In the first half of 2013, Lifelong Income Portfolio holding Enbridge Energy Partners (NYSE: EEP) generated enough distributable cash flow to cover its payout by 0.87 times, or 0.75 times if you factor in paid-in-kind units. Management also indicated that full-year earnings before income, taxes, depreciation and amortization would likely come in at the low end of its forecast.
The depressed price of natural gas liquids (NGL)–a group of heavier hydrocarbons that includes ethane, propane and butane–has weighed heavily on the master limited partnership’s (MLP) results in recent quarters. These commodities traditionally have tracked the price of crude oil, though an upsurge in production and elevated inventories have lowered prices and eliminated this correlation.
In particular, the price of ethane has declined precipitously over the past 18 months. The US ethane market has two primary release valves: the domestic petrochemical industry and ethane rejection at gas-processing plants–a phenomenon that occurs when the margins from separating the NGL from the gas stream turn negative.
The two most prominent olefins, ethylene and propylene, serve as the basic building blocks for three-quarters of all chemicals, plastics and synthetic fibers. Petrochemical firms produce these commodity chemicals in crackers that heat ethane and propane with steam. The majority of this capacity is located on the Gulf Coast.
Enbridge Energy Partners’ gathering and processing business entails significant exposure to NGL prices and has suffered from widespread ethane rejection in the Midcontinent region.
Meanwhile, volumes on the MLP’s liquids pipelines dipped during the quarter because of unplanned refinery outages and increased competition from rail–a headwind that should dissipate as regional price differentials flatten.
Nevertheless, management stuck to its story that conditions will improve in the back half of the year, citing rising volumes of Canadian light crude oil on Enbridge Energy Partners’ Lakehead Pipeline and improved utilization rates at key refineries.
We remain bullish on the MLP’s “Light Oil Market Access Program,” a slate of projects that will deliver inland crude oils to the Gulf Coast and East Coast. These growth initiatives should enable Enbridge Energy Partners to close its distribution coverage gap over the next two years and position the MLP to meet management’s target of increasing its payout at an average annual rate of 2 percent to 5 percent.
Patient investors with a longer time horizon also shouldn’t overlook the financing needs of Enbridge Energy Partners’ parent, Enbridge (TSX: ENB, NYSE: ENB). The sponsor owns a portfolio of high-quality pipelines that could be dropped down to the MLP.
Enbridge Energy Partners reportedly filed an initial registration statement with the Securities and Exchange Commission for the proposed initial public offering (IPO) of Midcoast Energy Partners LP (NYSE: MEP), a spin-off that would own a 39 percent interest in the parents natural gas- and NGL-related infrastructure. We wouldn’t be surprised if management applied the proceeds from this IPO to pay down debt and finance a potential drop-down transaction from its parent.