Every month, Roger Conrad and I host an exclusive Live Chat with Energy & Income Advisor subscribers. Given the breadth of the publication’s coverage universe, these informal conversations are wide-ranging, tackling whatever issues and questions are on our readers’ minds.
Our May Live Chat was particularly lively and went for seven hours, as we make an effort to answer every question that’s submitted. For this week’s installment of Big Picture, we decided to present an excerpt of some of our readers’ most frequent questions and our responses.
If you’re not a subscriber to Energy & Income Advisor, subscribe today to ensure that you don’t miss out on next month’s exclusive Live Chat.
Question: Which refiner would you buy today–Valero Energy Corp (NYSE: VLO) or Alon USA Partners LP (NYSE: ALDW)?
Elliott Gue: There’s no doubt that Valero Energy is the higher quality and less aggressive of the two refiners. They are the largest independent refiner in the US, and I like that they have a lot of capacity on the US Gulf Coast, a region where I believe we’ll see a lot of low-priced crude oil flow over the next few years, boosting their margins.
Alon USA Partners is a speculative pick. It’s a V-MLP, or variable distribution MLP. Unlike traditional MLPs, it doesn’t seek to distribute a minimum amount each quarter and grow its payout at a slow but steady pace over time. Instead, the MLP pays out all the cash flow it generates as quarterly distributions.
The V-MLP’s Big Spring refinery in West Texas is located in the heart of the Permian Basin, where crude oil prices continue to trade at a sizeable discount.
I’m looking at my Bloomberg right now and see that West Texas Intermediate crude delivered to Cushing Oklahoma sells for $103.63 per barrel, compared to just $96.88 per barrel for the exact same oil delivered to Midland, Texas, less than 600 miles away. The reason is that there’s a glut of crude oil in the Midland area as that’s the heart of the Permian Basin.
Overall, ALDW should do well in coming years, though the distribution will bounce around with refining margins from quarter to quarter. I like it as an aggressive income play. But, please do not make the mistake of assuming that it’s safe just because it has a big yield. Valero Energy is a much safer stock to own.
Question: USA Compression Partners LP (NYSE: USAC) took a big hit this week after a secondary offering. It tried to recover but is pulling back. I know you were bullish on compression. Are there any other factors that could be impacting this ticker?
Answer: USA Compression Partners’ decision to issue new units doesn’t change our take on the MLP. The MLP will use the proceeds from the offering to pay down its revolving line of credit, which increases its capacity to make an acquisition or fund organic growth projects over the next few quarters.
Although the additional units dilute existing unitholders’ stake in the near term, buying MLPs on the dip after a secondary offering has been a reliable strategy over the years. That’s because MLPs typically use the proceeds to buy or build new assets that add enough to cash flows that it more than offsets any near-term dilution.
I think USA Compression Partners has been hit particularly hard by this offering because it’s a fairly thinly-traded stock. After all, in the week preceding this announcement USA Compression Partners only traded about 25,000 shares per day. The market is taking some time to absorb the additional supply.
The company has a solid long-term growth dynamic in that shale wells tend to need compression earlier in their life cycles than conventional wells (because pressure drops faster). Also, I like the longer-term story surrounding the use of compression in “gas lift” operations.
Gas lift is a technique used to produce crude oil from mature wells.
Question: What is your favorite upstream MLP?
Answer: I continue to like Memorial Production Partners LP (NYSE: MEMP), which is much smaller but has a strong drop-down growth angle behind it. As most of the big upstream names have said that the acquisition market is really competitive, having a source of cheap acquisitions via drop-downs is a really big advantage.
Question: What’s your take on the Energy Information Administration reducing its estimate of recoverable resources from the Monterey Shale?
Answer: The Monterey Shale reserve downgrade has no meaning whatsoever in my view.
Reserve estimates are nothing more than an educated guess. We’ve always known that California is different (geologically) from the rest of the US due to the seismic activity there.
But the size of reserves that are technically recoverable in Monterey Shale really has no impact whatsoever on production or production growth potential for names like Occidental Petroleum Corp (NYSE: OXY), which has a massive acreage position in the Monterey Shale–largely by virtue of being the biggest producer in the state.
Although there was some hype surrounding the Monterey Shale back in 2010, the speculative nature of this play means that the market hasn’t factored this in to its valuation of Occidental Petroleum. Investors are more interested in Occidental Petroleum’s low production costs and plans to ramp up drilling activity in the Permian Basin.
The company’s California assets also continue to perform well–and that won’t change overnight because some statisticians tweaked their models. That’s one of the reasons Occidental Petroleum’s shares didn’t budge on this news.
A company called Venoco would be most affected by the announcement, but their management team took it private in Oct. 2012.
Question: Thoughts on Inter Pipeline (TSX: IPL, OTC: IPPLF)?
Answer: Inter Pipeline is a solid Canadian midstream company that should grow its dividend reliably. The company is also no longer a partnership, so US investors can buy the stock. On the other hand, Pembina Pipeline Corp (NYSE: PBA) trades on the New York Stock Exchange, operates similar businesses and arguably a better-run outfit.