Source: Seeking Alpha, July 8, 2020
The energy sector is a highly competitive, dog-eat-dog business. The fallout from a new judicial order compelling the closure of the Dakota Access Pipeline (DAPL) shows how one company’s loss can often be the catalyst for another company’s gain.
On July 6, a federal judge ordered DAPL to shut down by August 6 due to an inadequate environmental impact statement (EIS) conducted during the permit process. The U.S. District Court for the District of Columbia vacated the U.S. Army Corps of Engineers’ (Corps) grant of an easement to DAPL and ordered the pipeline shut within 30 days.
DAPL, owned and operated by Energy Transfer Partners (ET) with additional interests from Enbridge (ENB), Phillips 66 (PSX) and Marathon Petroleum (MPC), is the largest pipeline running out of North Dakota’s Bakken shale in the Williston basin. It has capacity to ship 570,000 barrels per day (570 Mb/d) of crude to its endpoint in Patoka, Illinois, where volumes are then transported to Nederland, Texas, via the Energy Transfer Crude Oil Pipeline (ETCOP).
ET is expected to fight the court ruling, but a federal judge on Tuesday denied ET’s initial request to stay the ruling. Assuming the order stands, downtime for DAPL is estimated to last for at least a year, and potentially much longer.
According to the ruling, DAPL shall remain idled until the Corps provides an EIS for the pipeline that meets the requirements set forth by the National Environmental Policy Act. The Corps has given a preliminary timeline of approximately 13 months to provide the EIS for DAPL. There is additional risk that the process could take longer than the Corps’ proposed timeline, considering the mean time to complete an EIS is 3.6 years across all federal agencies, according to the ruling.
As the DAPL owner and operator, ET would take the most direct hit from the pipeline’s closure. We estimate shutting down DAPL from August 2020 to August 2021 would erase ~$404 million from ET’s consolidated FY2020 EBITDA and ~$523 million from its FY2021 earnings. Furthermore, ET’s assets further downstream, including its Nederland oil terminal and Bayou Bridge pipeline connecting the Houston area to Louisiana, would also be impacted by lower throughput.
Beyond ET, the impacts of the DAPL pipeline closure will ripple far and wide among companies operating in the Williston basin and several other downstream crude markets.
Leading producers of Bakken oil, including Continental Resources (CLR), Whiting Petroleum (WLL) and Hess Corp. (HES), are set to face pipeline constraints and lower realized oil prices if DAPL is shut. Remote North Dakota is one of the most expensive places to produce crude due to the high cost to transport supplies to downstream markets. Bakken crude primarily moves south to the Cushing, Oklahoma storage complex via the Guernsey hub in Wyoming, to Gulf Coast refineries, or to refineries and pipelines based in the Rockies and Patoka, Illinois.
ET brought DAPL on-line in 2Q2017 to provide a more economic outlet for Bakken crude shippers, in the process displacing a significant chunk of crude barrels that left the Williston basin via rail cars. DAPL shipped 570 Mb/d in 1Q2020 from North Dakota to Patoka accounting for 38% of Bakken crude demand, by far the highest for any single outlet in the region. Other pipelines moving Bakken crude from the basin collectively shipped 516 Mb/d in 1Q2020, leaving only 186 Mb/d of unutilized egress capacity.
The recent collapse in oil prices has forced producers to shut in wells and cut rig activity, which we estimate will drop Bakken oil production ~357 Mb/d lower in August compared to 1Q2020. Nevertheless, Bakken crude will still be massively constrained if DAPL is shut, forcing more crude shipments via railcar.
In order to incentivize crude transport via rail, we estimate crude prices within the Williston basin will need to trade at a ~$10/bbl discount to Brent to cover the variable costs of rail transport. With the forward Brent-WTI Cushing spread averaging only ~$3/bbl over the next year, Bakken crude prices would need to fall an additional $7/bbl below Cushing in order to clear the market.
While a negative development for Bakken producers, there are several winners in this new market dynamic. Crude pipelines that compete with DAPL for services out of the Williston basin, including systems operated by Kinder Morgan (KMI), Tallgrass Energy (TGE) and ENB, will be of more value to shippers and should see meaningful revenue and earnings bumps during the DAPL outage.
The estimated $7/bbl discount to WTI is akin to the additional value for rights to ship Bakken crude to Cushing on other pipelines were DAPL taken off-line. The $7/bbl value is materially higher than the $4.35/bbl Bakken-to-Cushing joint tariff offered by KMI’s Double H and TGE’s Pony Express pipelines in late 2019. Current incentive rates on Cushing-bound routes from the Bakken are also generally under $7/bbl, indicating pipelines could capture upside from higher tariffs for spot volumes without DAPL as competition. Some shippers may even be willing to sign up for longer-term contracts in order to ensure firm pipeline takeaway, making it more difficult for DAPL to recover non-committed volumes upon re-entering service.
There will also be residual impacts on other downstream pipelines resulting from a DAPL closure. The Guernsey crude hub in Wyoming is likely to see the largest bump in inbound supply from the Bakken, as pipelines owned by True Companies and KMI (Butte, Belle Fourche, and Double H) are forecasted to bring 103 Mb/d of additional crude to the Powder River than originally forecasted.
The Guernsey hub has numerous connecting pipelines that feed refineries in the Rockies, as well as the Cushing, OK and Patoka, IL market areas. Due to downstream constraints on lines that supply refineries, most incremental crude from Guernsey will likely be transported to Oklahoma and Illinois by TGE’s Pony Express pipeline and Enbridge’s Platte pipeline. Given the 103 Mb/d of additional supply, both pipelines are expected to max out their receipt capacity at Guernsey, creating pipeline constraints and regional price discounts at that hub as well.
While a DAPL shutdown is a clear benefit to pipelines with takeaway from Bakken and Guernsey, the outlook is somewhat mixed for deliveries to the Midwest at Patoka. DAPL’s sister pipeline, ETCOP, will likely be negatively impacted by a DAPL closure, as most of ETCOP’s 431 Mb/d of volumes in 1Q2020 came from deliveries through DAPL. However, there is some upside available for ENB’s Spearhead and Flanagan South pipelines that provide capacity from Illinois to Cushing and are in line to obtain incremental Bakken receipts via ENB’s wholly owned North Dakota and Bakken Line systems.
The U.S. District Court’s decision has wide-ranging consequences for North America’s crude markets and the midstream operators that connect them. The impact of unexpected market events like the DAPL ruling creates both winners and losers in energy markets. If DAPL is ultimately idled for an extended period, the value of competing crude egress out of the Bakken and Guernsey markets will increase meaningfully, and a few pipeline operators, including ENB, KMI, True Companies, and TGE, will reap the majority of the benefits.