Q3 2020 Magellan Midstream Partners LP Earnings Call
Greetings, everyone and welcome to the Magellan Midstream partners third quarter 2020 earnings call. During the presentation. All participants will be in listen only mode. Afterwards, we will conduct a question and answer session at that time.
Time, if you have a question. Please press the one followed by the four on your telephone if at any time during the conference you need to reach an operator. Please press star Zero as a reminder, this conference is being recorded Friday October 30 of 2020, I would now like to turn the conference over to Mike Mears Chief Executive Officer. Please go ahead.
All right well Hello, and thank you for joining us today to discuss magellan's third quarter financial results.
Latest outlook for the full year and other topics of interest to you before.
Before we get started I must remind you that management will be making forward looking statements. That's defined by the Securities and Exchange Commission such statements are based on our current judgments regarding the factors that could impact the future performance of Magellan, but actual outcomes could be materially different.
You should review the risk factors and other information discussed in our filings with the FCC and form your own opinions about magellan's future performance.
You may have noticed that Magellan issued two news news releases. This morning. In addition to reporting our financial results for the third quarter. We also announced the publication of our inaugural sustainability report, which is now available on our website.
Sustainability is definitely not new the Magellan and we take our responsibility very seriously to safely and reliably deliver petroleum products that are essential and beneficial to the everyday lives not only our nation, but the world for many years to come.
We also recognize the growing stakeholder interest in transparency around E. S. C practices and hope you find the report to be informative.
Switching to earnings Magellan's business continues to be resilient and deliver solid results. During the year. It has been one of the most challenging periods on record as our industrial nation try to move forward in the midst of the pandemic and the related economic disruption.
With that said, our third quarter results exceeded our expectations by a notable margin benefiting from a number of favorable items, including lower expenses better than expected commodity profit and slightly higher refined products revenue.
Our CFO, Jeff Pohlman will now review, our third quarter financial results versus the year ago period in more detail then I'll be back to discuss our latest outlook for 2020 before answering your question.
Thanks, Mike.
Oh sure all I'll be making references to certain non-GAAP financial metrics, including operating margin and distributable cash flow or DCF.
We've included exhibits to our earnings release reconcile these metrics to their nearest GAAP measure.
Earlier. This morning, we reported third quarter net income, that's going up $211.6 million or 94 cents per unit on a diluted basis compared to $273 million or $1.19 cents, bringing in third quarter of 2019.
Excluding the impact of Mark to market activity adjusted diluted income per unit was 97.
Which as Mike pointed out exceeded the expected range of between 75, and 85 cents, which we provided with our second quarter earnings release.
Distributable cash flow for the quarter was $258.8 million $48 million lower than the $306.8 million reported in third quarter 2019.
Primarily due to a combination of lower refined products transportation volumes, lower crude oil spot shipments and lower commodity margins in the current quarter.
So turning first to our refined products segment provide products generated $239 million of operating margin in third quarter 2020.
A decrease of about $42 million versus the 2019 period, but most of that decrease resulting as expected from the impact of the pandemic on travel and economic activity, that's transportation and terminals revenue for this segment also decreased about by about $32 million gossip.
Gasoline aviation fuel remained the hardest hit by the pandemic and related restrictions, while lower drilling activity also negatively impacted distillate volumes.
Third quarter base refined products volumes, excluding the impact of growth projects were about 15% lower than third quarter 2019 for all products combined with gasoline distillate and aviation fuel seen declines of 11, 18 and 35% respectively.
Including the impact of growth projects overall refined products volumes were about 13% lower than the 2019 period.
Revenue was also decreased as a result of the sale, it's clean marine terminals and first quarter Twentytwenty and the decommissioning of our ammonia system in late 2019.
These declines were partially offset by higher average tariff rates, which were favorably impacted by the average 3.5% tariff increase that went into effect on July 1st of this year.
Well as I feel short haul movements, which earn a lower rate.
We also benefited from recently completed growth projects, including the West, Texas expansion that began operations during the quarter as well as writing she sent home project became operational in late 2019.
Operating expenses for the refined products segment decreased $8.7 million between periods.
Mostly reflecting the lower throughput and terminal activity during the quarter lower integrity spending and the absence of costs related to the sold a decommissioned assets I mentioned, a moment ago as well as the cost saving efforts of our business how conversation program.
Partially offset by less favorable product overages, which reduced operating expenses.
Operating income decreased $3.1 million due to insurance proceeds received in third COVID-19 related to Hurricane Harvey.
Product margin decreased $8.2 million compared to third quarter 2019, primarily due to unrealized losses on hedges, which do not affect our calculation of DCF compared to gains last year, partially offset by higher sales volumes related to our fractionation activities.
Byproduct equity earnings increased approximately $3 million versus third quarter 2019, primarily due to a higher contribution from the expansion of our Pasadena Marine terminal joint venture, which began coming online at first quarter 2020.
Partially offset by lower contributions from our participants joint venture impart due to mark to market gains in the prior year.
Moving now to our crude oil segment third quarter operating margin up $135.8 million was about $20 million lower than third quarter 2019.
Crude oil transportation and terminals revenue decreased slightly in the current quarter.
Volumes on Longhorn averaged 277000 barrels per day compared to 282000 barrels per day in the third quarter of 2019.
As expected our customers continuing to ship at or near their commitment levels volumes related to affiliate marketing activities during the quarter, partially offset the decrease in third party shipments in the current period did not include any third party movements and of course, the spot tariff rate.
I'll note that the revenues from our affiliate marketing activities are reflected in transportation revenue rather than product margin beginning this quarter.
Consistent with the guidance we've given over here we are not currently expecting any third party spot volumes on longhorn for the remainder of 2020, nor do we currently anticipate meaningful margins on any of our own uncommitted marketing activities.
Just given where differentials currently are and the supply demand dynamics and make it unlikely for those differentials to widen in the near future.
Instead, our forecast continues to reflect our assumption that our customers will ship a commitment levels well marketing affiliate continues to ship barrels person to its committed by selling agreements.
You may recall that approximately 75000 barrels a day of commitments on longhorn we're set to expire on September thirtyth.
As we have noted for some time now the current environment, particularly the current balance between.
Production and take away capacity, it's not very supportive of new long term contracts. So as anticipated we have turned to our affiliate marketing activities to optimize utilization on longhorn by entering into shorter term beisel arrangements with customers that will encourage continued high utilization of the pipeline with that.
[laughter].
And the margin we aren't from that driven primarily by the prevailing.
Well I think nothing in Houston.
Turning now to other crude oil revenues reported volumes on our Houston distribution system decreased significantly in third quarter 2020 persist third quarter 2019, with most of the decrease resulting from the change in the way customers contract for access to our see what joint venture export terminal.
As we discussed on our call last quarter. This change simply results in lower reported transportation volumes on our distribution system offset by higher communally revenue.
Our HTS volumes were also negatively impacted by lower seats from Bridgetex, while lower crude oil prices continued to impact the value of tinder barrels we received on our pipelines.
These declines were partially offset by increased utilization of our east Houston storage at higher average range during the quarter.
Crude oil operating.
Expenses increased $2 million during the period, primarily due to the timing of scheduled asset integrity spending and less favorable product overages.
Crude oil equity earnings decreased $14 million between periods Bridgetex equity earnings declined primarily due to lower spot volumes in the current period as well as to a committed shipper using previously earn credits during the quarter, resulting in bridgetex volumes of 333000 barrels per day compared to 144000.
The barrels per day in 2019.
Let alone or names below primarily as a result of our cell, but 10% interest in the joint venture during the first quarter 2020.
Otherwise solid motorcycles relatively in line as lower volumes of 164000 barrels per day compared to 185000 barrels per day in the 2019 period.
Offset by higher average rates and lower operating costs.
Consistent with my remarks regarding spot barrels on longhorn, we continue to anticipate no spot barrels or any other barrels on either bridgetex or someone put a remainder of the year.
Our guidance assumes that volumes continued to track existing customer commitments.
Finally product margin for the crude oil segment was $4.6 million unfavorable to the 2019 period.
Clearly as a result of the reclassification of bargains, we earn affiliate marketing activities to transportation revenue to conform to the current period presentation mentioned previously.
Moving out to other brands, such as depreciation amortization and impairment expense increased $15.2 million compared to two according my team primarily due to the impairment of certain terminalling assets during the period as well as higher depreciation related assets recently placed into service.
She may expense decreased $13.1 million, primarily due to lower incentive compensation accruals, which reflects our lower forecasted 2020 results.
Net interest expense was $5.4 million higher than the current quarter, primarily due to lower capitalized interest as a result of lower ongoing construction activity.
We also had higher average debt outstanding as a result of borrowings primarily made to finance our growth projects, partially offset by slightly lower average weight compared to between 19 period or.
Our weighted average interest rate was approximately 4.3% during the recent quarter and our average outstanding debt was $4.9 billion.
At September Thirtyth total long term debt outstanding was $4.95 billion.
Gain on disposition of assets was $2.6 million unfavorable due to an additional gain recorded in the prior year related to our discontinued Delaware Basin pipeline project that was sold to a third party.
Moving to capital allocation balance sheet metrics and liquidity.
During the quarter, we repurchased nearly 1.4 million units at an average purchase price of $36.87 for a total spend of $50 million.
That brings the total number of units repurchased year to date to 5 million units at a total cost of $252 million.
We have consistently noted in discussions of our repurchase program.
The timing price and volume with any unit repurchases will depend on a number of factors, including but not limited to our expected expansion capital spending excess cash available balance sheet metrics legal and regulatory requirements as well as market conditions and the trading price of our common units.
In terms of liquidity and leverage we continue to have $1 billion credit facility available to us through mid 2024 with $248 million drawn on our commercial paper program at September Thirtyth.
Our next bond maturity isn't until 2025, and our leverage ratio remains strong at 3.2 times for compliance purposes at the end of the quarter.
Well below our long stated limit of four times with.
With that I'll turn the call back over to Mike to discuss our guidance for the remainder of the year.
Thank you Jeff.
As we near the end of 2020, we have revised our DCF guidance for the year to 1.025 billion, which you may recall was the midpoint of our previous forecasted range.
While the trajectory of the recovery for refined products demand to more historically normal level still remains a bit unclear. We elected not to provide a 2020 Bcf guidance range. This quarter since it appears the refined products demand is relatively stable at the moment.
Therefore, our 2020 DCF guidance forecast generally assumes the recent refined product demand trends continue and that we experienced no new material social restrictions in our market areas for the remainder of the year.
Specifically, we estimate that our fourth quarter base business volumes, which excludes the benefit of recent expansion project with 13% lower than the fourth quarter of 2019.
By product, we expect based gasoline to be down 8%.
So, let's lower by 12% and aviation fuel off by closer to 50%.
These estimates also exclude our south Texas movements, which were represent more of a supply push system was short haul volume that moves at a very low rate.
We have also seen lower volume on the system and 2020 and once you factor in the South Texas volumes and incremental volumes from our recent Texas growth projects, we expect all in fourth quarter refined product shipments to be about 7% lower than 2019 period.
The demand dynamics of our systems have been interesting to observe during the current environment.
More rural markets are basically back to pre pandemic levels, whereas our larger metropolitan regions have been slower to return to work school in everyday activities. So their fuel demand continues to be below historical levels.
We have also experienced a slower ramp for volumes related to our expansion projects due to current market conditions. As you may recall. These projects are supported by take or pay commitment from strong counterparties. So in some cases, we may have deficiency payments due to us in the future.
For our crude oil pipelines, we continue to assume shipments generally in line with the committed volumes for the remainder of the year.
Regarding our commodity related activities, we have hedged more than 80% of our expected gas liquids blending volumes for the remainder of 2020 with margins averaging about 35 cents for the fall blending season.
As is typical we have also started to hedge our expected activity for early next year.
About 40% of spring 2021 blending.
At a 25 cent average margin.
You may recall that Magellan kicked off an optimization effort last year to identify cost savings and process improvement opportunities throughout the organization.
During 2020, we have identified about $30 million of the efficiencies that we believe a repeatable with the current year benefiting by about 20 25 million from these efforts.
We're continuing continuing to evaluate additional areas for improvement and we believe that annual savings could reach $50 million or more by 2022.
These savings are primarily being realized through better power and drag reducing agent optimization and business process improvements that are leading to reduce costs across the organization.
We are also making modest workforce adjustments in certain areas of the company through natural attrition voluntary retirement and targeted reductions.
Magellan's always operated in a lean manner, but we were taking the opportunity to improve where we can.
As previously indicated Magellan intends to maintain or quarterly cash distribution at the current level for the remainder of 2020.
Based on our DCF guidance of 1.025 billion, we expect to generate excess cash of more than 100 million and 2020, resulting in distribution coverage of approximately 1.11 times for the year.
Although we do not plan to provide guidance.
Specific to 2021 at this point, which follows our historical approach. We do currently intend to target cash distributions for 2021, consistent with our current payout level.
We understand the surety of distribution is important to a significant number of our investors and believe the current payout is sustainable next year, but.
Magellan remains focused on executing our long term strategy to maximize value for investors.
In addition to returning cash to investors investors. The our quarterly distributions. We also intend to deliver incremental value by utilizing a unit repurchase is unit repurchases in investments that meet our disciplined risk reward profile.
As Jeff mentioned, we purchased $50 million of our equity during the third quarter. We continue to actively evaluate additional purchases all with the backdrop of ensuring we maintain a healthy balance sheet.
And although investor sentiment seems to have recently turned against expansion projects generally we still believe that good returning low risk investments will continue to add value for our company as demonstrated by Magellan's historical disciplined investment approach.
Our current expansion spending estimates for approved projects or 400 million. This year with 310 million of that already spent through September thirtyth.
40 million 2021.
We continue to evaluate several attractive relatively smaller potential growth projects that may be approved in the near term, but to be clear, we anticipate significantly reduced capital spending programs over the next few years Brent.
For instance.
If we include these potential projects may be approved in the near term we would expect the actual 2021 gross spending likely to be in the range of 100 million.
That concludes our prepared comments and so operator were now ready to turn the call over for questions.
Thank you very much and ladies and gentlemen, if you'd like to register a question. Please press. The one followed by the four on your telephone you will hear Eightthree tone prompts to acknowledge your request. If your question has been answered and you like to remove yourself from the queue. Please press one three once again, we welcome your questions. Please press the one followed by the four one moment please.
And our first question comes from line of Jeremy Tonet with Jpmorgan. Please go ahead.
Hi, good afternoon.
Good afternoon.
I was just wondering.
It seems like the industry continues to mature at this point and Im just wondering how you think that you know unfold so as far as potential consolidation here on the upstream side, you've seen a number of transactions recently on the midstream side, we have not seen.
As much and just wondering you know any thoughts you might happen on how that could evolve how upstream consolidation could impact midstream business and granted magellan's in a much stronger position than many peers, there's not any imminent need to do anything.
From you guys, but wondering how you think about all that coming together there.
Well I guess first thing I would I would say I don't think that there is or will be a correlation between upstream M&A in midstream M&A I don't think one necessarily drive see other obviously, it's appropriate in the upstream and I think some I think it's appropriate in the midstream, but I think.
It's likely that the pace of midstream consolidation will be slower.
Speaking for Us I mean, we.
Frequently evaluating combinations and mergers.
And as you mentioned, we're in a slightly different position than some other of our peers with regards to a strong balance sheet, a healthy and in relatively stable business profile. So there is not an issue.
Impending urgency to do that nevertheless, we evaluated.
And we keep in mind at all to the elements are the critical or that you would consider in the merger such as balance sheet strength and maintaining balance sheet strength.
But the variability.
The earnings profile of potential targets, we evaluate all of that and.
So I probably won't go any further than that to tell you that we are active in that regard, but overall I would expect the pace.
Midstream M&A that to occur at a slower rate in and you may not see much meaningfully happened at all I can't say I don't know what my peers are doing but I wouldn't be surprised if there's very few transactions over the next year or so.
Got it thanks for those thoughts there and then.
Separately, if you look at the Magellan unit price I think Theres, a case be made orally or depressed at these levels and just wondering what do you think about the different tools at your response to address that you know it namely kind of unit buyback seems like something that would be at the top of the list. There you obviously don't want to increase your leverage but.
Is there ever you know.
In the ability to sell assets to private equity to kind of create more.
Quantity to go after that or it would ever make sense to reduce the distribution to buyback units just given you know.
Uniquely a cheap trading levels. Just wondering you know how you think about those that gives and takes.
Well I mean, you said on the possible levers you can pull to increase buybacks I think ER, we don't want to compromise our balance sheet and we won't compromise our balance sheet the buyback.
Units, which doesn't mean.
Leverage may not creep up a little bit what we're buying back units, but we're going to keep it well below the four times coverage target that we that Weve always stated.
The first thing that can happen is just business improvement overtime.
Which will allow for more free cash flow to buy back equity.
Selling assets is an option you know we did that earlier this year, we sold our marine terminals and we purchased units.
We evaluate that on a case by case basis, and we'll continue to do that we think if we think there's.
Abraham or an attractive arbitrage between a private market and our and our public trading values such that we can execute on that we will it's not a core strategy of ours, but we constantly look at it with regards to cutting our distribution to buy back equity.
Oh, that's not on the list at the moment I'll never say never going to be on the list. We are planning to do that.
I think.
Yup investors may have different view as to whether that's a good thing to do or not a good thing to do at this point in time, we're not planning to do that I'll just leave it at that.
Got it thank you very much.
Thank you Nick.
Our next question comes from the line of Tristan Richardson with Suntrust. Please go ahead.
Hi, good afternoon.
Just to build on the previous questions about.
Buybacks versus leverage I think on the last call Mike you mentioned that.
You guys don't necessarily have an interest in.
Seeing that free cash flow production exclusively accrued to the balance sheet and that there is some level where leverage become sub optimal.
Could you just give us a sense of kind of.
Maybe where a floor is and leverage where you know it.
You might be under levered or sub optimal from a capital structure perspective.
Well, we don't.
And I really don't have a good answer for you on what we consider a floor for leverage I mean, we.
You know in this environment, we're in the low threes, which we think is probably a good place to be given the volatility and the uncertainty in the market right now.
Ah so.
As you can tell you know we do feel like the weekend, we've got some room around.
That leverage ratio to buy back equity I mean, obviously.
You know we're borrowing.
We're not in a full free cash flow environment. This year I mean, we've got we're spending $400 million on growth capital this year, which exceeds our you know our excess cash and so incremental equity purchases.
Are increasing leverage so we're doing a little bit of that but we're being very very careful in that regard you know you're certainly not going to see us just ramp right up to a four times a level just because.
We've got we've got room.
To our targeted we may do that over time.
If we were in a much more stable environment, but it doesn't feel pratt hold that take the update of a step in the current in the current market.
Great very helpful. And then just one quick follow up on.
On the Bridgetex side I think over the past couple of quarters, you guys have to.
Talked about.
Customers with previously earned credits.
I guess just at a high level can you talk about that.
Bank credits and exploration deep deep credits expire over kind of a near to medium term and then I guess.
Could you see that dynamic continue.
Into future years just from.
Previous areas, where volumes were higher.
Well I'll answer it.
Generally I mean first of all credits do expire over time, obviously to the extent customers are using credits in current periods. They have expired, but those credits are not are you going to last into perpetuity.
Don't have the schedule in front of me as to whether those credits are going to going to be exhausted.
But it's it's.
Its getting too it's getting close to that point, where those credits are gonna be exhausted.
That's great. Thank you guys very much.
Our next question comes from line of Spiro Dounis Credit Suisse. Please go ahead.
Hey afternoon, guys, Mike you mentioned the expectation for Capex to be roughly 100 million next year any sense on what the return profile of that Capex looks like you did your typical historical range or has this these projects and subjected to a higher return threshold.
We're.
We're holding.
The majority of our project evaluations to a higher threshold right now Uh huh.
And Ah, that's partly why that capital.
Budget is expected to be as low as it is is because of that so we're going to be very careful with capital deployment.
The ones that we're acquiring you know it is not yet.
You know what's the what's the.
Second capital earn gets the certainty of that there were also focused on so.
Well, it's very clear to us that this is not an environment to be speculating on capital projects and we're not intending to do that.
And just to be clear on the $100 million number that potential.
I want I tried to be clear in my comments that approved projects are only totaling $40 million for next year.
Yes, the 100 million is if we if we approve some of these incremental projects, which we haven't done yet so.
They may or may not have but.
But we're going to be very focused on high return low risk projects.
Understood appreciate the clarification there a second question just just on the FERC you talked about entering into some buys so agreements on the affiliate side. It looks like the FERC is maybe looking to provide more guidance there and affiliate contracts specifically when it comes to regulated liquids pipelines I know the topics close to you you guys talked through.
I'm your views on what the FERC has proposed so far in any potential impacts the industry.
Well the FERC, a if you're talking about their recent notice for comment is really focused only on affiliate contracts for new construction.
And.
Yes.
Yes, we are I don't really want to get into all our comments on that we're going to file or comments here when they're due I think generally speaking.
The commissions thinking the right way about how affiliate contract should be addressed.
And you know we're going to provide.
Supporting comments in some area and maybe clarifying comments and others I do want to be clear, though that in our case.
Our buy sell activities are occurring only on into.
Intrastate pipelines not interstate pipelines, so they're not under FERC jurisdiction.
Understood and I appreciate that clarification as well thanks for the color guys.
The next question is from.
Next question is from Theresa Chen from Barclays. Please go ahead.
Hi, Thanks for taking my questions and first Mike can you provide some color on live good man data points across your areas of service given the recent uptick on especially in the mid con.
Well I think there's a couple of things here that we look to in one is our rural markets. Some as I mentioned in the comments are rural markets are essentially back to pre pandemic levels and you know.
That is you I think attribute to the fact that.
Most of the folks in the in the rural markets have been less and less impacted by cold weather related restrictions and shutdowns.
ER and you also have.
Their portion of the economy it needs to continue to run I mean, that's where we serve a very heavy agricultural area.
And so the activities around planting crops harvested crops and in all the logistics associated with that or have continued through through the pandemic.
If we look at our larger metropolitan areas.
In the states, we serve I think the level of restrictions have generally been lower than the coast. For example, the west coast for the East Coast.
And and so therefore, you've had more economic activity.
And in those in those areas, even though you know our largest reductions in demand are in the urban areas I think those reductions are still less than what you've seen in major.
Metropolitan areas as I said on the east and west coasts and to be clear with regards to our guidance.
Our guidance is really just a continuation of what we've seen in the last couple of months. So we're not we're not projecting an improvement in demand from what Weve seen say in September and October, we're really projecting and forecasting it to be flat.
And we wanted to be clear on that too because we haven't built into the guidance a risk of a significant second locked down which we aren't anticipating.
We're not hearing any rumors of that in the markets. We serve but it's certainly is still something that's possible.
Understood and following up on that one of the earlier questions related to the upstream consolidation can you talk about the potential impact. It may have on your supply push assets just given the recent acceleration in consolidation that month the producer.
And if not immediate given youre on minimum volume commitments across many of your pipes and longer term does this change anything.
Well I think I mean first of all you are right. It doesn't have an impact on us short term since were contracted substantially contracted I.
With credit worthy parties long term I would not expected to really change the dynamics and the level of production is going to be what it is.
Are you in the future whether what whether these entities have combined are not to the extent we have healthier entities.
That are operating in the Permian.
In the future in these combinations create healthier it help healthier companies I think that's just a net positive the trying to project at the expiration of contracts what.
The potential impacts of these combinations might have specifically on movements on our pipeline is very difficult to do we really look at it from a macro standpoint, what's the production in the basin where doesn't want to go.
And again, we feel like we're in a very strong position types go into Houston, which is you know both the demand and export center.
And ER and I think you know if you just look at some of the trends that are expected with Permian basin.
Crude oil too.
To continue to grow.
Grow slightly over over the next few years.
Production in other basins.
Outside the Permian to perhaps flatline or decline.
Yeah.
They have more Permian barrels want to go to Houston to replace those those physical barrels or types. So we feel like we're in a good position from a macro standpoint and.
So I'll leave it at that.
Got it and lastly, just on the heels of your sustainability report and thinking about your assets and potential projects over the long term how can magellan participate in the energy transition.
[noise] well, there's a couple of short term things we're focusing on.
The most relevant to us in the short term is renewables liquid renewables like ethanol and biodiesel and renewable diesel and were actively evaluating expansions in all those areas.
With regards to blending.
Most of the ethanol blending well I should say all of the ethanol blending occurs at the terminals. So we're looking at our capabilities to expand that biodiesel blending today. It happens at the terminals were looking at projects to be able to blend it into the diesel stream in the pipe.
Which will increase create more efficiencies and create more transportation revenue for us.
And we're also looking at the opportunities around renewable diesel.
Yeah, those are more longer dated theres really no renewable diesel is consumed in the Midwest that can change over time, and we're going to be positioned to take advantage of that.
We also are actively working on improving our our purchase of renewable power.
Power is coming from renewable sources.
I use the indirect energy transition effect, but were looking into that.
You start looking at things longer term.
Ah, there's really nothing actionable there, but we've started the work to determine.
What are the capabilities of our assets with regards to hydrogen transportation and those sorts of things. So we understand the opportunity and we can prepare for it if its available but that those are those are certainly not short term or near term opportunities for us.
Thank you I was hoping.
Our next question comes line of Shneur Gershuni, Yes. Please go ahead.
Hi, Good afternoon, everyone. Just a few clarification questions from me here.
First off I liked your response to trust and in terms of how your top thing with leveraged I just want to make sure I understood that is that you're you're willing to b.
Obviously free cash flow negative in terms of deploying on a buyback could be maybe is there a globally, but leverage is in check.
Is that a fair way to characterize your response to him.
I think that's a fair way to characterize it.
Perfect. Okay, and then secondly on the on the Capex front, you you talked about the potential to everybody about a $100 million worth of incremental projects at this stage.
I guess two questions here one.
Just to clarify was that $200 million previously and now it's 100 million and then secondly, I recognize it you need to have contracts and you you know your response to Spiro you know not wanting to deploy a g. careful in deploying capital in this environment.
What are the signposts steps need to be thinking about from a macro perspective visited congestion return.
Rigs you know.
Circling cycles that you're looking for as well so.
Well first.
First of all on your first question.
Huh.
Our.
Current capital plan for 2021, its $40 million.
And if we approve what weve that is likely to be approved from the backlog of projects. We're working on to the total for 2021 would be roughly 100 million. So it's an incremental $60 million of projects were talking and talking about I'm not sure where the $200 million.
Number you mentioned came from but those are the numbers that are that were looking at.
With regard to your second question.
You know I mean every project is different in the variables around that are are different with regards to the returns and the the risk some.
Some of those contracts I mean, some of those projects, we would we would secure minimal or eliminate the risk by.
Caused contractually there's other projects, where you know the or the U.S.
The economics are really within our control for instance, we have projects that would improve.
The logistics costs around our blending business. So we have we.
The facility, where it costs us.
The 15 cents a gallon to get butane into the facility. So that we can blend it and we have a project that can lower that cost of five cents, a gallon or that's locked in economics and that we will have to contract for that we know that we can capture it by improving logistic structure and when I say that that would be something like moving to a pipe.
Rather than trucking. So so that we know that the cost structure, absolutely would improve so those are the kinds of things we're looking at that.
Okay. Yes. My my question around the 200 million is more what you were evaluating I recognize that you had only on like the 40 previously and then maybe just to continue on here. Just you gave some interesting comments about costs about how you started to plan last year.
Identified 35 million if I heard correctly, you felt you could execute 25 million this year, which would mean an incremental five would probably show up next year and then Youve identified another 20 million that would come into place over the next two years for a total of 50 from your starting point is that did I get that right.
Just wanted to clarify that.
Yes, that's accurate.
Okay and then just one final question here, you've opened up the price.
Pricing for your hubs and so forth I was just wondering if you can give us some color around that at whether there's an opportunity.
Whether there is some third party opportunities there for you.
Can you give color on that.
Well there are some opportunities and for everyone on the call a.
And if I'm wrong, I think what you're referencing is that we've opened up.
Our trading our pricing point in Houston for crude oil to third party pipelines and yes that is creating.
Incremental opportunity for us through.
We've already you know captured some incremental and it's going to be happening as it has so much happened in the third quarter, but one of the future incremental volume on our distribution system.
Associated with that but the long term goal is to continue to grow the benefits of that pricing point to.
To the market such that it drives incremental volumes and storage opportunities on our system, that's where we get the benefit it's not really through the pricing through the contract. It's the more effective and the more customer friendly.
The more useful that we can make that contract.
The more liquidity physical liquidity will have on our system.
Our next question is from Keith Stanley with Wolfe Research. Please go ahead.
Hi, good afternoon.
I wanted to ask about just potential regulatory strategies as we move through next year. Just I guess you guys are forecasting refined products volumes still down double digits next quarter. So you see we have a bearish case, where volumes stay well below normal through next year, so a prolonged status quo.
Under that scenario would you look more closely at filing a rate case at FERC next year or how can we think about the criteria or timeline when you'd say, okay. We we need to file a rate case at this point and then separately just curious any updates on the the FERC process and potential to.
To seek recovery of some of the impacts from this year on on volumes.
So to address the first part of your question.
As a reminder, about two thirds of our markets our market based.
So we have the ability to increase rates in those markets without making a cost of service filing and so in those markets, yes, if our cost.
Per barrel mile.
Is not being reflected or increase in cost of barrel miles are not being reflected in our terra.
The ability to increase our tariffs to try to offset that.
As we as we need to do the other one third mark of our markets are.
The index FERC regulated or the index level, and so to do something different than the index.
We'd have to see.
It was right.
We are.
Evaluating that it's it's really too early to to pull the trigger on that we're not play.
Planning on filing a cost to service rate for 2020.
So it's really a matter of what is 2021 actually look like and is the deficiency in income.
At such a level that we are incented to file a rate case I think it's possible that happens.
It's not a certainty.
We're preparing for that we haven't been in a rate case, Fortunately since we've been in existence or these assets were in a in a rate case or under the previous owner.
Williams and some of US had experience with that and it's not something you take lightly.
It's a it's a large endeavor to initiate a rate case we're.
We're not opposed to doing it if we think that the benefit is worth it.
And we're preparing now so that we can do that and it.
And have all all of the the processes in place to support one if we feel like we need to but we're not really at a point to make a decision on that Oh.
Right now are on your last question, we're we're really waiting to see how the the entire year look.
With regards to cost recovery, what we've found is and you back up a little bit more of a large percentage of our indexed markets are in rural areas and as I mentioned those areas have come back to essentially pre pandemic levels.
So the cost recovery there.
ER is really only.
Relevant for a few months during the summer when we were really at the depth of the Oh the destruction of the man.
And so we haven't made a final decision on whether we feel it's worth making the filing for the for that recovery because that number is turning out to be not as large as we thought it was but we haven't made any final decisions on that yet.
That's very helpful and I'm, sorry, I'm going ask a similar question, which is on the market based rate side for refined products.
How can we think about how sensitive the market is to larger rate increases in volumes. They stay very low through next year. I know you guys raised the rates I think 4.5% or.
For those systems midway through this year I mean would you would you expect competitors also seek larger rate increases or do you think the do you think the market will be competitive and it's tough to raise rates more than say four or 5% or or is that a possibility if volumes stay very low.
Well it's I.
I mean, our experience today.
Since we've had market based rate locations.
Weve been able generally to increase rates.
To compensate us for our increased costs.
And when I say costs. It is really not Pos its cost per barrel mile because a large percentage of the operating costs of the pipeline is fixed costs, which has to do with integrity costs.
And those types of things, which are which don't fluctuate with how much volume you move so if you're moving less volume your cost per barrel miles caught up.
I don't have any reason to believe that our competitors.
Our more cost effective than we are such as I would I would think they would have the same cost per barrel mile experience that we do and so they should have the same incentive to raise their rates.
I can't tell you, whether they will not but our expectation is that that's what most likely would happen over time.
And no if it doesn't obviously, we'll have to adjust but our expectation and I think the rational.
Market response would suggest that that's what's going to happen.
Thank you.
Sure.
Our next question is so it's from Praneeth Satish with Wells Fargo. Please go ahead.
Thanks, Good afternoon, I'm wondering if you've had any discussions to potentially merge pipelines in the Permian basically shut down the pipeline and move the volumes onto another under a JV structure and I guess more broadly is this a strategy that you think the industry could pursue.
Well I really can't answer the first question, even if we were in conversations I can tell you that we look to optimize our pipes all the time.
And we're not opposed to talking to third parties about.
Combinations that make sense.
I think that there may be a time when it when it when those combinations will happen.
Or pipes or re purpose.
That's probably all I can say on that.
Okay.
And then on Longhorn I understand the marketing group is taking some of the space and the tariff will will approximate I guess the spread between hubs.
I'm wondering if you could comment on what your variable operating cost is per barrel. So I guess, we can get a sense of maybe what the minimum spread is that's required to utilize the space and sort of moving house.
Well I mean, there's there's a range of variable operating cost depending on how fast the pipe moving whether it's near capacity or whether it's not near capacity. So those numbers are all over the board you.
I think that you know the range, which I can give you a range, but it's not going to be helpful. Because it's a big range.
But I mean I can tell you that you know the differential from.
[noise] Midland to Houston today, I think was 50 cents of their that's pretty low and that 50 cents a barrel is within the range.
Uh huh.
Variable operating costs for some pipes at some blow right. So.
It is right now on the margin a a low margin opportunity at the current differentials but.
But I I don't want to quote you a specific variable operating cost because there's there's such a big range and.
And.
And when I say that I mean, I'm talking like 15 cents a barrel to 90 cents a barrel. So it's I mean, it's a big range in any specific pipe could be somewhere in that range at any point in time.
So I don't know that that would be real helpful. For you since you have to know pipeline specific and.
And I'm not going to close our pipeline specific numbers.
No I think that that helps just just to get a sense of it and just to understand based on the current spread thank you.
Next question is from Michael Lapidus Goldman Sachs. Please go ahead.
Hey, guys. Thanks for taking my question I actually have two one is I think is probably per cap kit I make sure I understand what your commentary about operating costs and cost reduction for the next couple of years are I mean, if I might just look at a year to date, our nine month DNA expense, that's down I don't know.
32 $33 million or so.
Are you expecting further savings on that line. This year in could you see that go down further in 21 or 22, well will some of that come back and then if there are other cost savings have been the operating cost buckets. How material do you think those could be I'm, just trying to parse it out a little bit between DNA versus two or you know kind of Bob field out back.
Well some of that.
Michael This is a function of this year and so gene is a good example, with lower results were going to have a lower comp.
Spencer Sadly so that's a big part of the variance there, which we would not necessarily for Jack or hope to project into the future going forward. There are some savings and DNA as part of our optimization efforts, but its really as Mike described more on the operation side So power.
And DRA efforts.
And and then also just optimization of our procedures and processes trying to be more efficient things, we're finding a lot of opportunities for that some of those revenue some of those were large.
Margins some of those are op expenses, there's a little GNM, there, but it's primarily on the operational side.
Got it and then so is what you're saying 'cause like operating expenses for the year down 27 million or so year to date are you, saying you think you can take another 20 or 30 out by the time you get to 2022, my understanding that correctly or does some of it come back and then come out.
Yeah, we're saying we think we can save a lot where we expect to see it from optimization efforts are rare area 25 million. This year, we can be up more in that $50 million in a couple of years some.
Some of the savings if you just took expenses year to date to saving some of those are related to the activity. This year. Maybe just there is some correlation between throughput activity and operating expenses as well. So you have an off off year. We've had this year, there's a little bit just like operating expenses as well. So you have to be a little careful extrapolating yet.
This year instead, we tried to isolate that $25 million of optimization, we expect to see in 2020 and seeing that go into that 50, and but you know we continue to work on that and we continue to look for as many opportunities as they can find Mike alluded to the fact that we've always been lean, but we are trying to take.
This lower capital.
Environmental focus on efficiency, we're seeing the fruits of that.
Got it thanks for that and my one question just when you and the board.
Think about the M&A environment right, because when industries are going through difficult times, one of the ways to improve things as to is is to use M&A as though as a tool to reduce costs.
But when you look across the different asset types and different businesses within midstream energy.
There are ones you look at and say you know what that's a business type that turn out that's what my risk return metrics would look like versus others would you say you know what.
That's just yeah, I mean, maybe it some crazy low price, but in general that's just a lower quality business and it would dilute my return on capital or kind of my my risk return metrics and therefore kinda. Thanks, but no. Thanks I'm just trying to think about what are the asset types that you kind of think about as hey, that's off the table.
Says Hey, you know what we would we would look at inconsiderate, but obviously M&A is hard and price dependent and all that but these are asset types that would fit within our melt.
Well, you know that I mean, I think you'd describe exactly how the process works I mean there are.
Peer companies that are more like that and when I say more like does have stable.
Prime.
Primarily fee based businesses.
With less volatility there would be more attractive to us than say a business it's entirely commodity sensitive.
She sees the two extremes now that doesn't mean, we won't look at both businesses, but the hurdle for us to be interested as much higher on the higher.
Variability business and and generally speaking you know it's a business is more like that from the business mix you typically you're going to have higher opportunities for cost savings.
Because you're doing similar things and you don't need to duplicate that whereas.
If you if it's a very different business that you're buying.
For example, a a processing business versus the pipeline business well you need the whole skills that you need to keep the whole skill set of people, who know the processing businesses, there's less efficiency or less opportunity for cost savings. So all those things go into the evaluations is.
Generally as you know, but those are just part of it I mean, you also balance sheet issues you have corporate structural issues you have the geographic location of the assets have met all of those things go into it.
Yeah, and so the short answer is I mean.
Yeah, there are companies for more interesting than others and there's companies were less interested than others or that we don't think would be a good fit and some that we think would be a good fit and so.
That color is where we spend most of our time when were evaluating this so.
I think I disagreed with what you just said I just said a different way.
No understood I appreciate it Mike. Thank you much much bought Scott sure.
Sure.
And our last question comes from line of Derek Walker of Bank of America. Please go ahead.
Good afternoon, Thanks, Mike Thanks for the commentary today.
Most of my questions are answered, but maybe I'll just ask a.
Couple of quick ones.
In the.
You mentioned sort.
Sort of this target distribution coverage at least 1.2 times, what they were quite parts demand and commodity prices stabilize or return to historical levels is that's an event that you see happening.
Sometime in 21 and that sort of back half 21.
How should we think about some of the commentary from your perspective.
Well I mean, that's.
Essentially you're asking for 2021 guidance, which were not prepared to give yet.
You know I.
When I just look at the landscape right now that's a tough question to answer I mean I think.
2021 still has a lot of uncertainty when is the vaccine going to be available when is it going to be widely dispersed when are people going to feel comfortable.
Going back to their normal lives in a normal mobility.
You know, we're going to build a view on that when we provide our 2021 plan.
But as far as probably is true with anyone who built the protection with that it's going to be subject to a lot of.
Assumptions in and when you make that many assumptions you probably aren't going to get them all right. So I guess I'm.
I'm not prepared to give you an answer on that today.
I think.
Well I would say is at some point, we will be back to normal.
And and so when we talk about that in the context of what's in the press release, we're talking about that sometime I don't know, but right now if it's next year or if its 2022 and at some point, we will be we'll have more color on that when we give guidance in January.
Got it and then maybe just lastly, just a clarification.
Mike you talked about sort of the rural areas being back to pre.
Pico levels.
Urban area still feel the impact so.
As far as the fourth quarter.
Numbers that you referenced.
Should we think about those as really just being the urban areas.
As far as the court quarter year over year numbers.
No those are the total numbers because I mean.
So essentially what you can read into that is the urban areas are doing worse than the numbers were providing and it's being offset by the rural areas back at current levels. So those those are total numbers.
Uh huh.
And again I'd reiterate that those numbers are essentially what we're seeing right now I mean, so we're not expecting improvement in the fourth quarter from what we've seen we're experiencing in September October we're expecting it to stay the same.
Those are actual kind of our actual range right now and.
So I hope that answers the question.
And Mr. Mears those are all the questions we have I'll turn it back over to you.
All right.
Thank you everyone for your time today and we appreciate your continued interest in general we will copy soon.
Ladies and gentlemen that does conclude our conference call for today. We thank you for your participation everyone have a great rest of your day and you may disconnect Your line.
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