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Plains All American (PAA, PAGP): The Signal to Noise Ratio Depends on Where You’re Standing

06/15/15 | Maria Halmo

Why do you invest? Is it to earn as much money as possible? Is it to use your capital in a way that supports your value system? To avoid stuffing it under the mattress? Or is it just fun for you to try to pick a winner?

What you’re listening for will determine how you interpret the recent Plains All American Pipeline (PAA) and Plains GP Holdings (PAGP) analyst day (slides available here).

If the signal you want is an expert opinion on where the energy markets are going, the fact that management called a 40% drop in oil during last year’s analyst day probably impressed your socks off. Since management runs an $18 billion, vertically integrated MLP that touches nearly every major basin in the United States and Canada, they probably have as much of a sense as anyone about where production and prices are going. Last year, they successfully predicted the rise in production growth, the increased price volatility, and the increased cost of capital. This year, management went on record with their belief that long-term fundamentals support higher crude prices, although continued volatility means there could be $50 oil before there is $70 oil. Long term, management is confident in the extent of the crude oil resource base, especially given proven drilling and recovery techniques. They believe the world needs production growth in North America. However, high inventory levels, an inability to export, and the potential for current offline production to come back will prevent markets from balancing in the near term.

PAA 1

However, Plains management (like everyone) also predicted more M&A activity. Earlier this year, they put a $1 billion revolver in place to take advantage of any potential opportunities. Asset prices have just remained high as sellers insist on valuations reflective of recovered commodity prices (while buyers, of course, base valuations on current prices).

However, there has been more merger activity, particularly between related entities. So the natural question is: what about PAA and PAGP?

I was not able to attend the New York analyst day in person, so I can’t report on management’s facial expressions when they were asked this inevitable question. A lot of investors are listening for any signal that there is another LP/GP consolidation. Right now, Plains doesn’t seem to be the most likely candidate. There’s just not a strong enough incentive given the 7% expected distribution growth at PAA and 21% distribution growth at PAGP. Plus, PAGP won’t be paying taxes for the next few years. More to the point, PAA has a BBB+ credit rating from S&P, a distinction it shares with only three other MLPs: Enbridge Energy Partners (EEP), Enterprise Products Partners (EPD), and Magellan Midstream Partners (MMP). Plus, should a large acquisition opportunity present itself, PAGP provides optionality for financing at the GP level.

PAA 2

Now to address the 600-pound gorilla in the room: a few weeks before the investor day, Plains had a pipeline rupture, spilling oil into the Pacific Ocean, where it ended up on the Santa Barbara coast. Now, if you are a famous bassist trying to take his family to the beach, you’re probably pretty mad. But if you’re an investor worried about the impact to the bottom line, the financial impact will be mitigated by Plains’ business interruption insurance and reserves for remediation. It’s neither the largest spill, nor the smallest, and despite Plains’ goal of zero incidents, it has hundreds of facilities and thousands of miles of pipelines. Previous spills have resulted in a settlement with the EIA and DOJ of $3.25 million and new operating procedures.

In general, we tend to find what we’re looking for, and hear what we want to hear. Are you looking for a company with a proven track record of growth and $9.5 billion worth of projects yet to build? Are you looking to be horrified at yet another oil spill? Do you want to believe in consolidation despite other more likely candidates? The choice is yours.