Blue Knight Energy Partners' Oil Storage Assets Set To Benefit From Contango

Summary

  • With oil at an extreme level of contango, Blue Knight's storage assets appear set to benefit.
  • The MLP is fairly valued on an underlying basis, hence storage profits present a free call option for investors.
  • The company also has little direct oil and gas exposure, and a major presence in asphalt, which would likely benefit from any infrastructure spending.
  • The company has a market capitalization today of $58M. It is not unreasonable to see $10M-$20M of incremental profits from improved pricing and demand for the company's 6.6M storage capacity over the remainder of 2020.

We are seeing once in a decade spike in demand for oil storage as oil prices are expected to rise steeply over 1-12 months based on the current futures curve. Blue Knight Energy Partners (NASDAQ:BKEP) (NASDAQ:BKEPP) owns 6.6M barrels of oil storage capacity. In Q1 2009, they saw economic benefits from oil price contango. This may happen again, and the boost could prove material to earnings. Even without such a boost, BKEP is fairly valued today limiting downside risk and, in addition, its asphalt assets may benefit from infrastructure spending should an infrastructure bill be passed. BKEP's market cap is $58M and appears fairly valued on historic operations. Yet, the incremental cashflow from storage over the coming quarters could be $10M-$20M, suggesting 15%-34% upside.

Blue Knight Energy Partners is a collection of acquired assets including oil storage and transportation assets and asphalt terminals. All are U.S. based and operations are primarily operated against take or pay contracts.

source: BKEP Investor Presentation

Storage Assets

The most interesting aspect of the business currently are the storage tanks the company operates primarily in Cushing, Oklahoma. During periods of contango these are desirable assets. Storing oil while its price rises is a profitable endeavor, bidding up the costs of storage, helping BKEP.

source: BKEP Investor Presentation

Contango means that the price of oil is expected to increase in future according to futures curve. This means that if you purchase a barrel of oil today, you can expect to sell it for $5 more in 3 months and $10 more in a year at the time of writing. It is possible to lock in arbitrage profits given this pricing is embedded in the futures curve.

Now, in order to do that, you need somewhere to store the oil. This makes storage a particularly valuable asset today. For example, BKEP can store 6.6 million barrels of oil potentially capturing a potential $5 premium in 3 months. The rough value of that is $33M dollars. Now of course BKEP will not capture all of that value, and some storage is sold under longer term contracts.

However, the last time we saw a strong contango in crude oil was Q1 2009 and during that period BKEP operating under a different name did earn $11M from its storage assets over 3 months per the 10-Q at the time. That's what the same assets earned for the entire year of 2019 per their most recent 10-K.

This is how BKEP discuss their storage assets per their most recent 10-K (page 32). With 60% of contracts expiring in 2020 BKEP may be able to negotiate favorably given current demand for storage. Though of course the remaining storage (2.2M barrels) that is under contract may not see an economic benefit from current price dynamics, and the remaining 1.1M barrels not currently under contract likely are today given storage demand.

As of March 23, 2020, we have approximately 5.5 million barrels of crude oil storage under service contracts, including 3.3 million barrels of crude oil storage contracts that expire in 2020. The remaining terms on the service contracts that expire after 2020 range from 15 months to 21 months. Storage contracts with a subsidiary of Vitol Group (together with its subsidiaries, "Vitol”) represent 2.9 million barrels of crude oil storage capacity under contract. We may not be able to extend, renegotiate or replace these contracts when they expire and the terms of any renegotiated contracts may not be as favorable as the contracts they replace.

Asphalt Terminals

BKEP's asphalt terminal assets are also significant. Though these are primarily operated under take or pay contracts they may benefit from any infrastructure projects. For example, the President has recently called for a $2 trillion infrastructure bill, which would very likely boost demand for asphalt.

source: BKEP Investor Presentation

Core Valuation

Aside from any storage boost to earnings we can value BKEP in a few ways.

Looking at dividend yield the company pays a $0.04 quarterly distribution, or $0.16 annualized. Assuming a 10% yield that would value the business at $1.60/share or 13% from current pricing.

On a free cashflow basis, I estimate normalized cashflow of $50M less $20M of capex leading to $5M of free cashflow (after $25M preferred dividends). On a 10x multiple that gives an equity value of $50M with 41M common units outstanding that would imply a valuation of $1.21/share or 15% below current pricing, but before any upside from incremental storage revenue.

Thus BKEP appears fairly valued at current pricing, but before taking account of any potential boost from improved volume and pricing for storage assets.

Sizing The Storage Upside

We cannot be sure what sort of a benefit from storage BKEP may see. Coming back to the example above with 6.6M of storage, 40% of which is already contracted, we have 3.3M barrels of storage capacity available. With a $10/barrel opportunity from the futures curve over the coming year, assume the storage provider captures half of that upside and it's $16.5M, to come at it another way. Normal storage operations yield around $3M/quarter and in Q1 2009 profits were $8M higher, that again suggests $16M of upside assuming the bulk of the storage benefit lands over 6 months.

Summary

BKEP is fairly valued without any boosts to profits from oil storage profits from contango. Oil storage should earn strong profits for the next 3-12 months, all of this benefit should accrue to unit holders, which could be in the region of $10M-$20M. This is a material benefit relative to a current market capitalization of $58M when the company appears fairly valued today without incremental storage profits included.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

This article was written by

Value-oriented ideas and special situations, generally mid/small cap. Also, orphaned and unfashionable investment ideas, ideally with a catalyst and the prospect of asymmetric upside/downside payoffs. Contrarian tendencies. To some extent I'll go anywhere if it's cheap and I'm more influenced by momentum and quality than I used to be.
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Disclosure: I am/we are long BKEP. 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.

Additional disclosure: May change positions at any time without notice. Author's opinion only, not intended as investment advice.

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