Bridge Over Troubled Water - Pipeline Commitments Key To Enbridge's Strategy

The energy industry in North America is in crisis. COVID-19 remains a remarkably potent force, stifling a genuine rebound in demand for crude oil and refined products — and the broader U.S. economy. Oil prices have sagged south of $40/bbl, slowing drilling-and-completion activity to a crawl and imperiling the viability of many producers. The outlook for natural gas isn’t much better: anemic global demand for LNG is dragging down U.S. natural gas prices — and gas producers. The midstream sector isn’t immune to all this negativity. Lower production volumes mean lower flows on pipelines, less gas processing, less fractionation, and fewer export opportunities. But one major midstreamer, Enbridge Inc., made a prescient decision almost three years ago to significantly reduce its exposure to the vagaries of energy markets, and stands to emerge from the current hard times in good shape –– assuming, that is, that it can clear the major regulatory challenges it still faces. Today, we preview our new Spotlight report on the Calgary, AB-based midstream giant, Enbridge, which plans to de-risk its business model.

Spotlight is a joint venture of RBN Energy and East Daley Capital Advisors. With the support of Oil & Gas Financial Analytics, Spotlight reports provide “deep dives” into the fundamentals that shape the outlook for midstream energy companies and are included as part of our Drill Down report series, which is available to RBN Backstage Pass members. Spotlight should not be viewed as investment advice.

“No risk, no reward.” It’s one of the oldest business adages out there, and there’s a lot of truth in it. But in a time of pandemic, demand destruction, production shut-ins, and capex cutbacks, there’s also a lot to be said for minimizing your company’s exposure to commodity price volatility, supply/demand imbalances, and the other market ups and downs faced by many energy industry players. The midstream sector, with its fee-based business model and contract protections such as minimum volume commitments, is generally less exposed to the industry’s scariest volatility than producers, oilfield service companies, and refineries, but even midstreamers face varying degrees of risk, depending on the particulars of their assets and their business structure. For evidence, consider Enbridge, North America’s largest energy infrastructure firm, which since December 2017 has been implementing a defensive strategy to minimize its exposure to commodity price risk and ramp up its reliance on long-term, fixed-price contracts.

There’s good reason for Enbridge to be cognizant of the risk. The company’s largest asset by far — the 2.9-MMbbl Mainline System (orange line in Figure 1), which transports heavy oil, light oil, and LPG from Western Canada to the U.S. Midwest and points beyond — allocates space on a monthly basis, with no long-term contracts. That wasn’t a big problem in recent years. After all, Western Canadian production was on the rise; the region was experiencing major takeaway constraints, resulting in extensive use of crude by rail; and the Mainline System was running 100%-full and its operators were forced to apportion space on its many pipeline elements. But COVID-related demand destruction, lower oil prices, and other factors led to a big pullback in oil-sands production this past spring, and suddenly Mainline was running considerably less than full — at only 82% of capacity in June, in fact — and Enbridge was earning less from the system than it had been banking on.

Figure 1. Enbridge’s Mainline System and Other Selected Pipelines. Source: RBN

There’s no way that Enbridge’s management could have anticipated the pandemic, of course — how could they? But fortunately, the company undertook a comprehensive strategic review three years ago and came to the conclusion that it should reduce its risk profile and take a number of other steps to ensure more consistent and robust financial results going forward. The headline goal of the program — details of which are discussed in the new Spotlight report — was transitioning the company’s asset mix into a pure regulated pipeline and utility model with three core businesses: Liquids Pipelines & Terminals, Gas Transmission & Storage, and Gas Utilities. Enbridge also will maintain a foothold in renewable energy by continuing to invest in European offshore wind projects. The strategic repositioning meant the company would seek to raise C$10 billion by divesting its midstream gas gathering and processing assets, which had higher volume and commodity price risk exposure, along with certain North American onshore wind projects. It also involved exiting certain North American onshore projects that offered fewer long-term power purchase agreements, as well as simplifying Enbridge’s corporate structure by absorbing a master limited partnership (MLP) that the company had taken on as part of its acquisition of Spectra Energy.

The company’s plan has already demonstrated some success. In contrast with most energy companies, Enbridge did not significantly revise its capital and operating plans in response to COVID-19. Enbridge was one of only three midstreamers to maintain its pre-pandemic 2020 EBITDA and distributable cash flow (DCF) per share guidance. The company also sustained its forecast of 5-7% annual DCF/share growth: 1-2% based on revenue escalators, cost efficiencies, and system optimizations, and 4-5% from completion of C$11 billion in capital projects expected to add C$2.5 billion in EBITDA. Underpinning this guidance are solid returns from the regulated Gas Transmission segment, where only 1% of EBITDA is exposed to commodity prices; the regulated Gas Distribution & Storage utility; and expanding renewable energy assets. Enbridge also expects Mainline pipeline volumes, which fell by 400 Mb/d in the second quarter of 2020 because of the pandemic, to recover through the second half of the year and return to normal in 2021. The company’s potential challenges are centered on its Liquids Pipeline segment, which is expected to contribute approximately 50%-60% of total company adjusted EBITDA in 2020-23.

Notably, a crucial step in Enbridge’s strategic transformation to a pure regulated pipeline/utility company relates to its Mainline System. As we said earlier, Mainline is the primary transporter of crude oil out of Western Canada. It also connects with other pipelines such as Line 9, the Southern Access Extension, Spearhead, Flanagan South, and Seaway that shuttle supplies to refineries and other customers in the U.S. Midwest, Northeast, and Gulf Coast, as well as Ontario and Quebec. In contrast with Enbridge’s natural gas pipelines, which carry volumes under long-term contracts, the Mainline system has been governed under a Competitive Toll Settlement (CTS), which regulates fees but does not require shippers to commit to certain volumes. Instead, shippers nominate volumes monthly and Enbridge allocates capacity. (We blogged about this issue specifically recently in Push Comes to Shove.) In December 2019, Enbridge filed an application with the Canada Energy Regulator (CER) to implement a new service-and-tolling framework for the Mainline on the later of the July 1, 2021, expiration of the CTS agreement or the completion date of the Mainline’s Line 3 Replacement Project. This plan would allocate as much as 90% of the capacity on Mainline to shippers that enter into eight-to-20-year contracts via an open season; the remaining 10% would be set aside for spot shipments.

While the transition fits with Enbridge’s strategic goal of becoming a pure regulated pipeline company, the major benefit of long-term contracts would be protection against volumes — especially heavy oil volumes — switching to two planned export pipelines, namely, the government of Canada’s 590-Mb/d Trans Mountain Expansion (TMX) project from Alberta to the Vancouver, BC, area (dashed purple line in Figure 1) and TC Energy’s planned 830-Mb/d Keystone XL pipeline from Alberta to the U.S. Mid-Continent (dashed green line).

There’s a big unknown, though, namely whether the CER will give timely approval to Enbridge’s proposal to convert the Mainline from a system that is uncommitted month-to-month to one that is 90%-committed over the long term. Enbridge has received strong support from refiners and integrated oil companies who account for about 70% of volumes on the Mainline; these shippers are interested in the supply certainty that comes from multi-year contracts as well as low transportation fees that would rise annually by only two-thirds of the general inflation rate. On the other hand, producers that would benefit from potentially lower tolls from competition from TMX and Keystone XL are interested in stalling or defeating the proposal. A CER hearing on the matter has been scheduled for April 2021, but Enbridge concedes that the process will likely extend past the current July 2021 CTS expiration. It is preparing to continue to operate under the CTS on a month-by-month basis until a final decision is made. The question is, will the regulatory process drag on so long that some shippers will be siphoned off by TMX and Keystone XL? Also, what if the CER rejects Enbridge’s plan?

Enbridge faces a few other unknowns as well, including how soon it will secure final regulatory approval for the Minnesota portion of the Line 3 Replacement Project (see Canadian Pipedream). The company’s projected 2020-22 growth is driven by a 24% increase in Liquid Pipelines adjusted EBITDA accelerated by the completion of the C$8.2 billion Line 3 project, which we anticipate will be fully functional in late 2021 if it receives Minnesota regulatory approval of the final uncompleted leg.

And there’s more. Questions remain as to whether critics of the Mainline’s Line 5 pipeline across Michigan’s upper and lower peninsulas will succeed in their long-running effort to shut that pipe down (see I’ve Got to Have You). Just last week, it was announced that Enbridge will restart the east segment of Line 5 in the Straits of Mackinac after receiving authorization from the Pipeline and Hazardous Materials Safety Administration (PHMSA).

The newly released Spotlight report addresses these issues and more surrounding Enbridge, and includes a forecast of the future performance of Enbridge’s Liquids Pipeline segment considering the regulatory challenges it faces, as well as the outlook for North American crude oil infrastructure. We also delve into the individual pipeline performance of Enbridge’s liquids and gas pipelines, including, among others, Athabasca, Spearhead, Seaway, and Flannagan South. For more information on the report, click here.

"Bridge Over Troubled Water" was written by Paul Simon, and appears as the first song on Simon & Garfunkel's fifth and final studio album of the same name. The song’s vocals were recorded in November 1969 at Columbia Studio B and E in New York City in November 1969, and the instrumentation was recorded the same month at CBS Columbia Square in Los Angeles. Paul Simon says the tune was written over a very short amount of time. Released as the second single from the album in January 1970, the song went to #1 on the Billboard Hot 100 Singles chart. It would become the biggest hit single for the duo of their career. The song won five Grammy Awards in 1971, including Record of the Year and Song of the Year. It has been covered by more than 50 artists, and has been certified Gold by the Recording Industry Association of America (RIAA). Personnel on the record were: Art Garfunkel (lead vocals), Paul Simon (backing vocals, acoustic guitar), Larry Knechtel (piano), Hal Blaine (drums), Joe Osborn (bass), Fred Carter Jr. (electric guitar), Gary Coleman (vibraphone), and Jimmie Haskell and Ernie Freeman (strings).

The album Bridge Over Troubled Water was produced by Paul Simon, Art Garfunkel, and Roy Halee. Released in January 1970, it went to #1 on the Billboard Top 200 Albums chart, and has been certified 8X Platinum by the RIAA. Four singles were released from the LP. A 72-minute documentary about the making of the album, The Harmony Game, was released in 2011.

Simon & Garfunkel are an American folk-rock duo formed in New York City in 1957, when they went under the name Tom & Jerry. They started using their real names when they signed a record deal with Columbia Records in 1963. The duo officially broke up in 1970, after releasing Bridge Over Troubled Water, the most successful record of their career. They have sold more than 100 million records worldwide and have released five studio albums, four live albums, one soundtrack album, 13 compilation albums, one EP, and 26 singles. Simon & Garfunkel have won one Brit Award, nine Grammy Awards, four Grammy Hall of Fame Awards, and a Grammy Lifetime Achievement Award. They were inducted into the Rock and Roll Hall of Fame in 1990. Both artists have gone on to successful solo paths since the duo's breakup, Garfunkel as a solo music artist and actor, and Simon as a music artist. They reunited for a tour in 2009, and a one-off concert at the New Orleans Jazz & Heritage Festival in 2010, but have not worked together since. Simon retired from performing in 2018.