ONEOK, Inc. (OKE) Earnings Call Transcript & Summary

Welcome, everyone. My name is Theresa Chen. I'm the midstream and refining analyst here at Barclays. It is my pleasure to welcome our next company, ONEOK. From ONEOK, we have Pierce Norton, CEO; Walter Hulse, CFO; and Sheridan Swords, SVP of Commercial. Welcome, everyone.

Thank you.

So let's just dive right into it and talk about the acquisition first. Can you talk about your strategic rationale for the proposed transaction and how that came about?

Yes. Well, first of all, Teresa, thank you for having us here today, and welcome, everybody. So I'll break the strategic transaction down into basically 4 parts. The first part is growth. Second part is scope, scale and basically diversification. And so first part on the growth thing, we believe strongly that these 2 companies together, we've looked at this for quite some time, both Magellan has this opinion and both we have the opinion that these 2 assets together can do way more than they could individually. So there's -- you can get into that a little more. Sheridan will talk about the different opportunities there that you have. The other thing is on the scope piece. ONEOK is a company that provides energy for utilities, which covers the residential, industrial and commercial and a little bit of the transportation piece. But what this adds to us is transportation. So you have electric generation, you have the traditional natural gas utility piece and then you also have added transportation piece. But we believe strongly that there's going to be a lot of demand for that transportation piece. And even if it wanes off with EVs in the United States, you're going to have the opportunities to go basically over the water with some of the same refined products. And then the scale, we were looking for something that would be meaningful and what I would call quality of scale. I mean you can do scale for scale's sake, but when you look at the quality of these assets and you look at the EBITDA that they generate and the minimum amount of capital that it takes to basically produce that EBITDA every year, that's what we call quality scale. And so that was what we're looking for. And then the last thing was diversification. This is a company that has been noted because of its presence in the Bakken that it kind of trades for the oil price. And if you look at refined products, when the oil price is down, usually have more consumption of refined products, it's kind of a little bit of an offset. It's not one for one, but there is an offset there. So it's really those 4 things.

Makes sense. And just thinking in the construct of [ they all have ] different value chains with overlap in the infrastructure, how does your expertise in NGLs and natural gas from a commercial perspective translate to expertise or potential expertise and growth in refined products?

So I think the first thing is, is, obviously, we're dealing with -- on the NGL side, we're dealing with the refineries today as we deliver purity products into the refinery. So we have some of the same. We do have some of the same customers that not -- that we realize. We move product, we can market product, we can deliver product into these refineries or into the Gulf Coast into the export terminals by using the same thing we do today from a commercial standpoint. And then you get on to on the crude system, we have an extensive network of dealing with producers. They're -- much more than they do from that standpoint. So we know the producers. We have great relationships with them to be able to source product on to their pipeline just from a commercial standpoint, we actually think we're going to bring a lot to them from that standpoint.

Makes sense. So on your second quarter earnings call, you did provide some quantitative details on expected commercial synergies. Can you give some examples of the opportunities related to batching, blending and bundling?

So the first thing, let's talk a little bit about batching. I don't think everybody has -- as we've had more conversations to understand exactly what batching is and how we will do it. And this is -- we do this today. This is -- we move refined products on our NGL pipeline today. And so how you do that is if you have a -- for example, purity NGL pipelines, if you're moving propane and you want to move unleaded on that, what you're going to do is you're going to put a buffer of normal butane in there. There's going to be a couple of thousand barrels of normal butane. In terms of a pipeline, that's miles of pipeline that will be under normal butane. So we'll have propane, the buffer of normal butane, and then we'll put unleaded right next to it. And the reason we use the buffer of normal butane is normal butane can be mixed into propane, there's spec for that. And as well, know that normal butane can be mixed into unleaded for blending. So as that moves down the pipeline, we have a system where we can track that buffer as it goes down and you're talking about miles of pipeline. So when it comes in, we will, what they call, cut, we'll cut the batch. We'll [indiscernible] more of the normal butane into the unleaded and that we get an upgrade on that or you get some blending on that and the other ones will stay in the propylene. That's how we can batch down the pipeline. So you think about it that these 2 systems sit on top of each other. To the extent that it turns as the market changes or you get spikes in the market and there's pinch points along Magellan's system, we can move on to the NGL system around those pinch points or if there's more long-term constraints on either one of the systems, we can move back and forth because the pipelines sit on top of each other to get to these locations. And one of the examples I used on the earnings call was Sterling pipeline system that moves from the Mid-Continent down to the Gulf Coast. And we can use that system, especially now that Medford's -- we've moved -- effectively, we've moved Medford down the Gulf Coast, we have capacity on Sterling today. We can use that pipeline to move product into the Gulf Coast area. They also have a pipeline that can go that way, but now we'll be able to much better move product back and forth between the 2 systems more efficiently where we can move product into and out of the Gulf Coast region as needed. Those are the example of batching. Blending, when we start talking about blending, one thing we do with -- we obviously have a tremendous amount of normal butane. With our systems, we -- one thing we are going to be able to do is cut down on their trucking costs being able to match normal butane to their end-use markets. Where now they're using a lot of trucks to get there, we can lower that as well. And also, by having a normal butane more readily available, we'll be able to reset blending a little bit on that side of it. And that also goes into some of other blending that they do as well. The bundling piece is the one piece that we talk about that we will have to have a little bit of customer interaction with them. We think the blending and the batching we do not. But on the bundling piece, as I talked about, we have a lot of conversations, a lot of contacts with producers in the field. So you talked about like in West Texas, or in the Mid-Continent where we will go out and talk to somebody, a producer about moving their natural gas and moving their NGLs, now we're also talking about moving their crude oil. And by that, we can create a portfolio of opportunities for them and contracts where we can move value to the customer through all different streams, and that way, we can incentivize more products to come on to our pipelines. So those are examples of it.

Got it. And as you plan to execute these synergies, what is the level of CapEx requirement required here, if any?

So I think there's -- we think this is all very -- first, there's some that's going to have no capital on it. Then there's going to be minor capital that we'll need as we can go forward. What I would say is there may be opportunities as capital kind of goes up a little bit, they will be low-return projects, and they will be -- nothing like you see -- we're not talking about $1 billion here or anything that, but there will be some as we grow in the short term. As we get further out, there may be opportunities here down the road to extend both systems into completely new markets. But as we do that, they will be at very high return type of projects. We'll be able to do that. That's what we think the benefit of bringing the 2 systems together; assets breed opportunities. And so we think there are going to be some opportunities out there for maybe bigger projects. But in the beginning, it is going to be very low capital, some no-capital projects to capture the synergies that we've outlined today.

Which are points to the higher return.

Understood. So within batching, blending, bundling, these potential projects and growth in the system are independent really of demand and look at growth. Right? So if demand is flat and want to, for example, take market share from existing midstream competitors, how do you think you'll be positioned to compete with these companies?

Well, the first thing we're going to be able to do, by being able to bring the 2 systems together, we're going to be able to do it more efficiently. We're going to be able to be a much lower cost to get into new markets or get around constraints. We'll also be able to hit market demand quicker by having -- not having the constraints on either one of the systems as well. So it's going to be a cost system. And there's also the opportunity to offer open up new markets. So we may have people in the Gulf Coast that can't get product into the upper Midwest customers, so that will allow them to get into new markets that they're not seeing. But on the other side, I think there's also a growth component to it as well because we talk about the growth in the Permian crude oil, and you talk about the bundling piece, well we'll see growth coming out of the Permian in terms of crude oil. And we think through what the assets we have in the Permian today and our relationships we have there, we'll be able to capture some of that growth [indiscernible].

Does acquisition accelerate your ability to add NGL exports to your asset portfolio, touching on that fourth bucket of financial synergies?

I would probably say it helps us advance our NGL export. We wanted to look at NGL exports. We've been studying that for a period of time. But what Magellan brings us is they operate in export terminals and they've built export terminals. Those are 2 things that ONEOK does not do today. So with them coming on, I think that is very much going to enhance our ability to get a terminal up and going with those expertise on site. Now we will -- as we close this, we will look at their existing terminals to see if there's opportunities to build an NGL terminal, if there's synergies there as well, but we need to get kind of close dive into that much more. We have not put any of those synergies in what we've already shown the marketplace. None of that is in there, but we think there could be an opportunity for them. But definitely, on the operation and construction, it is going to advance [ ever ].

Okay. And speaking of the numbers that have been put out into the marketplace, can you discuss the pro forma financial and CapEx assumptions included in the proxy? And what is the basis for these assumptions and are they still valid at this point?

Sure. Well, I think it's important to understand the context of when those projections were created and what the purpose of why they were created. They were created in August of '22, and they were created for the Board presentation that would lead the approval of our 2023 plan, had nothing to do with an M&A transaction and was really focused on 2023. Our Board has a process where they only approve the coming year and set the metrics on which they evaluate our performance. As we give them a quality opinion on this, it's primarily on 2023. And then in all of the capital that we might be bringing to market in this particular incidence, we put in the full boat of Saguaro pipeline because if you look from our Board's perspective, they don't want us to get to July of the next year and say, oh, by the way, we've got this $1 billion plus asset that we want to build. We didn't tell you about it when you approved our plan. So we're a little bit conservative on that side. So that is a fully loaded CapEx, and in the outer years, a pretty conservative look at what our forecast would be. Dial forward when we get into the -- we started this discussion in September of '22. We didn't expect it to take 9 months when we did that. And those numbers then continued to live through the process as we were going forward. We didn't go out and create a new set of numbers for an M&A transaction. We used what the Board had planned -- had approved for our plan. Magellan did similarly the same thing. They were using their planned numbers as well. So those are -- that's the way they were put together. We have obviously found many new opportunities since August of '22 in our base business. And then you, Sheridan, has talked about some of the synergies that we see here going forward. So I would say that in February, when we put our fresh guidance, you will see the benefits of the transaction, the benefits of the growth in our base business. And obviously, in 2023, we have put out our forecast. We've already raised that by $100 million in our expectations after the second quarter. So the base business is very robust, and that will carry to the forward view.

With the backdrop of elevated capital needs for growth in your business, both organically and inorganically, and a number of stand-alone projects still under development, looking forward, what is your prioritization in the use of free cash flow and are stock buybacks still in the mix?

Yes. Well, first of all, I mentioned that we fully loaded the CapEx going forward. So I think the Saguaro pipeline will be coming in at a very -- a significantly lower capital amount than we've had in that forecast before. So I think on a going-forward basis, we will have kind of a consistent capital over the next several years. You're right. That's going to create a situation where we have a significant amount of excess free cash flow above and beyond our CapEx and our dividend. Obviously, we're looking for opportunities for high-return growth projects. But to the extent that we have additional free cash flow, I'm sure the stock buybacks would be something that we will consider and the Board will take into account, much more so than we have in the past primarily because in the past, we had -- we were either in a build mode or we were in a debt reduction mode. In this instance, we're going to do a balance sheet reshape very quickly and be in a position to look at all forms of capital return.

One of our priorities over the last couple of years has been to reduce our payout ratio. So that's come down nicely. And so we're in a better position now, especially in a post-Magellan transaction because of the free cash flow and actually limited amount of capital that it takes from that business to sustain that amount of cash flow. So the company is going to be really, really well positioned in the future for all forms of capital allocation.

And as you've been on the road post the announcement of the transaction and spoken to as many of your holders, what has the feedback been from investors on this acquisition? And has it changed over time since the original announcement?

Yes. Well, I think it's definitely changed. I think that when we originally announced the transaction, I don't think the marketplace clearly understood the interchangeability of these [indiscernible] pipes and the purity NGL pipes could be used for refined products. Clearly, as we've been able to get out and talk about the possibilities with these pipes, as opposed to even just the specific opportunities, the marketplace has embraced that and we've seen investors coming around where they understand batching and they understand blending and the opportunities that could give us. And I think we've seen that reflected in the performance of our stock. But initially at announcement, I think that we had some explaining to do, and we've done our best to try to get that clear to the market.

And from here until September 21, the vote date later this month, are there any remaining key milestones that we should be aware of?

No. We're in a position today where the votes are the -- are really the gating item at this point. We've gotten all of our federal approvals. Of course, there's always minor consents that happen from a legal standpoint when you're bringing together 2 companies. But the only gating real approvals that we need that would -- are conditions for closing are the unit holding vote and the shareholder vote.

And I want to give kudos to the Magellan executive team. They have taken the attitude from the very day one of this announcement, basically on Mother's Day of May 15, that they will not look back and say we should have done this or we should have done that. They've well talked through all that. They've got backup plans to everything. They've executed everything, in my opinion, just flawlessly to date. And so they have done a really great job and made a lot, a lot of headway there.

So turning to the base business, with second quarter earnings, you increased annual guidance for the year. What is driving your higher expectations?

Well, it's actually the performance of all the assets. We've got higher volumes in our gathering and processing business. We've got higher volumes in our NGL business. At the end of the day, we are a volume-based business. The commodity prices go up and down, but the product has to move in this country, whether or not it's coming from the supply side or the demand side. You got a little bit of storage if for some reason on the demand side that gets a little bit out of balance, and it's either on the gas side or even on the liquid side. But at the end of the day, we're about moving volume. That's exactly what we do. So the volume is really what's driving the outperformance. We've had upticks in our gas storage business because with the winter storms that we've had recently and, in particular, Uri, the value of storage is definitely being realized. It's always been strong in the natural gas distribution side, but you also are seeing that strengthening also on the electric side, where they might not have typically taken out storage during the winter. There's this extra demand. So there's competition from electric side and the gas side that's pushing those prices up on the value of storage.

Makes sense. And you also increased capital expenditure guidance for the year. Can you discuss the projects within that and time lines for completion?

Yes. So 2 of the big projects we have in there is obviously the Elk Creek expansion that we have coming on. And we've talked about that for a period of time, that we were not going to get caught short capacity coming out of the Bakken. And we continue to watch that, continue to monitor long lead time items and when we think we'll need it and we come to a point that it's now time to start buying those long lead time items, get them in a position, make sure that we have the capacity coming out of that. At this time, we haven't either discussed time line or cost on that, but you can be fair to say that it's going to be a very high-return project for us [ some time ]. The other big one we have is the West Texas pipeline expansion. When we bought the pipeline, the West Texas pipeline from Chevron in 2014, we put in a strategy that we would just start incrementally looping that pipeline with a 24-inch pipeline. So we could put a little bit of a loop in if we needed an extra 20,000 barrels a day. Put a little bit more loop in if we needed 30,000 barrels a day. So we kept doing that as we went along. We've come to a portion now that we really have to complete though which is do the hydraulics. So we have less than -- we have about 100 miles of pipeline left to put in the ground to complete that. And once we complete that, then overall, we'll more than double our capacity coming out of the Permian Basin at this time, where we've already secured contracts to give us a favorable return on that and that leaves us a tremendous amount of capacity still left for us to leverage or that we could go out there at very low prices to be able to secure more volume on the system. So we think that gives a very good competitive advantage out of the Permian at this time. And will -- but also gives, as we talk about Magellan, gives us the opportunity, we may be able to take the legacy system and move it into something else if we so desire. So it gives a lot of optionality around that in a very low hurdle rate to get [indiscernible]. So those are the 2 main projects that increased that capital.

Yes. And you had asked me earlier about the CapEx that was in the projections in the proxy. The West Texas expansion was actually in that capital that was in the proxy. So the only incremental capital that was adjusted from the proxy data was the expansion of Elk Creek. Both of those were new because -- from our guidance in February. We hadn't had them approved by the Board yet. But those are -- and you talk about large capital in the context of our usual builder, when we're doing long-haul pipes, these are very small projects, but they're the most meaningful that we've taken on here.

Understood. Related to the West Texas NGL pipeline projects, first, if you can quantify how much that that was either baked into the proxy or how much you expect at this point, that would be great. And also, if you can discuss the progress in -- or potential hurdles in contracting NGL volumes without that upstream use for gathering [indiscernible] assets?

Well, I'd say on the last question about being able to contract without gathering and processing, when we first bought that pipeline, we had about 110,000 barrels a day coming out of the Permian. Today, we are close to 300,000 barrels a day. So without any gathering or processing, we've tripled capacity come on over there. And part of the reason that we can do that is: one, we think we're a lower-cost provider to that, as I explained earlier; but also because we look at customers, we have a lot of customers in the Permian that are also our customers and Mid-Continent customers and the Powder River customers in the Bakken. So when we look at and propose a contract with them, we're looking at them in total, and we will be able to sometimes offer value in different areas that our competition can't, maybe in the Bakken, maybe in the Powder, to help us be competitive in the Permian. So that's how we've been able to grow up to this period of time. And that's how we've been able to secure the contracts that are going to support this expansion continuing to go forward on that.

So when you talk about the dollars, we haven't been specific about the dollars, but I would frame it up like this. It's only 100 miles of pipe. And as Sheridan just -- we're now moving about 300,000 barrels, pretty much at capacity. When we add this small loop, we'll be able to pick up the volume that he's contracted for that. But we will expand -- when we come off of that loop, we will have over 700,000 barrels a day of capacity out of the Permian. So we'll have effectively several hundred thousand barrels a day of capacity for free from this final looping. So it's going to put us in a fantastic competitive position.

Gives you the most efficient round out of the basin.

Understood. Going back to Saguaro, for that pipeline project, can you talk about the next steps to FID?

Yes. I think that at this point, we're, to some extent, waiting on a couple of things. One, our presidential permit is still outstanding. Everything is going right in line with plan and we'd expect that here time this fall. But probably more importantly, we're not going to go FID on a project until the overall project, the LNG facility itself, is FID. They have done a fantastic job commercially. They've got 3 majors that have contracted the capacity. So commercially, I think you can look at it as that project is pretty much done. So now they're out, I presume, to do their financing. And as that financing comes together, they'll be in a position to go to FID, and we'll see the project moving forward.

Great. And going to the gathering processing side of things, can you talk about your outlook on Bakken producer activity and what the recent conversations have been like for these customers?

Right now what we're seeing in the Bakken, there's enough rigs up in the Bakken and completion crews to grow crude oil production. When we kind of look at it, we kind of base everything off on flat crude oil production, in a flat crude oil production environment, we're still going to see growing natural gas due to the rising geo [ fault ]. But we -- with this rig count we have today, we'll see growing crude oil. So we'll see growing gas that's added as well. So we're very constructive about the volume up in the Bakken. And the last gas plant we put in there, we have some operational leverage up there to be able to grow without having spent a significant amount of capital. And with the Elk Creek expansion, we're going to be able to handle that as well. So we're -- the Bakken looks to be very strong going forward, especially in the environment that we're in today with enough rigs to grow production. And we get this -- also this growing production as we talk to the users up there. They, the ones that are there, there are a lot of the who's who on the E&P side, and they're committed to maintaining or growing their production up there at a very steady rate.

Great. And where are you seeing in terms of ethane recovery across your operations? And what are your expectations for the remainder of the year?

We're still in the same environment that we have been in for a period of time is that ethane and full recovery coming out of the Permian. The Mid-Continent is going to kind of go in and out right now in Mid-Continent and recovery for the most part, but that will come in and out. And then the Bakken is going to be a reduction unless we incentivize that thing. So that's really how we see it going forward. We probably do see for the rest of the year, we'll probably see the Mid-Continent in recovery [indiscernible] as we get a little bit of spike in gasoline and gas -- not gasoline, gas is weaker then too November, December time frame. Not much has changed on our outlook on a net recovery across their system.

Okay. And further downstream, what is your view on domestic petrochemical demand and also NGL export demand?

So on the petrochemical demand, they did have a period of time they were -- had a lot of product on hand, and they've been able to work that off. And so now we're seeing the domestic petrochemicals at a high utilization rate. You're seeing ethane prices kind of rise up a little bit for that, because that thing's still most favored feedstock go forward. We think that will continue and continue as we grow. We're actually seeing some of that exports coming around on the petrochemicals side as well. So we were very constructive of that, that they'll stay at a high operating rate as we go through this year into next year. We do have 1 unit coming on next year will give a little bit of added capacity to that [ but the other thing demand ]. From an export standpoint, we are at record exports right now. Every -- all the time, we are continuing to export more NGLs over the country, and I think that's going to continue to happen as we continue to go forward. There are a couple of expansion of products are going to come on and they're going to be needed up here in the next few years. That's going to be needed, and we will have the NGLs to continue to feed that. So that's where we think all the incremental NGLs are going to go is going to be exported. We're still very constructive on [indiscernible] full for an extended period of time.

And finally, on the fractionation piece. So since the loss of Medford, you have been utilizing that third-party fractionation. What's your outlook for continued third-party fractionation [ come off ] and for next year?

I think we said in the earnings call that right now about $30 million a quarter is roughly where we're going to be at going forward. That -- A little bit, that could be driven up just a little bit if we have continued to see growth in NGLs as we continue, which would be a good thing because what we're -- the fees we're collecting are higher than our third-party fractionation cost. But there's more fracs coming on here later this year and into the second part of 2023 and the first quarter of 2024, there's more fracs coming online. So we think that external frac market, we'll be able to favorably contract what we need to have contracted in 2024. Where we are right now with 2024 third-party frac costs, we're at a comfortable level of what we have contracted. So we feel we would be in a good spot, but that's already been put to bed. There's still a little bit left that we could contract. We just want to see how things are going to go through the rest of the year. So that's how we see the frac market.

Great. Thank you all very much.

Thank you, Theresa.

Thank you, Theresa.