested that this approach can compete with pipelines on cost.

Canada National Railway Company's (NYSE: CNI) existing rail network runs from Alberta to New Orleans and Mobile, Ala., prompting the company to encourage partners to expand their terminal capacity in these areas to support growing shipments of bitumen by rail.

By the end of 2013, Arc Logistics Partners' facilities in Mobile will include:

  • A rail yard capable of receiving unit trains of 120 railcars, as well as a state-of-the-art steam heating system to reheat bitumen cargos;
  • A heated and insulated pipeline that would transport the reheated and diluted bitumen to the MLP's storage terminals; and
  • Two docks capable of loading inland barges to ship the bitumen to Gulf Coast refiners and Panamax-size product tankers for seaborne exports.

In a presentation at an industry conference in February 2013, Arc Logistics Partners noted that shipping Canadian oil-sands production to Mobile can halve costs and transit times relative to delivering these volumes to the Houston area. Management estimates the time to load a cargo in Alberta and unload these volumes in Mobile can take between eight and 14 days.

Arc Logistics Partners also owns more than 40 acres of additional land for incremental capacity additions if shipping oil-sands output by rail takes off as expected.

The MLP's 10.3 percent equity interest in Gulf LNG Holdings also offers exposure to plans to add 2.1 metric tons per annum of export capacity to the Pascagoula terminal; current operator Kinder Morgan Inc. reports that the facility's partners have inked three memoranda of understanding with potential customers.

That being said, the facility has yet to obtain approval from the Federal Energy Regulatory Committee or authorization from the Dept of Energy for shipments to countries with which the US doesn't have a free trade agreement.

In Kinder Morgan Inc.'s conference call to discuss fourth-quarter results, CEO Richard Kinder emphasized that development of export capacity wouldn't progress until El Paso Pipeline Partners secures firm commitments from potential customers. (Check out our take on Kinder Morgan Inc. and Kinder Morgan Energy Partners LP's fourth-quarter results.)

Given the number of LNG export projects that US operators have announced, some of these facilities likely will fall by the wayside. The Kinder Morgan family of company's 2014 Analyst Conference (scheduled for Jan. 29) should provide further clarity on the plans and outlook for the Gulf LNG project.

We wouldn't be surprised if Lightfoot Capital Partners were to drop down its 9.7% interest in Gulf LNG Holdings to Arc Logistics Partners at some point.

The Verdict

  • Arc Logistics Partners' minimum quarterly distribution of $0.3875 per unit implies a distribution yield of about 7.8 percent - fair compensation for an MLP whose major growth projects won't ramp up right away.
  • Questions also remain about the extent to which the potential approval of TransCanada Corp's (TSX: TRP, NYSE: TRP) Keystone XL pipeline would affect rail shipments of bitumen to the Gulf Coast.
  • Until we hear more details on the Gulf LNG project, it's difficult to muster much enthusiasm for Arc Logistics Partners' acquisition of this asset.
  • That being said, the stock could be an interesting shorter-term trade for investors willing to bet that the market hasn't priced in the ramp-up of volumes at the MLP's terminal and transloading facility in Alabama.

Learn more about our favorite energy-related MLPs in 3 Master Limited Partnerships to Buy Now.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.