Plains All American Pipeline, L.P. (PAA) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Plains All American Premium Basin JV Conference Call. [Operator Instructions] Please be advised that today's conference may be recorded. [Operator Instructions] I would now like to hand the conference over to your host today, Roy Lamoreaux. Please go ahead.

Thank you, Sara. Good morning, and thank you for joining us to discuss the Plains and Oryx Permian Basin joint venture announcement. Accompanying slides for this call are posted within the conference call section of PAA and PAGP's Investor Relations website. An audio replay and transcript of today's call will also be posted to our site as each become available. Important disclosures regarding forward-looking statements and non-GAAP financial measures are provided on Slide 2 of today's presentation. Today's call will be hosted by Willie Chiang, Chairman and CEO; Jeremy Goebel, Executive Vice President and Chief Commercial Officer; and Chris Chandler, Executive Vice President and Chief Operating Officer. Additionally, other members of our executive team are available for the Q&A portion of today's call, including Harry Pefanis, President; Al Swanson, Executive Vice President and Chief Financial Officer; and Chris Herbold, Senior Vice President and Chief Accounting Officer. Before turning the call over to Willie, I want to mention that today's announcement will be the focus of our call this morning. We plan to address any other topics in our second quarter earnings conference call scheduled for Tuesday, August 3. Additionally, given that the joint venture is yet to close, we'll be somewhat limited in our discussion and plan to keep our call relatively brief this morning. With that, I'll turn the call over to Willie.

Thanks, Roy. Good morning, everyone. We appreciate you joining us this morning to discuss this very positive announcement for Plains, Oryx and our Permian Basin customers. As we highlighted in our press release, we have signed a definitive agreement, whereby Plains and Oryx plan to form a 65%, 35% joint venture of our assets within the Permian Basin. This transaction aligns with our multi-decade business model of optimizing critical energy infrastructure by improving connectivity, repurposing assets, redirecting flows and integrating newly constructed capacity within our existing systems. It's through consistent execution of this strategy over the past 30 years that we have developed 1 of the premier crude oil midstream platforms in North America. Over the last few years, we have discussed the need to further optimize Permian midstream infrastructure to enhance interconnectivity and efficiency. This transaction represents a very positive step in that direction, and we are very pleased to partner with Brett Wiggs, Oryx's CEO; Carl Flower, Oryx's President and the entire Oryx team to enhance our capabilities to benefit our customers and our stakeholders. Plains will serve as the operator of this strategic joint venture, and the joint venture will be consolidated on Plains financial statements with the combined JV representing approximately 30% of our pro forma 2020 book value of total assets. The JV entity structure offers a durable economic platform that's attractive to Plains and Oryx in any reasonable oil price environment and Permian production level. As Jeremy will discuss, we've worked collaboratively with the Oryx team to develop an innovative debt-free entity in a cashless transaction that aligns our financial and portfolio optimization strategies. The tiered distribution sharing agreement was key to unlocking this JV opportunity as it helps facilitate the debt-free asset contribution. We expect the JV to be near-term free cash flow accretive for each of the partners reinforcing Plain's ability to maximize free cash flow to the benefit of our balance sheet and equity holders. Before turning the call over to Jeremy, I would mention that we continue to believe that the Permian is a world-class resource positioned to grow crude oil production more than any other major crude oil basin within North America for the foreseeable future. This strategic JV will position the combined system to deliver optimal service for our customers while unlocking efficiencies that will benefit both customers and the joint venture partners. With that, I'll hand the call over to Jeremy.

Thanks, Willie. Let me echo how pleased we are to work with Oryx to take our combined systems to the next level for our customers and also to thank them for the role they played in creating this innovative JV structure. As summarized on Slide 3, the transaction includes all of Oryx's Permian Basin assets and with the exception of Plain's long-haul pipeline systems and certain of our intra-basin terminal assets, the vast majority of Plains Permian assets. These assets are being merged through a cashless transaction into a newly formed debt-free JV entity. The JV will be owned 65% PAA, 35% ORYX with the overall split generally reflecting the partner's relative contributions based on a number of factors, including current and expected free cash flow had current Permian activity levels and relative drilling inventories contracted to each system. Plains will serve as the operator of the JV assets and a joint operating committee will be in place that includes representatives from both Plains and Oryx to provide oversight on material JV operating and commercial decisions. Additionally, voting rights will be consistent with the partner's ownership levels and 100% of the JV's activities will be consolidated into PAA's reporting financial results. To that end, let's move to Slide 4, which is complemented by tabular data on Slide 5. Aligning on our Permian assets and capabilities with Oryx enables the combined JV system to be operated more effectively and efficiently, meaningfully enhancing the capabilities of our collective system. The flexibility and value it creates for our customers and the quality of planes and Oryx long-term free cash flow. Plains value proposition to customers centers on our operating and commercial capabilities, specifically large-scale supply aggregation, quality segregation, flow assurance and direct downstream connectivity to multiple markets. As illustrated on Slides 4 and 5, the JV expands upon these operating capabilities, enabling both Oryx's and Plains existing customers, increased connectivity and operational flexibility and additional access to all major Permian intra-basin supply and takeaway hubs, most notably, Wink, Midland, Crane and McCamey and by extension, access to all available downstream markets. New or enhanced connectivity for the respective systems are highlighted in yellow and purple on Slide 5. In short, this system will provide exceptional levels of optionality and market access to our combined customer base. Additionally, as you can see from the tabular data provided on Slide 5, the JV diversifies and enhances the quality of Plains and Oryx's long-term free cash flow profile through a variety of complementary attributes. This expands our collective portfolio of high-quality, long-term committed acreage, which in both the Delaware and Midland Basins is underpinned by drilling activity at current rig counts with an average life of 30-plus years with the vast majority of drilling locations having projected IRRs of 25 to 50 or even higher percentages at $50 WTI. Notably, the JV extends Plains weighted average gathering system contract tenor gives Plains the opportunity to serve additional high-quality private producers and further reduces Plains relatively modest exposure to federal lands. Moving to Slide 6. The JV entity free cash flow available for quarterly distributions will for each year be subject to a tiered modified sharing agreement, or MSA, for up to 10 years. Please note that all references to free cash flow are net of investment and maintenance capital expenditures, consistent with how we have previously defined it. As illustrated on this slide, the MSA's initial tier is designed to facilitate Oryx required refinancing at its equity owner level of its current operating level financing, which is a condition to closing. The MSA subsequent tiers are designed to true-up distributions consistent with overall ownership percentages and provide planes with potential upside so long as the MSA remains in effect. For context, excluding synergies, pro forma 2021 JV adjusted EBITDA and free cash flow is forecasted to be approximately 800 million and 625 million, respectively, which is well within the Tier 3 distribution level. Notably, this does not include approximately 50 million of synergies, 8 days to the JV, which we expect to capture on a run rate basis within 12 months, which could increase to 100 million or more over time through additional integration and optimization opportunities. And not to mention meaningful leverage to Permian production growth. With that, I'll hand it over to Chris to discuss the integration plans and optimization opportunities.

Thanks, Jeremy. With this transaction, on a combined basis, we will integrate roughly 5,500 miles of pipeline assets and related storage capacity and importantly, our people and systems. I would like to complement Oryx on the outstanding system they have developed and a strong operational reputation they have earned through the years. We have extensively reviewed Oryx's assets designed with specifications, operations, in addition to maintenance and integrity program to ensure a seamless transition, while ensuring alignment with our HSE standards, sustainability program and ESG improvement activities. One of the tools we have successfully employed during our history of optimizing assets has been the formation of strategic JVs to create long-term strategic value with industry partners to better serve our customers. As Jeremy illustrated, the work shippers will quickly gain connectivity to an expansive Permian header system and by extension additional downstream pipelines, including Plains' assets that service intra-basin, Mid-Continent, Gulf Coast and export markets. In turn, one of the synergies includes Plains being able to eliminate a currently scheduled capital project and instead use the Oryx infrastructure to improve access for our shippers to key delivery points in West Texas. Additionally, we have pinpointed multiple other opportunities to generate synergies through the optimization of our combined operations including operating and G&A costs as well as other investment and maintenance capital allocation opportunities. Examples of this include capital savings via well connect optimization, such as building from the system that is closest to the producers, in addition to power optimization, increased scale to more effectively manage crude oil quality segregations and commercial opportunities stemming from a more diverse set of shippers, customers and increased scale and efficiency. Importantly, we expect that optimizing our combined system will enable us to further reduce our collective environmental footprint and greenhouse gas emissions. We are happy to discuss these and other items further in Q&A. But for now, I will hand the call back over to Willie.

Thanks, Chris. Well, today's announcement represents another meaningful step in the continued execution of our long-term strategy and our ongoing effort to optimize all aspects of our business. In the near term, the JV positions Plains to increase the optionality and the flexibility for our customers while capturing synergies and integration opportunities. Longer term, as the Permian enters another multiyear period of growth, the JV's combined asset base will allow additional optimization opportunities and utilizing the -- and utilize the operating leverage within the expanded and integrated system. In conclusion, we are very pleased to announce this today, and we thank you for your investment in and support of Plains, and we look forward to providing you with additional updates on our second quarter earnings conference call in August. With that, I'll turn the call over to Roy to lead us into Q&A.

Thanks, Willie. [Operator Instructions] I'll reiterate that we plan for the Q&A to focus on our announcement, which, as a reminder, remains subject to regulatory approval and certain closing conditions. As a result, we will be fairly limited in the level of detail we plan to share beyond what was discussed within our prepared commentary and slide presentation. As mentioned previously, we plan to defer questions unrelated to today's announcement for our second quarter earnings call in August. Additionally, our Investor Relations team plans to be available throughout the week to address additional questions. Sara, we're now ready to open the call for questions.

[Operator Instructions] Our first question comes from the line of Shneur Gershuni with UBS.

Maybe to start off, I was wondering if we can sort of focus on the strategic nature of this combination. I guess I'm trying to understand the strategic nature in general. So I think we all understand the benefits of the $50 million to $100 million of synergies. But I was just wondering if you can sort of talk about what I think is a twin strategic benefit. Is it really the way that I think about it is that it's kind of an optimization of your gathering assets, which historically has been very competitive? And then secondly, as I sort of look at Slide 10, the second benefit is it opens up the door for more Oryx volumes to potentially come on to the Plains takeaway system. Just sort of wondering if you can talk about like the strategic nature outside of the $50 million to $100 million of synergy.

Sure, Shneur. This is Willie. I think we've been pretty vocal about the need for optimization in the basin. Again, just reinforcing kind of the strategy. The sector has been in a significant growth mode over a period of time. We were already shifting into what I would call efficiency model. You've heard me speak about it that way. As capacity was a lot of capacity was being built. And when you think about the demand impact with COVID, it kind of reset the entire production structure of the Permian. So this transaction, this -- the strategic joint venture really is -- meets the need of that, right? You've got a lot of assets. We've all been optimizing within our own systems. There's broader optimization that can happen. And I think you hit it on the head. If you look at Slide 5 and some of the slides in the appendix, you can really see the connectivity improvement that it makes. And again, back to flexibility for the shippers, being able to get to different markets optimizing the systems, we've done a lot of that in-house. And as we think about the opportunities to continue to do that across the entire Permian Basin, we think it's a very, very strategic opportunity for us to chase.

Great. Perfect. And maybe just one follow-up. Just given the peer payout structure, I just kind of want to understand the philosophy about payouts from the JV. Given that there's no debt and free cash flow is basically populated post CapEx, is it fair to assume that the partnership will distribute its free cash flow every year as kind of a general practice or would there ever be reasons to retain cash inside the JV?

It's certainly the intent to distribute cash flow and the structure is really designed. If you think about the -- if you look back like slide, I think it is 6. You can see the Tier 1 and Tier 2 structure is really there to protect the cash flow stream to Oryx in a low case at $428 million, you go into the Tier 3, which is the 65-35 split. And as we've disclosed, if you look at the free cash flow, reinforces free cash flow has been a term that we've been using a lot. We expect the 2020 numbers to be $625 million. So you can see we're clearly into the Tier 3 levels.

And Shneur, just to add on to that, it's -- that's excluding synergies and the structure is there. One, it was part of the consideration for their financing part of the consideration for them going from an operator to a minority interest and it provides playing some upside as well. So it was part of the negotiation, it was important to the counterparty, and we worked through it to get it there. But if you look -- if you take the 2021 or at $625 million you layer in a 12-month run rate of $50 million of synergies exclude any potential growth in the Permian Basin and you're well within the Tier 3 structure.

And Shneur, there is a requirement to distribute all the cash on an annual basis.

Our next question comes from the line of Jeremy Tonet with JPMorgan.

I just wanted to kind of pick up on the deal, I guess, maybe on the heels of what you're discussing there with the type of the structure, why it was set up with these breakpoints. But also, the bigger question is, what led up to this transaction, why now? What is Oryx's I guess, long-term outlook here? And it seems that the sharing arrangement is kind of tilted towards Plains. So I'm just wondering if that -- if that feeds into the whole dynamic of what's coming together here?

Well, I wouldn't think about -- Jeremy, I wouldn't think about it as how it's -- who it leans towards. I mean I can assure you that -- yes.

I just meant the top tier it gets higher for Plains. Sorry?

I got you. Yes, I think the best way to describe this is the structure was really the way that we opened up the discussion to be able to get to a point which made sense. And our expectation is we're going to be in that tier 3 range for quite some time. But the strategic rationale behind this, you've got the tiered structure there was really everything we've already talked about, and I think the opportunities, and I'll complement works on this the ability to think beyond just an immediate transaction, but how do you build a stronger enterprise for our customers, ultimately.

Got it. And I guess, for Oryx, is this kind of a long-term strategy for them? Is there terms of like exit a ROFR or anything like that? Just trying to get a feel for how that would look in the future? And also, what brought about the JV now versus any points in the future in the past?

Well, we can't speak for Oryx on what their long-term strategy is or their sponsor, but this is really set up to be a permanent structure going forward. You can see the term of the MSA, and there are some clauses in there. If either party wanted needed to do something, there's a governance structure that allows a discussion on how to do that. There's a modified ROFO process if Oryx wanted to monetize and Plains had the desire to make an offer on it. And then on Plains size, there's some tag-along rights if we were to do something and Oryx could participate in a piece of it so. But I would think about it as really a permit structure going forward.

Our next question comes from the line of Tristan Richardson with Truist Securities.

I appreciate all the comments. One quick 1 just on the strategic rationale. When it comes to the incremental long-haul opportunity for Plains. Is there a way you can give us a sense of that there? Or in other words, how much of Oryx's volumes today go on to third-party long haul that presumably over time could potentially move on to Plains system?

Yes, Tristan, we don't want to get into discussions of different contracts and where the volumes are going. But what I would tell you is we structure this is -- as you saw in the announcement, this really does not include any of Plains' long-haul systems. If you think about the system, it's really at the outlet flange of what we would call some of these intra-basin hubs. So the synergy capture that we've got takes that into consideration. Further down the road as there's opportunities and you have a broader system, there's more opportunities and optimization opportunities. But the synergy calculations that we've done really just includes what's within the realm of the JV.

Okay. And then what's the best metric to use to compare the pro forma JV with maybe Plains' gathering and intra-basin operations today. I mean I think the 6.8 million barrels of capacity is really helpful but is there plans gathering and intra-basin EBITDA that you're willing to share versus maybe the 800 of expected JV EBITDA. Anything to compare the JV versus Plains the existing business today would be helpful.

Yes. Tristan, take a look at Slide 5. I think that's probably the best slide to go from. And what we've done is we've put all the metrics down and given a pro forma for the JV. But as we think about it, really what's written in the box, if you think about it, it's cash flow, and we share the respective cash flows for 2021 free cash flow. PAA is $425 million. Oryx is approximately $200 million. That gets you to the $625 million of free cash flow. But as we think about it as cash flow not only this year, but over the 5-year period that we look forward, and it's the core drilling inventory that each party brings to the JV. And both of those are roughly 65-35. The other metrics are there, but I would tell you they're probably not as key as far as how you think about the JV split. And then clearly, what helps us, you can see the diversity of the shippers and combining the 2 together really gives for Plains, I'll speak for Plains, it extends the tenure of our contract life. There's a nice balance between the regions that we operate in. We're a bit stronger in the Northern Delaware. They have been stronger in the Southern Delaware. And when you think about public versus private, there's some benefits there as well.

Our next question comes from the line of Michael Blum with Wells Fargo.

I just want to make sure I understand the MSA tiering arrangement. Because I think you -- because, I think you made a comment that it protects Oryx the downside. So I'm trying to reconcile that statement with the Tier 2. I understand Tier 1, clearly, that does, but Tier 2, it seems like there could be a situation where Oryx has no -- Oryx gets no cash flow and yet they have all the debt. So I'm just trying to understand how that would play out. And I guess the follow-on to that would be if some situation probably unlikely that Oryx were to-go bankrupt, how -- what happens to the JV?

Yes. Let me start with that and Jeremy can jump in. If you just think about the tier structure, I would think about the Tier 1 as the protection for Oryx. And it's a 50-50 split. So Tier 2 really just catches the JV, catches us back up to 65%. That's the nature of the tiers. And then Jeremy, you want to take the other piece of this?

Sure. Michael, we don't want to speak on behalf of Oryx, but just recognize that any debt servicing would be well within side of their -- the first tier. And the second tier is just intended to be a catch-up. And don't think of this as annual distributions, this is quarterly distributions for a business. So it's not like they go to 0. It's just the amount that's distributed within the quarter. And as Willie has mentioned, we expect to be well within Tier 3 for a long time or approaching Tier 4. Like this is a business that we would expect to grow with the Permian. It's something that we're excited about. We have the synergy capture, which we've outlined, and the business performance today should be well above both those tiers. So it would just look like a 65-35 distribution on a quarterly basis.

Michael, if you just look again at the 428, the Tier 3, $625 million is what we expect 2021 pro forma to be. So you can see there's roughly a $200 million buffer between Tier 3 and going into Tier 2 or Tier 1.

Okay. Great. And then just another question for now is just, is it fair to say that the reason you didn't just buy Oryx is because of you didn't want to take on the debt load. Is that just the right way to think about it? Because obviously, it's -- the assets fit like a glove. I mean there's no really disputing that. So I just wanted to understand that piece of it.

Michael, clearly, you've heard our commitment to financial discipline, the balance sheet. And so that was a big key factor for us. And in my prepared comments, I talked about the discussions that we had, and this is really a nice way to be able to work together in service of our customers. But I think it would have also been difficult to get to a transaction at a valuation that we would have been wanted to be able to do.

Our last question comes from the line of Harry Mateer with Barclays.

I guess first question is can you guys just comment on rating agency discussions for Plains ahead of this deal and whether you think the transaction is consistent with your credit ratings goals along with your other financial priorities?

Yes, Harry. Absolutely, we've chatted with the -- with all 3 of our rating agencies. I won't speak for them. We certainly shared with them the virtues of the benefits of the transaction, but really won't speak for them on. We hope you see the virtues of it. And I think you're right as far as the credit -- improved the credit profiles of -- there's a lot of positive things that it does for Plains.

Okay. Okay. And then just to maybe put some sensitivities around this, I mean, at the depths of last year, maybe on a quarterly basis or annualized basis, I mean, how much EBITDA would this JV have done? Can you give us a sense for that?

I don't think we have those numbers -- those numbers aren't something we have that are ready to share. But I would I think about that $200 million that buffer that we just talked about, I think that probably gives you a pretty good buffer as far as where we think we'll be.

Willie, I'll just add that largely consistent with what you -- what the 2021 number is, I would say, it didn't get much below that on a run rate basis.

Okay. That's helpful. And then maybe just to close it out, are there any formal guardrails in place as part of the JV agreement to keep the JV debt free? Or is it just financial policy and obviously, plans as a majority of the voting rates, and we know your financial priorities?

The governance structure should cover that.

There are no further questions.

Listen, this is Willie. I just want to thank everyone for dialing in. I can't tell you how excited we are to go forward with this. Obviously, we expect to close in the fourth quarter. So there's a lot of work to be done on integration planning through the time. During this period, we still operate as separate companies. But again, back to the question that I think it was gave that brought up this is really a nice way, a debt-free cashless transaction for us to capture synergies and provide a better solution for producers in the Permian. So thank you very much for dialing in.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.