MPLX: A Bargain Inside a Hated Industry

Renewable energy is the next big thing.

Everybody knows that.

It will replace all that dirty old oil, gas, and coal… and the world will be a brighter, cleaner place starting at about noon next Wednesday.

That’s the story we see everywhere these days. The politicians are pushing it and so is Wall Street:

Plan for a clean energy revolution and environmental justice– President Biden

Green energy is finally going mainstream– Wall Street Journal

We’re going to have a rapid transition to a net-zero [carbon] economy– Robert Litterman of Kepos Capital

An economy that runs purely on renewable energy may happen someday. But the hard truth is that we’re still years away from it.

Today, for example, solar power only generates 3% of our country’s electricity.

And while there’s certainly progress, alternative energy solutions such as wind power aren’t that “mainstream” either. Wind energy has risen from 2.4% of the U.S.’ electricity production in 2010 to just 10% today.

Like Germany, some countries have stated that it is their goal to be 100%-renewable in energy production by 2050. That’s three decades from now, not today or next week.

But even three decades is a stretch.

The International Energy Agency (IEA) doesn’t even think the milestone will be hit by 2050. Their most recent energy outlook suggests that more aggressive steps would have to be taken. They note that:

“A large number of unparalleled changes across all parts of the energy sector would need to be realized simultaneously, at a time when the world is trying to recover from the Covid-19 pandemic.”

That’s for the countries striving to become 100%-renewable.

Countries like China, India, and other emerging markets won’t even get close.

As far out as 2050, the majority of electricity produced around the world, including here in the United States, will still be produced using oil and gas.

Renewables will eventually pass coal and nuclear will continue to gain ground, but we will still primarily use carbon fuels to run the world.

Now, don’t take this the wrong way.

I love renewable energy. It is the fastest-growing portion of the energy market, and it will take some bit of market share away from the traditional energy industry every year.

I have been writing about investing in renewable energy for years now. Both Brookfield Energy (BEP) and NextEra Energy Partners (NEP) will forever be at the top of my Buy in a Crash List.

They should be on yours as well.

Both companies are cash-producing machines that will just keep throwing off more money as renewables continue to develop.

But as we work to produce more renewable energy, we are beginning to find more problems.

To name a few…

  • Solar power plants and wind farms require enormous amounts of space.
  • Windmills use heavy metals like neodymium and dysprosium in the construction process; The blades are almost impossible to dispose of properly.
  • The spinning blades are killing staggering numbers of birds.
  • Solar panels contain all sorts of fun and expensive stuff like lead, cadmium, and chromium.
  • There are ongoing storage and transmission issues with all forms of renewable energy.

Heck, not even two months ago, a cold snap froze thousands of solar panels and wind turbines in Germany, forcing the country to quickly revert back to coal and other non-renewables.

And of course there is the debacle that happened a few years back in Texas.

Again, none of this is meant to denigrate renewable energy. I LOVE renewable energy and we should do whatever we can to reduce emissions without destroying the economy.

I’ve recommended renewable energy companies in the past, and plan on doing so again whenever the opportunity arises.

But I also seek exposure to traditional energy companies.

I have explored these stocks in the past and expect to again in the future simply because oil and gas will continue to be produced and used to run the world economy. 

And as long as we’re producing oil and gas, it will have to be moved from the well to the refiner or exporter and then to the end-user.

And as long as we’re producing oil and gas, the elite world of private equity will be finding ways to cash in.

Pipeline Profits

As oil & gas production has boomed across the United States, energy companies have realized that there is a fair bit of money to be made by exploiting an interesting corporate structure: the Master Limited Partnership (MLP).

MLPs consist primarily of companies in the utility and energy sectors. Dubbed ‘midstream’ firms, they provide the linkage between energy producers (upstream) and utility end users (downstream). 

Midstream companies operate wide networks of assets including pipelines, storage tanks, processing equipment, and rail lines designed to facilitate the movement of raw and finished energy products.

But here’s the kicker, midstream companies can have different corporate structures for tax purposes.

This is where the MLP comes into play. MLPs are tax-advantaged entities that don’t pay income taxes at the corporate level. In exchange, they are required to distribute all available cash to investors, so they are usually higher-yielding investment vehicles.

Increasingly, big-name companies like Phillips 66 (NYSE:PSX) and Devon Energy (NYSE:DVN) have announced plans to spin off their midstream assets into MLPs. 

But today, we are taking a look at a midstream MLP that was spun out of Marathon Petroleum (MPC) in 2012: MPLX (MPLX).

Even after the spin off, Marathon Petroleum still owns a little over 60% of MPLX. Marathon uses the assets owned by MPLX and is its largest customer.

Their assets include:

  • Crude oil and refined product pipelines
  • An inland marine business
  • Light-product, asphalt, heavy oil, and marine terminals
  • Storage caverns
  • Refinery tanks, docks, loading racks, and associated piping
  • Crude oil and natural gas gathering systems and pipelines
  • Natural gas and NGL processing and fractionation facilities

The bulk of what MPLX provides is gathering and processing.

This consists of four steps:

  1. First, the gas is passed through a network of pipelines known as gathering systems directly connected to wellheads in the production area. These gathering systems then transport raw or untreated natural gas to a central location for treating and processing.
  2. Then we have processing, which removes the heavier and more valuable hydrocarbon components, which are extracted as a mixed NGL stream that includes ethane, propane, butanes, and natural gasoline.
  3. Then we have fractionation, which is the separation of the mixture of extracted NGLs into individual components for end-use sale.
  4. The final step is getting the natural gas to be delivered to downstream transmission pipelines, and NGL components are stored, transported, and marketed to end-users.

MPLX also provides logistics and storage services.

This division owns all the assets that move oil and gas around the United States and stores it until needed. This includes 13,000 miles of pipeline throughout the continental United States and Alaska.

Their storage caverns consist of butane, propane, and liquefied petroleum gas with a combined capacity of 4.7 million barrels in West Virginia, Michigan, Illinois, and New Mexico.

MPLX also owns terminal facilities for the receipt, storage, and blending of refined petroleum products located throughout the continental United States and Alaska and has a combined total capacity of approximately 34 million barrels.

Its terminals and refinery assets also include rail and truck loading lanes/racks in addition to barge docks, which support the transportation of oil and gas via rail, over the road, or marine.

The marine business owns and operates 23 boats and 286 barges, including third-party chartered equipment, and includes a Marine Repair Facility, a full-service marine shipyard located on the Ohio River adjacent to Marathon’s Catlettsburg, Kentucky refinery.

MPLX also owns an interest in Louisiana Offshore Oil Port (LOOP), the only U.S. deep-water oil port located offshore of Louisiana. The port is used for both importing and exporting crude oil.

Phew. That was a lot, I know.

But my point is that MPLX has an incredible collection of almost irreplaceable assets.

High-Yields at a Discount

Although 2020, and the wild moves in the energy markets, did impact the company, the fact that most of their business is done on long-term contracts with fixed commitments helped MPLX weather the storm better than most energy companies and MLPs.

So while many MLP’s were forced to cut their dividend, MPLX kept payments steady.

mplx dividend

MPLX is currently yielding almost 10%, so we get a big chunk of the anticipated total return in cash upfront every quarter.

MPLX has also been aggressive about protecting that payout. In the latest earnings discussion, they said that they are on target to reduce capital spending by over $700 million and operating expenses by approximately $200 million.

During the third quarter, the new Wink to Webster Permian crude oil pipeline project achieved mechanical completion on the main segment connecting the Permian Basin to Houston, Texas. That pipeline started moving oil and gas in the fourth quarter.

Before the first gallon went into the pipeline, 100% of the capacity was contracted with minimum usage commitments.

Their Whistler natural gas pipeline project that will move gas from Waha, Texas, to the Agua Dulce market hub in South Texas is 90% completed and should be in service in the second half of 2021.

New pipelines mean new cash flows for MPLX.

As conditions have improved in oil and gas pricing, management at MPLX has become excited about its business’s long-term prospects. Their oil and gas producing customers have been able to use the cash flow from higher prices to rebuild shattered balance sheets from the madness of the spring.

More mergers and acquisitions in the oil and gas industry are also providing MPLX with more financially strong companies in its customer base.

MPLX is so confident in the future of the oil and gas industry and their operations specifically, that the board authorized a share buyback program of up to $1 billion.

When I plug the dividend and cash flows into my calculators, I cannot come up with a value for this company of less than $40 a share. Combined with a double-digit dividend payout, the total return potential of MPLX is outstanding over the next several years.

We also have some strong partners as fellow shareholders.

The biggest shareholder is Blackstone, the world’s largest alternative asset manager. They have owned shares since 2017 and were large buyers of the stock in the fall of 2020. Blackstone owns billions of dollars’ worth of energy assets in its private equity funds. They have three private equity funds that focus exclusively on energy.

When they buy into a publicly-traded energy company, it’s because they see the opportunity for massive long-term returns.

TPG Group, out of Fort Worth, Texas, is another large shareholder of MPLX.

Brookfield Asset Management (BAM) is one of the largest owners of energy assets in the world, and they own more than 6 million shares of MPLX.

Now, no investment is risk-free, and MPLX is not an exception to the rule. The price of the partnership is heavily influenced by oil and gas prices. Declines in the price of oil could cause the shares to sell off at some point. MPLX has a decent balance sheet, and it has been improving its strength lately, so I am confident that it can survive market turmoil just as it did last year.

There have been rumors that Marathon may buy the shares of MPLX it does not already own, but I don’t think that will happen anytime soon.

I sure hope it doesn’t.

I want that cash flow to continue to flow into our pockets for a very long time.