Tallgrass Energy Partners, LP (NYSE:TEP)
Q2 2016 Results Earnings Conference Call
August 03, 2016, 04:30 PM ET
Nate Lien - Head, Investor Relations and Financial Inquiries
David Dehaemers - President and Chief Executive Officer
Gary Brauchle - Executive Vice President, Chief Financial Officer and Treasurer
Bill Moler - Chief Operating Officer
Kristina Kazarian - Deutsche Bank
Brandon Blossman - Tudor, Pickering, Holt
Christine Cho - Barclays
John Edwards - Credit Suisse
Ethan Bellamy - R.W. Baird.
Charles Marshall - Capital One
Ted Durbin - Goldman Sachs
Good day everyone and welcome to the Tallgrass Energy Quarterly Investor Conference Call. At this time, I would like turn the conference over to Nate Lien. Please go ahead, sir.
Thank you, [indiscernible]. Good afternoon, everyone. We appreciate you joining as we discuss, among other things, the Tallgrass Energy Partners and Tallgrass Energy GP results for the second quarter of 2016, which were released through our joint press release and 10-Q this afternoon.
Joining me on the call this afternoon are David Dehaemers, Tallgrass’ President and Chief Executive Officer; Bill Moler, Tallgrass’ Executive Vice President and Chief Operating Officer; and Gary Brauchle, Tallgrass’ Executive Vice President and Chief Financial Officer.
Before turning the call over to David, let me remind you that this call is being recorded and a replay will be available for a limited time on our website. Additionally, our comments today will include forward-looking statements and estimates. These forward-looking comments are subject to various risks and uncertainties, and reflect management’s views as of August 03, 2016.
Please refer to our filings with the SEC, which are available on our website, including our 10-Ks, which provide discussions of factors that may cause actual results to differ from management’s projections, forecasts, estimates and expectations. Please note that except to the extent required by law, Tallgrass undertakes no obligation to update any forward-looking statements. Please also refer to our earnings release for reconciliations between our non-GAAP financial measures referenced in this presentation and the most comparable financial measures calculated and presented in accordance of GAAP.
With that, let me now turn the call over to David for his opening remarks.
Good afternoon, everybody, and thank you for joining the Tallgrass Energy’s second quarter earnings call. I have to tell you I always look forward to these calls because it is kind of one time each quarter where we get to talk to everybody at once and kind of have the table. And today we've got a number of things to go through, not only our performance, but some other matter to talk to, some a little lighter, some a little bit more meaningful and serious.
And I guess before I kind of dive into what we did this quarter, I would like to just kind of step back and talk about a few things that seems to me sometimes that in the midstream energy business as well as the MLP world people forget about these things and that that is simply this, that MLPs is really are not simply this unique animal that is out there.
Frankly, MLPs are just like any other company and a company that is publicly traded like ours or any MLP would actually be a corporation were it not for the fact that the Internal Revenue Code gives it the ability to be taxed as a partnership and so that the only difference. Probably one of the things that make MLPs unique that I think people forget about are these partnerships are structured so that these MLPs with long-lived assets are able to generate cash flow that then is returned to their unitholders and that is cash flow from operations.
And so I think people sometimes forget that and think that MLPs are just the kind of unique animals out there and it is a whole asset class that needs to be looked at, extremely different from any other business et cetera and I think it's important to step back and take a look at that and remember that at times.
One thing that we've had happen in this last two weeks is we did take REX out of service. We thought it might be out for eight days. I think we were down somewhere between four and a half, and five days, which we feel really good about. I think I would instruct everybody if you get a chance to take a look at our website there are four or five pictures that are going to be up on there for a couple of weeks.
They are really good pictures of the construction work that we did where we're tying in the compressor stations, the three new compressor stations on REX and there are four or five great pictures of very hard working pipe liners working through the night and tying those pipelines in and I would encourage you to take a look at those and see the type of work that we do and the service that we provide.
Finally again, before jumping in on the lighter side of things, we have a social media consultant around here now and that is my 14-year-old niece and my 12-year-old nephew, and they told me, they said, uncle David, you really need to think about what's going on in social media and I said oh yeah, why is that, and they said well, for instance do you know that there are people that are on your earnings call that play drinking games? And I said, what are you talking about? They said they count the number of words that you say certain phrases at times and they take a drink and they claim that by the time your earnings calls are done that they are drunk. Well, we want to be socially responsible and so therefore we're going to try and change some of those words.
So no longer will the – we will at least try not to use the words Chicken Little or Mad Money or things are working our butts off as an example. So whoever is doing it may have just had three drinks, I don’t know, but I guess I would encourage you to look for the replacement works for those because we cannot totally let them off the hook.
With all that said, as you can see in our earnings release we had another very strong quarter with a number of positive commercial and financial developments including financial results that reflect two months of distributions from REX for the first time as a result of our 25% acquisition in May. The settlement of REX'S claim against the former unit at the Department of the Interior, that's the Mineral and Mining Service, MMS additional contracted capacity of REX. In the settlement in principle of TIGT's rate case and open season on Pony Express for new condensate stream and the in service of TDev's Buckingham terminal among other things.
Let's first review the outstanding financial results for the second quarter which led to TEP's 12th consecutive quarterly distribution increase since its IPO in May 2013 and TEP's fourth consecutive quarterly distribution increase since its IPO in May 2015. The second quarter adjusted EBITDA for TEP was $114 million, not including any of our fully collected net deficient payments under our take-or-pay contracts on Pony Express, but inclusive of two months of distributions from REX. If you include the quarter's net efficiency payments in adjusted EBITDA, the amount would have been $122.6 million.
We have again included the table in our press release to show the impact of deficiency payments if we were to have included them in adjusted EBITDA. In addition to that supplemental disclosure this quarter, we have included another disclosure to illustrate the impact that incremental barrel shipments on Pony Express had on our current results as well as a description of how they could impact our future results.
I guess I would remind you that incremental shiploads are similar to walk-up barrels in that we ship them and that when we ship them they are earned revenue in current period cash flow. But unlike walk-up barrels they are with or contracted customers and incremental can be used as a credit against future take or pay barrels.
Gary also explained this to you in detail I think on our last Q4 call and so if you have any additional questions you can reach out here me or Gary, but we felt like it was an important disclosure for you to know. We don’t necessarily know that anybody that is our existing customer that ships incrementally honest will ever reduce the RIM [ph] and receipt commitments in a future period, but we wanted you to know what that looked like.
TEPs DCF for the second quarter which does include deficiency payments was $112 million and once again beat our own internal expectations. Coverage for the quarter was a very strong 1.41 times with approximately $32.5 million dollars of cash generated in excess of distributions. Since TEPs IPO in May 2013 our cumulative coverage is $91.3 million and our cumulative coverage ratio is 1.2 times.
Why do I tell you this? Because like anything we don't, I have said this many times over and over again, we don't run our business for 90 day periods. We run it for the long haul. There is no doubt that at some 90 day period we may experience a hiccup and that is partially the reason that you run coverages like this and you generate earlier cash flow that you don't distribute.
As mentioned in the opening, our strong performance in the REX acquisition supported TEP increasing its quarterly distribution by $0.05 per unit to 75.5 cents or $3.02 annualized. This represents an increase of 77.1% for the first quarter of 2016, 30.2 cents year-over-year growth and approximately 163% growth from the annualized minimum quarterly distribution of $1.15 at our May 2013 IPO. The increase is consistent with TEP's piece plan to recommend to the Board of Directors of its general partner increases in its second and third quarter, so one more to come here 2016 distributions that will aggregate to approximately $0.09 over the first quarter of 2016 distribution of 70.5 cents.
As a result of the 75.5 cent distribution at TEP, Tallgrass equity will receive distributions of $40.3 million on its 20 million TEP common units, GP interest and IDRs and in turn TEGP will receive $11.7 million from Tallgrass equity or an increase of $1.7 million from the first quarter of 2016. Based on that amount, TEGP declared a distribution to Class A shareholders of 24.5 cents or $0.98 on an annualized basis which represents increases of 16.7% from the first quarter and 84.2% since TEGP IPO-ed in May 2015, so a little over a year.
Before I turn the call over to Gary, just let me say one other thing that even today I got a piece from somebody that talked about other coverage universe. There are 82 MLPs out there and 70 had reported. The average increase for those 70 was 2% year-over-year, compare that to our numbers. In addition, the median distribution yield for the whole MLP universe which is over 100 today is about 7.1%. We are at 6.5%, again median is not necessarily the average, but I guess I would tell you by any measure that I can think of 6.5% compared with a median of 71 does not place us by any way in shape or form overvalued in my opinion. In fact, we are undervalued.
With that, I'll turn the call over to Gary.
Thanks Dave. Good afternoon everybody. Let's jump right into the segment performance and then I will talk about balance sheet, leverage and liquidity. In our crude oil segment which is [indiscernible] generated distributable cash flows in TEGP is $74.3 million versus 98% interest during the second quarter of 2016. The increase of $2.8 million in a very sequential quarter mainly [indiscernible] to reduce the expenses and I will tell you that Q2 represents yet another very strong performance for Pony Express.
With respect to volumes on Pony Express, average daily [indiscernible] in Q2 was approximately 286,000 barrels a day, palpable to Q1 average of approximately 291,000 barrels a day. Preliminary July figures show throughput of approximately 280,000 barrels a day and preliminary August shipper nominations would predict that we will move approximately 295,000 barrels per day this month. So, Pony continues to move volumes consistently at or near it's contracted capacity.
Starting with the natural gas segment, which includes pipe, trailblazer and now 25% interest in REX. This segment produced adjusted EBITDA of $45.8 million up approximately $29 million as compared to both the sequential and prior year quarters. The increases are related to the inclusion of two months of distributions from REX TEP's 25% interest that is required in May. I would caution you against annualizing the segment's performance, because it only includes two months of REX distributions and it does include TEP's 25% interest in the REX litigation settlement.
TEP accounts for REX as an equity method investment and expects to continue that accounting treatment even when TEP owned 75% of the pipeline. I will admit that's not a perfectly intuitive answer, but it is what GAAP requires in this particular case. So TEP will not consolidate REX's debt and only include the equity and earnings in TEPs net income. And as for TEPs adjusted EBITDA, that amount will include only distributions received from REX and not 25% of REX'S EBITDA.
Firm contracted volumes for TIGT and Trailblazer averaged 1.48 million cubic feet a day during the second quarter which was in line with the first quarter volumes. Bill will give more details later, but importantly, TIGT has settled its rate case and is awaiting final approval and it's safe to say that the financial benefit to TIGT going forward will be meaningful.
The processing and logistics segment generated adjusted EBITDA of $3.5 million for this last quarter second quarter of 2016 representing a slight increase as compared to the sequential quarter $3.5 million decrease as compared to the prior year quarter. The decreases are due to lower average and less volumes at the processing facilities and as we look ahead in this segment, the volumes are expected to remain low in this year. But I will tell you that we continue to expect additional contributions late this year and for full year 2017 from the recently acquired water assets as the minimum volumes under those contracts ramp up.
Moving on, as you may recall, when TEP purchased the additional 31% interest in Pony in January this year should have granted TEP call option on the 6.518 million units that were issued as part of the consideration in the drop-down transaction.
The strike price of the option is $42.50 per unit. During Q2 TEP issued 3.563 million common units under its ATM program for net proceeds in excess of that strike price. In fact, the net average issuance price was $47.23. As those units were issued, we paid down the balance on our revolving credit facility and then on July 21, we drew on the revolver to repurchase and retire the same 3.563 million common units from TDev. This is the reason the revolver balance increased subsequent to quarter end.
Based on the net proceeds of $168.3 million that TEP received from the issuance of those units it made a payment of $151.4 million to TDev and that was the 3.563 million units funds $42.50 for the repurchase of those units. The difference of almost $17 million was used to reduce borrowing under TEPs revolving credit facility and the reduction of the debt in that amount reduces the purchase price and therefore the transaction multiple for Pony dropped 3 from approximately 9 times to 8.8 times.
The multiple could be further reduced to the extent TEP is able to issue additional common units at net prices above the strike price of $42.50 and redeem any of these remaining 2.95 million units that are subject to the call option. As we said many times before, this transaction and its structure is one of many examples of the supportive relationship that TEP continues to enjoy with TDev.
Now leverage and liquidity. TEP's leverage at the quarter end was approximately 2.7 turns based on the trailing 12 months adjusted EBITDA including the actual distributions associated with the 25% interest in REX. If you were to use the debt balance of just over $1.4 billion as of July 29 that I just described our leverage ratio would be approximately 3.1 times, which is on the low end of our investment-grade target of 3 to 4 turns and I would suggest to you that either of those numbers is among the best in the MLP space today. As the liquidity as of July 29, TEP had well over $300 million of liquidity available to on it on our $1.75 billion revover.
Before I turn the call over to Bill, I want to briefly touch on the potential bond issuance at TEP that's been contemplated now for some time. I know many of you are aware of the substantial improvement in the energy high-yield markets that occurred heading into the Q2 earnings season and we are too. We've been monitoring market conditions very closely. We remain ready. So I'll tell you that the pricing of our inaugural issuance is important for a number of reasons, not the least of which is its impact on TEP's cost to capital. So we remain very focused on picking our spot very carefully.
Now Bill will update you on our assets. Bill?
Thank you, Gary. First step is Pony Express. As Gary highlighted earlier in the call, Pony Express continues to exceed our expectations, volumes that have been consistently at or near our near contracted volume. Last quarter I mentioned the work that our commercial team has done to expand the diversity of the system using as an example the connection to Genesis Powder River. Another example is our recent announcement of an open season for our fourth common stream on Pony Express. This new stream will be a light crude or condensate and allow us to compete for those volumes in the region as well/
In addition to the new common stream our commercial team continues to work at adding additional demand connections in the Pony Express from a local refiner near our pipeline. As a reminder, P66's Ponca City Refinery is an existing demand connection on the system. No agreement has been executed, but we are working it hard and hopeful that it will be commercialized in the near future.
With such supply diversity as crude oil coming from the Bakken, the Powder River basin, the DJ basin the Niobrara wellhead connectivity through our two joint upstream pipelines, Belle Fourche and Highland our multiple common back stream system, refinery connectivity and an additional Tallgrass terminals injection site at Buckingham which just went into service yesterday and our expanding capacity of at least 100,000 barrels a day, Pony Express is well-positioned to compete for barrels both now and in the future.
Let's talk about TIGT rate case. We filed the TIGT rate case with the FERC in late October of last year. It was the 90s since TIGT had had a rate case and was well over due. The filing proposed changes to TIGT's rate structure, updates to its tariff, implementation of a rate increase for our firm and interruptible transportation and storage services. The FERC accepted our filing in those rates in the filing went into effect on May 01, 2016 subject to refund.
Even though those rates went into effect on May 01, our top priority was always to settle the case with our shippers on fair, mutually agreeable terms. I am happy to report that we have reached an agreement with those customers representing a majority of firm fee revenue on the TIGT system as of December 31, 2015 to settle all rate related issues.
On June 08, we filed the offer of settlement with the commission and on July 14, the presiding administrative law judge certified it to the FERC. In conjunction with that settlement, TIGT executed contract extensions with certain firm capacity shippers for an average additional term of 3.25 years. TEP expects TIGT's annualized revenue to increase by proximally $13 million a year as a direct result of this rate case settlement. We and our shippers are very happy with that outcome.
Let's talk about REX. As a reminder, Tallgrass development has a 50% ownership interest in REX and operates the pipeline and TEP now owns a 25% interest in REX as a result of the acquisition completed earlier this year. As mention on prior calls, REX's capacity enhancement project is in full swing with well in excess of 60% of the projected capital spent through June 30. We are still on schedule for an in-service date on or prior to year-end. This milestone will represent another positive cash flow step change that this team has created around this asset and footprint.
I would also point out that we took the east end of REX down on Tuesday, July 19, for five days in order to perform some of the necessary work on the three new compressor stations that are being installed. The outage was expected to last until Monday, July 25. The teams worked very hard, indictment in the pictures on the website, you can see it. Everything fit was welded up tight, done in a very safe manner and we are able to complete the work two days ahead of schedule and bring the pipeline back into service on Saturday the 23rd.
For those of you who watch the market, when REX goes down there is impact and we wanted to get that line back in service as quickly as possible and our team did an outstanding job of communicating with our customers well in advance of that outage in order to minimize their financial impacts, our operational impacts as well as those to REX. We do not anticipate any additional outages related to this new construction.
Another recent positive development at REX that some of you may have read about is Spire Incorporated recently announced Spire St. Louis pipeline project which is a new lateral capable of moving 400 million cubic feet a day that will interconnect with REX in Scott County, Illinois. As a result of that project, REX has signed a precedent agreement with a subsidiary of Spire for 20 million cubic feet a day of capacity. With the signing of this agreement, the total contracted capacity on the capacity on the capacity enhancement project is up to 2.73 billion cubic feet a day. We feel very confident in the demand for the remaining capacity and will continue to work the contracted prior to in-service.
I would also like to briefly touch on the Ultra Petroleum bankruptcy proceedings and the status of our $303 million claim. REX's President has been named the Co-Chair of the creditor committee with Ultra and has been heavily involved in the negotiation process from day one. While the process is still ongoing and we have no current view to share into our potential recovery, we are confident in our ability to recover a substantial amount of that claim.
Finally, Tallgrass Terminals, as a reminder, Tallgrass Terminals is owned by Tallgrass Development, a private company. The past three quarters we have reported on the progress of the Buckingham truck unloading terminal and I'm happy to report that the terminal is now in service and accepting deliveries which will provide more optimality for our shippers and will better position Pony Express competitively.
With this terminal up and running and with the contributions from the sterling terminal and our interest in the deep rock terminal at Cushing, we currently expect Tallgrass Terminals to produce annual adjusted EBITDA in the range of $10 million to $12 million. We also anticipate this number will grow over time as we execute on acquisitions and continued organic growth such as our storage terminal in South Cushing on the 500 plus acres that we purchased in 2015.
We expect to begin civil work on that project in mid August and we continue to be very positive about terminals and the opportunities that project and terminals will present throughout our footprint for future growth.
I will now turn it back over to David for his closing remarks.
So this is usually the time where it is one of my more enjoyable times as long as – as well as Q&A on these calls and I do have a few closing comments that I will make that are probably along the norms of what we've done in the past, but before that, I do have one serious matter and I think this is the appropriate forum to do it.
I want to talk about this serious matter TEP and TEGP as public companies have to live with all sorts of SEC regulations around our disclosure, things we say, things we have to provide in our filings, not the least of which is fair disclosure. It appears that some of the public and especially certain analysts do not have to live within those rules or frankly it appears any rules.
And you probably wonder now what am I talking about; well I'm going to tell you specifically what I'm talking about. On Monday, July or August 01, at 8.40 p.m. an analyst from Hedgeye Energy [ph] sent an unsolicited email to, I don’t know how many people, but it clearly made its way to us. It went to many of our investors. It went to many of the regulated analysts or the people that act like analysts that cover our company.
The headline of that piece says TEP/TEGP: Pony Shipper BCEI warns of potential contract restructuring. BCEI is also known as Bonanza Creek Energy. I'm going to read you two paragraphs out of this note and then I will point out to you why this is a serious problem.
"BCEI is a committed shipper on TEP's Pony Express oil pipeline contracted to ship 12.6 MBD through April 2020. BCEI is also committed to ship 15 MBD on NGL Energy Partners' Grand Mesa oil pipeline that goes in service in 4Q, 2016. In BCEI's 10-Q it warns that it will soon be deficient on both contracts and it attempts to aggressively pursue restructuring these contracts…"
"We estimate that BCEI's commitment to Pony Express amounts to $17 million per year, 12.6 MBD at $3.75 per barrel. BCEI's latest disclosure suggested that it is going to be highly deficient on that commitment starting in September 2016." So those are the quotes. You all know what is funny about this? Frankly, it is not funny. What it is, is liable. And the reason it is liable is because Bonanza Creek is not a shipper on Pony, they have never shipped one barrel on Pony Express. They certainly aren’t a committed a shipper.
I would suggest to people that write things about our company, be that in social media or as purported analysts, get their facts straight before they go libeling our company because they are liable for that.
I will end with my message being this. We work really hard around here for a lot of people that have a lot of money invested in our future. People are obviously welcome to believe our story, not believe it, buy our stock, sell it short, whatever. What you aren’t able and have the right to do is make up your own set of facts and then slander us. If this continues we will have other means for which we will address this in the future.
Now getting back to kind of the more enjoyable part of our job here, I think this quarter and now finally having REX partially in TEP brings to the forefront all the hard work that we have done around here. I will remind everybody that the reason that 25% of REX is in TEP today is a third-party acquisition that we made from Sempra. I know there are certain people out there who might think that because Philips didn’t agree to roll for into the asset that it wasn’t a great buy.
The fact of the matter is, we all have roll for this. We had discussions with Philips. There were good reasons that they did not the least of which is REX is the only non-oil, non-liquids in other words natural gas asset that they own. You can obviously talk to them about other reasons that they may or may not have, but it did not have anything to do with REX being a valuable asset or not.
I think those people that know us and actually follow us closely and look at our body of work over the last, in my case 20 years, in Bill's case 30 years and the whole management teams they look at our entire body of work, not the least of which is the last three or four years should give us the benefit of the doubt relative to we know what we are doing and working very hard to create value for our shareholders. This should not entitle people to a drink, but we in fact work our fingers to the bone.
And so we have 600 plus employees here. We've got 40 engineers. We've got 300 people in the field. We’ve signed commercial contracts over the last two years totalling over $5 billion worth of value and I think that is deserving of some respect.
Having said that, again I was talking early on that actions speak louder than words. While I do enjoy these conference calls and getting to the opportunity to tell you all about TEP and what we have done in the last year or the last quarter as well as the last year and what we intend on doing from this point forward, I will tell you that I enjoy more letting our actions speak for what we have done.
With that, we’ll open it up for questions and again as always we appreciate your support and interest in our story.
Thank you. [Operator Instructions] We will take our first question from Kristina Kazarian with Deutsche Bank.
Good afternoon guys.
So you guys mentioned in this in a press release and also chatted about in your opening comments, but can you guys talk about the opportunities to on the condensate batching open season you guys alluded to refinery and connected well, but what sort of EBITDA uplift we could be seeing here and how generally we should be thinking about this?
So, Kristina I'll let Bill answer the bulk of that, but one thing I'll point out to you is, when we first started Pony two years ago or 18 months ago depending on which section it was, we had the refiner that Bill referred to which is Ponca City at that time accepting, zero barrels of oil at that time when we first started out.
Today they are accepting tens of thousands of barrels a day. I’m not going to tell you specifically how much, but they are and that’s just one refinery along that system. So with that, I'll let Bill talk to you about the batching and then the other refinery, et cetera.
We filed the open season. The open season runs for 30 days. We’ve had several parties already contact us for the necessary confidentiality agreements and subsequently they get the full package of what the services look like. We have the capability. We have the terminaling at Cushing to deal with condensate. We have the pumps, the horsepower to move condensate and as you know, we have 100,000 barrels a day of excess capacity that for all intents and purposes is free and available today on Pony. So anything we get from the condensate or like crude open season will be great and mostly added there very little incremental cost to the system.
Can I predict how much that is going to be at this point? I can’t, but we’ve had some good interest thus far and hope that interest continues to grow. On the refinery front, we’ve said it a number of times that Pony is not a one trick Pony. When we originally built this line it was, its intent was to be Bakken crude going straight to Cushing and nothing more. We commercialized, developed and built the neckline [ph] to add the DJ barrels and the Niobrara barrels. We added Genesis bringing powder barrels over.
We have deliveries to refining in Oklahoma soon to be other refining and then what’s left goes to Cushing. So it is that diversity that we think differentiates us from all others and that diversity is going to bring fruitful results over time.
Okay and then a follow on to that, we got an announcement from someone else last night, talking about the Sandpiper cancelation, can you may be just talk about the long term read through on that?
Yes, Kristina, its Dave. Sandpiper was at least in my opinion a pipeline that really, it's fine to think of these things. It probably shouldn’t have gone as far as it went. I think that the consolidation that’s taking place with the Bakken pipeline, Bakken Express where Enbridge and maybe it is Marathon joined in on that, makes the most logical relative to infrastructure et cetera.
I think that, again like one of the big picture things, that I think sometimes people are failing to understand is that the Bakken is a fairly big play. Not all we get as much as 200,000 barrels a day from the Bakken today. But the Bakken Express pipeline isn't going to sap all the capacity out of that particular production area. And in fact not every barrel in the Bakken wants to go to Patoka or wants to go to Nederland.
And I think people forget to realize that the Bakken tariffs are not all that much – in fact they are not any better than tariffs that are combined tariffs that would get people both the Cushing into the Houston ship channel. And ours are all gathering systems at the header where as barrels are going to be brought into the Bakken pipeline system have a cost to get the barrels to the head point of its system and then they also have cost particularly in Nederland to get the barrels out of Nederland either to a out borne ship or to another refinery.
And I'm certain – it's certainly got big players involved in it, and certainly and we know they have contracts, all of which is good for the country's infrastructure, but it's not going to sap everything dry. And the fact of the matter is, we have every reason to believe that the shippers that are honest today, nobody likes $30 and $40 oil. It's not really good for frankly anybody in my view. But if you see $55, $60, $70 oil again, all of our shippers are going to want to go to the same place that they're going today, which is either those endpoint refineries which they're going to have all connected by then or Cushing whereby they can go just about anywhere they want.
Perfect and then last quick followup from me. How do you guys want me to be thinking about the other half of the option and just time frame on executing that portion?
The simple answer would be it's anything above $42, $50 is to TEP's benefit and just a little history on that. At the time you never know exactly where things are going to trade now things are going to look, I think we felt that TEP for this last quarter and what we did, we had inquiry and we felt like we needed to take some of the chips off the table. It benefited TEP you saw to the tune of $17 million lowering its purchase price. It benefited TDev which obviously back in January when we wanted to drop down the asset was very supportive and took back units when it really would have preferred to have cash.
So, we kind of viewed it as a win-win. I know that's really not responsive to your question which is kind of looking forward. I guess I would just tell you that we will play it as it comes. We've got about a year more to run on the options, so it's not like we're in any particular hurry, and like I said in my opening remarks, I think our view is that we're undervalued now as it is.
So, our goal is to optimize our cost of capital for TEP and for our unit holders and there's no set plan. I hope we are fortunate enough to have a good price to where we can deal with it here in a very logical manner over the next year.
Perfect. Thanks guys.
And next we’ll move on to Brandon Blossman with Tudor, Pickering, & Holt.
Good afternoon gentlemen.
Hello David, how are you?
I am good. So I'll switch over to the gas side, the 400 million a day demand lateral off of REX seems like a very positive development. Can you comment on just how you see that kind of moving forward you got to get out 20 million a day of contract capacity. How do you think that that demand evolves in terms of contract capacity on REX over the next five years?
We obviously look at it as a very positive addition. We told you guys early on that we’re going to work very hard on the supply side in the Marcellus and the Utica. And knowing that we have 2.6 Bcf by the end of the year capable of flowing less to east and 1.8 Bcf a day currently available west to east that we are a pipeline that is probably oversupplied and we need to add demand laterals.
Matt and his team have done a great job of going out and securing direct connected demand sources. That 400 million a day we did get a contract from Spire as a result of that negotiation and interconnect. They are currently out in an open season. That open season may result an LDC taking all the space. It may result in some of our current shippers paying a fee to get to a market at St Louis.
But more importantly than anything is its 400 million a day of direct connected burner tip capacity that gas coming from the Rockies or from the Marcellus and Utica can go to. So, the more takeaway we have, the more demand direct connected demand where you don't have to pancake pipe on pipe on pipe is a good thing for us. So it gives all of our shippers a new liquid point of sale and that that's encouraging and very positive.
I agree. Anything that you'd like to tease on a go forward basis, what's the outlook for something incremental that looks like this over the next year or two?
This is Dave. I would add to Bill’s comments. I don’t know if so much of teases. Like it or not, the energy industry whether it's kind of upstream producers even midstream to some degree and or LDCs, there is a certain amount of history, and there's a certain amount of inertia that exists. People are used to doing business between companies for a long, long time and it takes a long time for things to change.
I mean clearly you – we all recognize that delivery of natural gas fundamentally has changed in this country in the last five years, and I think because of that healthy season particular are looking to source gas from other places than they were in the past. I think they have new routes that they can take that presumably will net them at lower cost to their customers. And I guess all I would tease is like Bill says, there's a lot of capacity on that line, and as you go through time if it's proven out that Rockies gas or Marcellus, Utica gas or Mancos Shale gas is cheaper, that's a good thing for everybody.
And the teaser is what we basically said in the prepared comments, which is we do still have a little bit of capacity left of the power up and the team is out working very hard to get additional direct connected demand load tied to the system and I think we will be successful in having that sold out before it is placed in service.
The other thing I will add to Dave's comments is, the cost recovery mechanism policy that FERC came out with to help improve energy infrastructure in the country really gives a huge advantage to REX. We in our rate case filed a cost recovery mechanism within our initial filing. People don’t quite know how to get their hands or heads around that just yet regulatorily. We put it in our rate case.
I will say we settled around it, but there is going to be a day where the South to North infrastructure that is many, many, many more years old than REX are going to start needing to recover their maintenance capital to keep those pipelines buyable. When that happens, these LDCs are trying to get ahead of it and they are coming to REX to enjoy new infrastructure that is only six years old and not infrastructure that is 10 times that age. So we think that is a big advantage to us as well.
Okay. I definitely appreciate all the color guys. Second question, same topic going the other way, West, East REX, any more antenna like extensions of one and extends on the horizon as you guys look forward?
We aren’t currently chasing any or trying to get any done currently. One or more of our shippers may come to us out of the blue and request it. Matt and I talked a little bit about the Ultra settlement that may result in contracts, that maybe result in who knows what that ends up looking like, but at this particular point there is none of that going on.
That is it for me. Thank you very much.
Next we will move to Christine Cho with Barclays.
Hi everyone. I wanted to start on REX, just some clarifications if I could. How do – so you guys talked about how you guys are going to be dealing with REX in your financials. How does the rating agencies view at least with your 25% interest in REX, when they look at your leverage? So are they going to do the same thing where they’re just not going to include the debt and just like the distributions you receive or are they going to look at the 25% portion of the debt and your proportion of EBITDA?
Yes, Kristina, it’s Gary. I have to confess that I don’t think we have perfect knowledge exactly of the way that they model those things. I think they might look at it in fact perhaps both ways, at least one agency may. But I think we’re cognizant of the leverage profile of TEP on both basis and we will manage it relative to that, but again I have to tell you that I think one of them probably looks at it in that fashion, not exactly sure of the other.
I’ll supplement a little bit to Gary’s. I think that one agency that always proportionally consolidates everything is going to continue to do that. I think whether it’s 25%, 50% or 75% that it owns, it is totally counterintuitive, even to me, who is just a dumb old accountant that it’s not consolidated after 50%, but my suspicion is that either way they do it as well.
So let’s say we're fast forward we’re up to 75% ownership. Either way they do it, whether it’s consolidating the debt and consolidating all the way down through net income and adjusted EBITDA, we’re going to end up with a good answer regardless.
Okay. And then also when you guys talk about your long-term three to four times leverage ratio that you want to keep, I should be calculating that the way you guys described it on the call, right? Like just distributions, no debt from REX?
Yes. You should, but again both [indiscernible] answers.
Like Gary said, I mean we’re well aware of what it is running it both ways and when REX is in at 75% and giving what we've stated long-term that we think that REX’s leverage ratio need to be, our goal is to kind of be in that same thing. We said all along three or four times any way, shape or form, you look at it.
Okay. And then just, another question on REX. So you guys provided financials here, which I thought were pretty helpful. Year-to-date, it looks like the maintenance CapEx for REX is $4 million. I know that there is seasonality to this number, so I was curious if you could provide like a more normalized full year number?
Yes, Kristina, we don’t really provide that level of detail in terms of maintenance CapEx. I will say that I think there may be a view that REX is 100% maintenance CapEx is $25 million or more a year and that is not the case currently and hasn’t been over history. Yes I think you can probably use 10 to 17, somewhere in the neighbourhood on an annual basis, but again these integrity programs change from quarter-to-quarter, year-to-year, so just because of that as well.
So, I mean again, Kristina, keep in mind, REX is, six year old pipe, I meant it’s not 70 year old pipe like Plantation Pipeline is as an example. And I’m not trying to crib on plantation, I mean just a fact. But, so it’s only six years old, number one. Number two is, I mean I just yesterday approved an AFE [ph] for $3 million of right away remediation where you've had, ground swells that have sunk in because of what drift et cetera and that's stuff that you just deal with all the time. So I mean, right there, there is another $3 million. But like Gary said, it’s not anywhere near what’s some of the pundits seem to think it might be.
Okay, helpful and then last question from me. I just wanted to go back to this third-party pipeline that’s being built out of Bakken taking the supply to the gulf. And I understand that you have your contracts that run through, I think its 20 or 21, but I guess, what are your thoughts on offering something competitive with that by teaming up with other pipes that go to the Gulf from Cushing through another joint tariff?
It is interesting you bring that up, because we have been thinking about that, and again, Bill will probably wax more eloquently on this than I. But our customers, we’ve been talking to them about this. Our customers like the refinery complexes that we are going to directly see today. They like Cushing, they don’t particularly have a need or feel the sense that they need to go to the Houston Ship Channel, but as you rightfully asked and point out, it has not been lost on us that we might not have an additional joint tariff partner that allows us at some point in the future should our customers desire to get to the Houston Ship Channel.
Great, thank you for the color.
And next we will move to John Edwards with Credit Suisse
Yes, hi everybody and congrats on another nice quarter.
Hey, John thanks.
Thank you, John.
Just kind of following the last question here, so with the Bakken crude pipeline coming on, I guess, you’re saying that you don’t really view that as competition, I guess, that would be the wrong word, but may be just, how do you think about, the renewals going in four or five years, do you really think that impacts or you just think there are still enough volumes to go around for everybody?
Well John, I mean a couple of things. One is four or five years is really hard to predict period. I mean the oil markets only go out what two or three years, gas markets may be that long, and frankly, I’ll be really, really happy if I’m alive in three or four years.
Having said all of that, RBN Energy wrote a really great piece on the Bakken and the DJ and all that, places where we pick up oil front and before the Bakken really got going, the thing that really got the oil out of the place was crude by rail. And the thing that pipelines are displacing be that ours or others in the DJ, the Powder, or the Bakken, for that matter, the thing that’s really being displaced is that. And with Sandpiper going away, our view is that the market for pipeline capacity isn’t really going to outstrip Bakken. Will it outstrip at 20? Yes, because no one’s going to be producing and that’s going to affect everybody.
Is it going to outstrip at 50? Probably not, in my view. So I mean it’s a multivariable thing and it’s just not easy to answer. I guess, I would tell you, if you are following up on Kristina’s question, if you take our stacked rates and our joint tariff partners and put another one in there to get to the Houston Ship Channel, we could be more than competitive with barrels to get to the Houston Ship Channel versus Netherland.
And it’s extremely hard to tell you. Just like we did on REX, we’re talking with our existing customers about extending our contracts now. Across the board you've got people who say, you know what crude’s been $25 this last year and today it’s $40, and yes it was $50 last month. But we don’t even want to talk about until it stabilizes more. We’ve got other customers that say, hey, you know what, yes, we’ll talk to you about it and so I don’t know what to tell you beyond that. Bill, you want to add anything?
The only thing that I will remind you is that two years ago we had four pipelines, who were cordial enough to flatter us by coming in and offering to build pipes in areas that which we served. That was two years ago. Two years ago, we were in the ground. Two years forward, two of those are gone.
We’re down to two and we’re still the only pipe in the ground. I’ve been to Patoka, Illinois and I’ve been to Cushing, Oklahoma, and only one of those locations has a big sign out front that says, pipeline hub of the world and it’s not Patoka. Patoka is an interesting spot. You can get to some interesting markets, but Patoka is not going to outrun Cushing. There is no way. Cushing is where people go. Cushing has the point of liquidity. And do they want to get to Houston? May be. Do they want to get to the Ship Channel? May be, or are they just happy enough to sell their crude to somebody else at Cushing.
And it could be anyone of those three answers. But again, I feel very confident in what we’re doing, moving forward with the diversity we have of supply, with the diversity we have of the market. We’re taking natural gas principles which we all know here very well and we’re applying them to the crude oil market. And that is, you match supply with demand and as long as you can do that you're going to have volume on your system for as long as you can expect.
All right, thank you for that. That is really helpful. That is all I have. Thank you so much.
And next one is to Ethan Bellamy with R.W. Baird.
Hi guys. So I do think it's fair to ask about the shippers on Pony. You told us one company that's not a shipper. Are there any other shippers that you can disclose? And I'm presuming the answer to that is no, but could you tell us about the credit quality of those customers and are you – do you have any concerns about any of the shippers on that line right now?
Well, you're right. No, we can't disclose our shippers other than what we reported to in the SEC across the whole company. And then B, we could talk to you about that, I don't think we see anybody right now that is of particular concern. Obviously, we have one shipper who is not shipping, they're paying us, but they're not shipping their full volumes and that is what it is. I don't know if it's particularly concerning. I think as for as credit, we got a fair amount of credit. We have rights to the oil in the pipeline. We also have other collateral that we took in terms of lines of credits and guarantees et cetera. I don't know Nate, Gary, anything pops out to you?
Ethan, we gave some pretty detailed discloses at year end around TEP's customer and their credit profiles, both at the investment grade level cut off as well as if you were just to look at double-digit growth at that point, we did in this queue we filed here just a short while ago, and at the investment grade cut off level it's give or take 50%. If you were to look at the BB+ and this is across all of the TEP customers, it's well north of that. And that is just the financial health, notwithstanding those that are not ready to investment grade as Dave said we, do have a substantial amount of collateral security and we will continue to do that.
Got it. And then there was a 2% decrease of the Pony volumes. Should we expect volumes to be flat for the rest of the year or continue to trend largely down like that?
Again, I think that's not meaning to be totally cute, but tell us where oil prices are going to be and we'll tell you what volumes look like, 2% is not that big a deal.
We've already told you what nominations are at least for the month of August which are above the two prior months. So, no, there is not a trend and people decide what to do with their barrels on a monthly basis. We hear from them on the 20th of each month where they want to take their barrels and that's what the nominations become, and so far, we've been running close to contracted capacity, plus or minus 2% isn't in our margins.
Okay. And then I'm just trying to triangulate from as many directions as I can here. I presume that when you guys did the drop-down evaluation, that you had some sort of a barricade on crude and potential volumes, and I'm wondering, how the current environment and outlook stacks up to the discussions when you did the drop-down valuation?
Obviously, we had a fairness opinion. You're right, you know what those things look like. And yes, I think that was all taken into account. Whether in January it prognosticated that we're going to be at $39.88 or whatever close that today in the forward curve was going to look at I can't say that at all. I think that with the exception of maybe Moody's Crude Deck, the forward curve that's out there for most people that have some sanity is probably what we're thinking about.
I think just like the environment we've been in, I think anywhere from kind of 40-ish to 60 is going to look about the same. And I think step stability above 60 which I think for everybody is probably going to have people shipping on us full and maybe even having us start to have some walkup business. So I'm trying to help you Ethan, I just don't know how to do it.
Well I appreciate the intent anyway. And then, the last question. I mean obviously, we've had some simplification in the sector, particularly the LPG decompression trades, and it looks like your peer group, particularly the bigger and more mature partnerships are going through a cleaner structure. I recognize you don't have a big GP burden, but if all things go well, then you will at some point. Is the structural change any time in the future, is that something you've considered?
We've talked about this before. I think there is a significant difference between where we're at in our life and where we're at in terms of the way we have set ourselves up versus the guys. The guys who have done it recently all found themselves in a pickle, I mean whether it was debt or their business model or whatever.
And they were, somewhat had their, at least in my belief, had their hands forced relative to kind of collapsing those. Each one of them did it a little differently and we don't necessarily debate whether the appropriate value was given or not. But I think we're just in a different spot. We've got good business model, it's long-term. We've got good assets.
We're fairly lowly levered. I think we've kind of met all of our marks along the way, and frankly, again, like you said yourself our GP IDR debt, GP IDR take is not huge. It's going to grow. Will there be a point in the future? Yes, I think every MLP kind of hits an inflection point. The place that I used to be at took 15 years for them to hit that inflection point. We've been doing this for what, three or three and a half years.
Whether that inflection point is a natural result of so successful a model that everybody has done really well, both the LPs and the GP or it's as a result of economic circumstances where you've got a poor business model or you've gotten yourself over levered, time will tell what that. So yes, I think there will come in point in time. I cannot prognosticate right now when that will be or at what point.
Thank you and congratulations on posting solid numbers for the quarter.
Thanks Ethan. Operator, we have any more questions? We will take two more, we will take two more.
Okay. And we will take the next one from Charles Marshall with Capital One.
Hey good afternoon everyone. I think in recent presentation, it looks like there was a new pipeline project from Douglas to ONEOK Bakken Express Pipeline. Can you just provide any color there and just kind of lay out the scope of project, timing, cost et cetera. Any color would be helpful?
The color is this. I suppose, in the drinking game, people are going to start using diversity as one of the words. But today, Douglas is singularly connected to one NGL line that takes that crude to Borger, Texas. We have a contract with those folks through the end of this year and we are going to diversify our NGL takeaway and have entered into an agreement with ONEOK where we built the line over to them. They transport on it, lease it and give us a fee for doing it and we enjoy a lower TNF rate on them than we did on the prior folks. So it's operational synergies as well as cost savings getting those NGL barrels to market.
Great, I appreciate that. And then I guess with respect to Tallgrass terminals recognizing sensitivity around talking about future drop-downs, but outside of just proper valuation and timing, is there anything stopping you guys from evaluating a drop-down of the terminal assets or are you looking for more EBITDA scale from those assets, if you can kind of just talk about that?
Yes, I think it is a little bit of EBITDA scale and it isn't so much of trying to grow the EBITDA and dropping in at X multiple et cetera as much as we have some things that we're working on where we feel kind of the appropriate maturity risk level is appropriate at TDev at this point and not necessarily for TEP.
And so, I would say it's more a function of that. Clearly, we could deal with it at any point and at some point that in and of itself doesn't make any significant material difference anymore. But for example, Bill talked about in his comments that we bought 550 acres of land down in South Cushing and that’s something that this week we’re starting civil work on to develop a terminal down there that will be at least partially used by Pony.
Got it. That’s helpful. And I guess just one last one from me, sort of a followup to a previous question, just asked slightly differently. But with regards to REX and just looking at the counterparty exposure, both on the West-to-East and East-to-West lines, is there any update that we should be sort of aware of, any type of material counterparty risk? I know you guys you talked about that in the past, we’ve talked about it also here, but is there anything incremental to provide on the call with any of your counterparties?
Well, I think the good news is that natural gas, my last trade was like $2.88 with them and I think with the healthy gas market kind of around in that $2.50, $3 it takes a lot of the problems away for people. It probably frankly, somewhat takes away the problems for even the people that you just named that have filed already. So Gary, any comments on that or?
Nothing else that is any material in any fashion on REX, although we do continue to watch those payments on a monthly basis and frankly sometimes more frequent than that, so.
And then I would add that over the second quarter we had a record of 3.57 Bcf moved on the pipeline in one day. Just for those of you who don’t get that math, that’s approximately 1.8 Bcf a day moving West-to-East and 1.8 Bcf a day moving East-to-West. We’re moving 1.8 Bcf a day East-to-West every day.
And people can’t wait for the expansion to come on. I know the question was about credit risk, but you can see what the markets did when we were down for four days. This is hugely meaningful and impactful infrastructure to this country and necessary and we’re not worried about; if we lose one that there won’t be 10 to replace.
That’s all really helpful. Thanks guys. Congrats on a great quarter.
We’ll take our final question from Ted Durbin with Goldman Sachs.
Thanks. Just on REX again on the power up I think you said you are on track for the timing, are you still on track for the CapEx as well, I think it was $530 million as we were thinking?
Yes, on time, on budget.
Alright, still thinking we will pay down debt at REX once the CapEx rolls off; plan to kind of continue to pay down the maturities that are coming due?
Nothing’s changed there, I think that 18s send 19s and do you have another question just out of curiosity?
No. Just use of free cash flow really distributions, especially with Tdev I think is the distributions kind what they will use that for paid debt paid that number.
Yes, we I think, let me making it before I answer that, so just before we hear the thousands of beeps when the phone, just let me make a unabashed attempt to get in my final things that now Tallgrass is the little pipeline that could and that I think we’re going to wrap up in time for everybody to still make their Lou Dobbs feature of the night.
So now the Ted, seriously, nothing is changed I mean, I think you will see, I think we believe TEP coverage will tick up next year and obviously, that’s we’re going to have good cash flow because Power Up is going to come online on REX and we still anticipate that long-term, we want to bring the REX debt down to kind of that 4x give or take multiple and so that you’re going to see as building up at least cash on a coverage basis so, that long-term we can put that back into REX and pay the debt down when it comes to maturity.
Got it. And then I just guess that if your view is that the stock is undervalued, as you think about the next drop-down, are you not happy to do equity to do the next drop? I mean, you had Tdev come in with some support, not taking cash just how are you thinking about the mechanics of the next drop?
We would again; we’re just trying to match and I'm not sure what you led you to ask if we would not be happy to do equity on the next drop. I think we've talked about the next drop being kind of mid-year next year, and it is our goal to keep a good capital structure. I think we are very low levered today. I don’t know what 65% equity 35% debt or something like that and I don’t see any reason to change our – it is working for us other than again, I just think that we deserve a better equity price and I would be delighted to at some appropriate portion to fund the next drop-down with the kind of appropriate amount of equity at a good price.
Okay, that makes sense. I'll leave it at that, thank you.
Hey thanks Ted.
Operator, thank you for everything and everybody that was on the call I really appreciate your time and interest in our company. We're just getting started, so thanks a lot, good bye.
You are quite welcome. That does conclude our conference call for today everyone. We do thank you all for your participation.
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