The recently announced combination of DCP Midstream LLC and DCP Midstream Partners LP creates the nation’s largest natural gas processor and natural gas liquids producer at what may be a particularly opportune time. The newly formed DCP Midstream LP, operating as a master limited partnership, owns 61 gas processing plants with a combined capacity of 7.8 Bcf/d—enough to process more than 10% of current U.S. production—as well as 12 fractionation plants, 59,700 miles of gas gathering pipelines and 4,600 miles of NGL pipelines. Better yet, many of these assets serve some of the U.S.’s most prolific and promising production areas, including the Midland and Delaware basins within the Permian; the Denver-Julesburg (DJ); and the side-by-side SCOOP and STACK plays. In today’s blog, we review the combined entity’s assets and prospects for growth in what soon may be happier times for NGL processors.
DCP Midstream LLC (a 50/50 joint venture (JV) of Phillips 66 and Spectra Energy, the latter of which plans to merge with Enbridge later in the first quarter of 2017) and DCP Midstream Partners LP (a master limited partnership, or MLP) announced on January 4, 2017 that they have signed and closed a deal that transfers all the assets and debt of DCP Midstream LLC (which we’ll refer to as “the LLC”) into DCP Midstream Partners LP (which we’ll call “Partners”). Partners, the MLP––whose assets and outlook we discussed in detail last year in our Spotlight Report, We Get Back Up Again (a Backstage Pass subscriber-only analysis, provided through our partnership with East Daley Capital, we provide as a free bonus to all of our blog readers today; see how to download below) —on January 23 will be renamed DCP Midstream LP. Phillips 66 and Spectra share a 38% ownership interest in the newly expanded MLP (the balance is owned by public unitholders).
Figure 1; Source: DCP Midstream
Rolling the assets of LLC—the Phillips 66/Spectra JV—into the MLP not only simplifies the corporate structure (see Figure 1 for a “before and after” look), it allows a fuller examination of the LLC’s assets. Why? Because while Partners (as a publicly held MLP) was an open book, the details of the assets held by LLC had been reported under the veneer of an “equity method” investment by both parent companies—thereby limiting disclosure to what the parents chose to reveal. In essence, by transferring the assets of LLC to the MLP, the newly announced deal pulls back the curtain to show all of what LLC owned. The bulk of LLC’s assets were gathering and processing systems, the majority of them in the Permian, the Midcontinent (including SCOOP/STACK), and the DJ Basin. LLC’s interests also included a one-third ownership interest in the Sand Hills NGL pipeline (more on Sand Hills in a bit).
Figure 2 provides a big-picture look at what the newly combined entity (DCP Midstream LP) owns, as well as the natural gas volumes it processes (~6.7 Bcf/d) and the NGL volumes it produces (~400 Mb/d). The inset to the lower right summarizes the assets brought to the combination by Partners (“DPM”/green-shaded column) and LLC (“Midstream”/white-shaded column); the light blue-shaded column shows the new entity’s combined assets and the dark-blue-shaded column shows the degree to which the addition of LLC’s assets boosted the MLP’s numbers.
Figure 2; Source: DPC Midstream
As part of the new deal, DCP Midstream LP unveiled plans to build and own a new, 200-MMcf/d gas processing plant in the DJ Basin called Mewbourn 3. The $395 million Weld County, CO project (which includes associated gathering pipelines) is expected to enter service by the end of 2018; another 200-MMcf/d plant there that would come online as in 2019. Both new plants will tie into the150-Mb/d Front Range Pipeline, which transports mixed NGLs (or “y-grade”) 450 miles from the DJ to Skellytown, TX (northeast of Amarillo, TX). There, Front Range feeds into the Texas Express NGL pipeline to the NGL storage and fractionation mega-hub at Mont Belvieu, TX. (DCP Midstream LP holds a one-third stake in Front Range.) The DJ Basin has been a real positive for the MLP, whose 800 MMcf/d of existing processing assets there (icons in left box in Figure 3) recently have been running at more than 100% of their rated capacity and are currently producing ~75 Mb/d of NGLs, all according to DCP. (The partnership also owns the 500-mile Wattenberg Pipeline, which moves up to 22 Mb/d of y-grade from the DJ to the NGL storage/fractionation hub in Conway, KS.)
DCP Midstream LP on January 4 also announced plans to expand the capacity of the 720-mile 280-Mb/d Sand Hills NGL pipeline (from the Permian to Mount Belvieu via the Eagle Ford) by another 85 Mb/d to its full 365-Mb/d potential in late 2017. (LLC and Partners each contributed a one-third stake in Sand Hills to the newly expanded MLP; Phillips 66 Partners owns the other third.) The 2016 expansion of Sand Hills to 280 Mb/d (from the original 200 Mb/d) already is running at ~90% of capacity, and the MLP expects that—with new, third-party processing capacity coming online in the Permian’s Delaware Basin, and a possible expansion of processing capacity in the northern Delaware by the MLP—flows on the expanded Sand Hills pipeline will ramp up to near full capacity in short order. That seems like a reasonable assumption.
Figure 3; Source: DCP Midstream
The center and right boxes in Figure 3 show the expanded MLP’s gas gathering and gas processing assets in the Permian and in the Midcontinent, respectively. Its holdings in both areas are noteworthy: ~1.5 Bcf/d of processing capacity and 105 Mb/d of NGL production in the Permian’s Delaware and Midland basins, and ~1.8 Bcf/d of processing capacity and 95 Mb/d of NGL production in the Midcontinent. By the way, all of these Permian and Midcontinent gathering and processing assets were just added to the MLP by LLC. While the Midcontinent assets have suffered from perpetual volume declines in recent years, new drilling in SCOOP (South Central Oklahoma Oil Province) and STACK (Sooner Trend Anadarko Canadian Kingfisher) could help offset conventional declines from mothballed plays in western Oklahoma and Kansas. As we have been saying in the ongoing Stardust, And Much More blog series, while SCOOP/STACK producers are primarily targeting crude oil and condensates, the area also is seeing a resurgence of natural gas output from associated gas. And, given the play’s production economics, location and ample infrastructure, gas supply from SCOOP/STACK has the potential to be directly competitive with Marcellus/Utica supply. All that bodes well for DCP Midstream LP’s assets there, assuming the company competes aggressively with other hot midstream companies in the region like Enlink Midstream Partners, Enable Midstream Partners, Oneok Partners, and Targa Resources. As we describe in detail in our 2016 Spotlight report on DCP Midstream Partners—available for free download (see link at bottom of this blog) —the MLP has been working to reduce its exposure to commodity prices through hedges and through aggressively renegotiating gas generate revenues based on the three basic types of contracts with natural gas producers in use by the gas processing industry:
- Fee-based deals under which the processor receives a fee per volume of gas processed,
- Keep-whole contracts under which the processor retains the extracted NGLs and returns or pays for the Btu content of the gas delivered to the plant. Processors benefit under these deals when natural gas liquids prices are strong relative to natural gas prices (aka the “frac spread”).
- Percentage-of-proceeds (POP) arrangements under which the processor is paid a percentage of the value of residue gas, NGLs, and condensates sold. The processor’s revenues rise and fall with the relative prices of those commodities.
According to data from our friends at East Daley Capital, fee-based contracts in 2015 constituted 61% of the gross margin for DPC Midstream Partners’ gathering and processing contracts. The newly expanded MLP indicated on January 4 that (thanks to its efforts to mitigate its commodity price exposure) the number now stands at 65%, and another 7% is hedged (another mechanism to reduce price risk on non-fee processing margins). By the end of 2017, the MLP plans to increase that fee-based/hedged total from 72% (65% fee-based plus 7% hedged) to as much as 80%. That strategy is very much line with the aims of any true-blue MLP, namely to minimize risk and focus on providing reliable returns to their general and limited partners.
We suggested at the get-go of this blog that the decision to transfer DCP Midstream LLC’s impressive portfolio of assets into an expanded MLP is well timed. The reasoning behind that is this: As RBN has been saying for some time now, the old expectation that NGL prices will remain low may no longer hold water. New NGL export terminals and new ethylene plants (aka steam crackers) coming online are very likely to increase demand for NGLs, boost ethane and other NGL prices, and encourage increased NGL production. An MLP with DCP Midstream LP’s well-located asset base and growth potential seems to put the MLP in a good place for success in 2017 and beyond.
Note: Neither this blog nor the free Spotlight download below (originally published for Backstage Pass subscribers on February 23, 2016 and titled DCP Midstream Partners—We Get Back Up Again) should be viewed as investment advice. Neither RBN Energy or East Daley Capital is an investment advisor. Spotlight is included as part of RBN’s Drill Down report series and is provided to RBN Backstage Pass members as part of our premium services package.
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