Some Have a Way With Words. Plains All American … Not Have Way

Words matter. Which helps explain why Plains All American Pipeline LP finds itself in its current predicament. This is its current predicament:

Plains Flailing

Plains fell as much as 18 percent on Tuesday morning

Source: Bloomberg

Late on Monday, Plains announced second-quarter results that missed at both the earnings and Ebitda level. More importantly, it cut guidance it had only reiterated in May.

The problem lies in the “Supply and Logistics” division — which, unlike Plains’ pipeline and facilities businesses, has more of a trading and marketing flavor to it; not just moving oil and other fuels around for clients, but trying to capture spreads caused by, say, regional price differences. This has, at times been a very profitable business:

Spot The Difference

Profits (or lack thereof) in Plains’ supply and logistics business stick out for their volatility

Source: Company filings

The supply and logistics collapse is only one part of the problem here. The bigger one is its sheer volatility.

As a master limited partnership, the investment case for Plains rests largely on its ability to fund a stable distribution — the equivalent of dividends for regular companies — each quarter. Fees earned on critical long-distance pipelines and associated infrastructure underpin this quite nicely, as the other two lines on that chart demonstrate.

Marketing, on the other hand, can supercharge profits at times and underpin big increases in distributions. Indeed, that’s what happened at Plains in 2012 and 2013, when oil prices were surging, its supply and logistics business was going gangbusters, and it was about to IPO the parent company, Plains GP Holdings LP — the value of which rests entirely on distributions from the MLP:

Plains, Hills and Valleys

Plains accelerated distributions to unitholders in 2012 and 2013 at the top of the oil cycle

Source: Bloomberg

In this, Plains exemplified the hubris that spread through the pipeline sector when oil was in triple digits (Exhibit A: the debacle of the failed merger between Energy Transfer Equity LP and Williams Cos. Inc.). The supercharged marketing profits inevitably attracted competition funded by eager capital markets, which then destroyed said supercharged profits. In the meantime, Plains’ leverage jumped — net debt was 5.8 times Ebitda at the end of June, according to CreditSights — and, having over-promised with those earlier dividend hikes, it has had to cut them. And the new guidance comes with another cut, its exact magnitude yet to be announced.

Here’s the thing: What Plains announced last night is actually the right thing to do. It is effectively saying that distributions from here on will be based on profits from the transportation and facilities businesses, while supply and logistics will be ignored (hence the cut). In drawing a clear line between the stable and volatile parts of its business, it is aligning expectations more closely with the requirements of MLP investors, which, by and large, crave steady distributions and a good night’s sleep above all else.

The problem is those pesky word thingies.

As recently as May’s analyst day, CEO Greg Armstrong talked at length about OPEC’s efforts to rebalance the oil market and the potential for another price spike down the road.

That was by no means all he said but, even so, this is not the right message at this point.

Back in January of last year, I wrote about how Plains’ guidance on an oil-price recovery looked far too bullish and a dividend cut was needed to deal with its cash-flow deficit and leverage. Instead, the company issued $1.5 billion of convertibles in what it called a “one and done” transaction. Six months later, it bowed to the inevitable and cut the dividend in what one might dub a two-and-through move.

Ripping off the Band-aid isn’t easy and doesn’t promise a swift recovery, as Kinder Morgan Inc. can attest. But it does set a credible baseline from which to rebuild. Plains’ own client base in the E&P sector, ranging from U.S. independents to behemoths like Royal Dutch Shell Plc, have largely given up on the happy talk about a big rebound in prices and instead emphasize what they can do internally to make a profit with oil at $50 (which, by the way, is only “low” if your mindset remains geared to the ahistorical notion that $100-plus is normal.) 

Restoring credibility in this way is vital if Plains hopes to recover from Tuesday’s three-and-flee moment.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in New York at [email protected]

To contact the editor responsible for this story:
Mark Gongloff at [email protected]

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