Plains All-American Pipeline (PAA) is a fairly high-yielding midstream partnership that unfortunately suffers somewhat from a lack of coverage amongst the investment community. However, this lack of coverage can sometimes create opportunities for investors that know how to take advantage of them. We recently saw the company make significant progress on a few of its growth projects that could easily result in the company seeing forward cash flow growth. Ultimately, this cash flow growth could result in a rising distribution for the company's investors.
Red Oak Pipeline
One of Plains All-American Pipeline's major growth projects today is the Red Oak Pipeline, which is being constructed and will ultimately be owned by a 50/50 joint venture between the partnership and Phillips 66 Partners (PSX). The $2.5 billion project is just one of the new pipelines that is being constructed to help alleviate the lack of takeaway capacity plaguing the Permian region. This particular pipeline system is intended to transport crude oil from the Permian basin and Cushing, Oklahoma to Houston, Texas and other areas along the Gulf Coast. In so doing, it is one of the pipelines that will help support the emerging American crude oil export story.
As of last month, the two companies announced that they had sufficient commitments to proceed with the construction of the pipeline. The practice of securing commitments from customers prior to construction is a common practice in the midstream industry and it is something that we should appreciate as investors. This is because these commitments ensure that the pipeline companies are not spending a great deal of money to construct infrastructure that nobody wants to use.
The advance commitments also have the effect of ensuring that the pipeline company will generate a positive return on its investment. Unfortunately, at this point, neither Plains All-American nor Phillips 66 Partners have stated exactly what the projected return off of the Red Oak pipeline is. Usually, projects like this have an EBITDA multiple between 5.0-7.0 though so it seems likely that this will be the case here.
As the company already has commitments in place, it seems rather curious that last week it started looking for additional commitments for the use of the pipeline. It seems likely that what is happening here is that the companies already have enough commitments to ensure a positive return on the project, which enables them to proceed. However, there is likely still some free capacity available through the system so the partners are trying to see if anyone wants to use it to maximize the throughput of the system. This would have the effect of maximizing the company's revenue and cash flow from the pipeline, which is something that we always like to see.
As already mentioned, at an estimated total cost of $2.5 billion, the Red Oak pipeline is one of the larger projects serving the Permian basin. The project as a whole includes 650 miles of pipelines carrying a maximum of 400,000 barrels of crude oil per day. This consists of a new 30-inch pipeline from Cushing to Witchita Falls and Sealy, Texas. From Sealy, there will be another 30-inch pipeline to Corpus Christi and Ingleside and a 20-inch pipeline segment to Houston and Beaumont. All in all, this is a rather ambitious project that is currently scheduled to come online as early as the first quarter of 2021. We can therefore expect it to begin contributing to the results of both Plains All-American and Phillips 66 at around that time.
Canadian Pipeline Expansions
Much of the media coverage on the North American energy story has focused on the shale oil production growth in the United States but there is another part of the story that we do not hear as much about here. That is the rising oil and gas production in Canada, especially around the oil sands. As I have discussed before though, the oil sands have been suffering from a lack of sufficient takeaway capacity, which led to a massive glut of production and a widening differential between WTI and WCS prices. That problem has fortunately largely been rectified due to the Alberta government forcing companies to temporarily cut production while the glut continued.
This does position Canada well to be an exporter of energy to the rest of the world if it can correct this problem with takeaway capacity. This has become increasingly important to the economy of Alberta now that the United States no longer needs to import oil for its own consumption. Earlier today, Plains All-American made a proposal that could help solve this problem. That proposal in short was the addition of new pipelines in Canada, Montana, and Wyoming that could ultimately connect to the just mentioned Red Oak pipeline and deliver the Canadian light crude oil to the Gulf Coast.
This would allow it to be exported from that location instead of from the Canadian coast, which could be an advantage as the provincial government of British Columbia has been rather hostile to fossil fuel projects lately. This is thus clearly a development that could be a good thing for that region as well as being profitable for Plains All-American Pipeline as it charges fees for the resources moving through this proposed system.
Plains All-American explained how it intends to achieve this goal as part of its announcement. The plan is to double the capacity of the existing Rangeland Pipeline, which extends from Edmonton, Alberta to the U.S. border where it connects to the Western Corridor pipeline system in Montana and Wyoming. If Plains All-American proceeds with this expansion then it would also expand the capacity of the Western Corridor system to accommodate the higher volumes.
The end goal is that these resources be transported the whole way down to the Red Oak system but that would likely require more work to increase the capacity of the various systems between Wyoming and Oklahoma. It would, however, provide a source of new incremental resources to further fill up the Red Oak system, as the partners are trying to do with the secondary open season round that was already discussed.
It is important to note that Plains All-American has not provided a timeline for the development of these Canadian projects so we do not when the company will begin to see the cash flow from these new volumes. Indeed, we do not know for sure yet if it will ultimately proceed with these expansions as there may not be demand for them or there may be regulatory problems or any manner of other problems. The extra volumes will certainly boost the company's revenue and cash flow when it comes online though so this could certainly prove to be a positive for the company's forward growth.
Plains All-American Pipeline has long been liked by investors due to the relatively high distribution yield that it pays out to its investors. As of the time of writing, the company's common equity yields 5.88%. This is certainly much higher than what most of the other things in the market yield.
While a high yield by itself is nice, it is even better when a company grows its distribution over time as this provides us with a steadily growing income and an improving yield on cost. This is an area in which Plains All-American Pipeline has occasionally struggled. As we can see here, the company slashed its distribution back in 2017:
While most investors do not like distribution cuts, this one did have the effect of improving the company's balance sheet as it allowed the company to devote more money to paying down its debt and improved the company's coverage at the same time. This is something that a lot of master limited partnerships have been doing since the oil bear market in the middle of the decade as previously these companies were overly dependent on their access to the capital markets to finance their operations as they were paying out all of their cash flow as distributions. The new model should be much more sustainable and therefore better for investors, although it was painful for those that were long the company around the time of the cut. We can see though that the company has been growing its distribution since that time.
This recent distribution growth has been driven by various projects that have been coming online in recent years and driving growth in the company's distributable cash flow. As I discussed in an earlier article, Plains All-American Pipeline should be able to deliver 65% growth in its distributable cash flow over the 2017-2019 period:
Source: Plains All-American Pipeline
Obviously, none of the projects that were discussed above will be online in 2019. Thus, they will not be able to contribute to this growth. However, what they will be able to do is help the company continue this growth streak over the next few years. For the most part, we should see the company increase its distribution as its distributable cash flow increases, which would benefit those investors buying the common units today.
In conclusion, Plains All-American Pipeline is not a company that we see in the news very often but this can sometimes create opportunities for investors. Over the past week, we have seen two developments that could prove to be quite positive for the continuation of the company's growth story as we enter the next decade. Ultimately, this could result in the company growing the distribution over time, which is the kind of thing that we like to see out of our income investments. Overall, there are certainly some things to like about this company that may make it worth a position in your portfolio.
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Disclosure: I/we 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.