Magellan Midstream Partners, L.P. (NYSE:MMP) Wells Fargo Midstream, Utilities & Renewable Power Symposium December 7, 2022 8:40 AM ET
Company Participants
Aaron Milford – Chief Executive Officer
Conference Call Participants
Unidentified Analyst
Welcome, everybody. Michael [indiscernible] with Wells Fargo. If you don’t know me, welcome. We are very pleased to have Magellan Midstream Partners here with us this morning to kick us off. We’ve got Aaron Milford, CEO sitting right next to me and other management in crowd who don’t want to get up here. So, if there’s any hard questions, I’m sure he’ll be called upon. But this is a breakout session. So, it just meant for you all ask your questions. But if you don’t, I will. So, fair warning.
I think I’m going to turn it over to Aaron to start with a few opening remarks, and then we’ll open it up to Q&A.
Aaron Milford
Thank you, Michael, and we appreciate the opportunity to speak this morning. Thank you guys for being here early. It seems a little early and starting the day off, hopefully with a good session here.
What I’d like to start with is really make the big three main points about Magellan before we get into the Q&A. And the three main points are mainly meant to be thematic. And the first point I would make is at Magellan, we deliver crude oil, gasoline, diesel, jet fuel, all the fuels, frankly, that are necessary to run our economy. And we think those fuels are essential to having a functioning and efficient economy. So, that’s the first point. We’re essential.
Second point. We think we’re going to be essential for a really long time. Even with the backdrop of energy transition, electric vehicles, batteries, alternative fuels of all varieties, we think that transition is going to continue. But as it continues, we’re still going to be essential. We’re still going to need crude oil, gasoline and jet fuel to run our economy.
So, as that happens, we think that the demand for the fuels that we deliver are going to — is going to remain really steady for a really long time. And as the energy transition moves forward, whatever that may look like, we’re still going to be essential even out in 2050 because we’re still going to be needing the fuels that we deliver. So, we’re essential and the essential nature of what we do leads to a very steady demand profile we think, for a very long time.
You put those two things together, essential and steady, it generates an opportunity for us as a company to provide and earn discretionary free cash flow. And as we earn that discretionary free cash flow through time, we have the opportunity to allocate that capital in a way that we believe creates value for our unitholders and investors.
And if you think about that equation, we think that’s a very powerful equation through time, essential, steady cash flow generating. So, we’re very optimistic about what the next 30 to 40 years looks like. I know there’s probably more pessimism about our business, but we’re pretty optimistic, frankly. So, that’s the theme.
We’re optimistic because we’re essential, we think demand is going to be steady. And we’re going to be generating what we think will be a substantial amount of free cash flow through time that we get to allocate back to investors to create value. It’s really that simple. That’s the equation.
So with that, I’ll turn it back over to you.
Question-and-Answer Session
Q – Unidentified Analyst
Thank you for that, and we’re happy to take questions. So, one wants to be the — first question. All right. I guess it’s going to be me to start.
Aaron Milford
All right.
Unidentified Analyst
Since you start high level, maybe I will as well, I think it was a year ago, maybe or your last Analyst Day, where you spent quite a bit of time going through the EV scenarios and potential penetration rates and impacts to potentially to gasoline demand long term in the US. Has your thinking changed at all since that — since you put out that analysis? Have you seen anything in the market that would sort of push you one way or the other? I mean, I think since then, Russia invaded Ukraine, I mean some big geopolitical things have happened. On the other hand, it feels like every commercial I watch on TV for a car is in EV. So it feels like the industry — auto industry is really pushing EVs pretty aggressively right now. So, to get kind of your latest thoughts on that.
Aaron Milford
So the short answer to your question is, the perspective that we shared in April of this year at our Analyst Day that, energy transition will continue, but our opinion is that it will continue most likely at a much slower pace than what the average person may believe. It went into the reasons why we can do that here if there’s interest. And our overall perspective on that hasn’t changed. You’re right. There is a lot of marketing, a lot of headlines, a lot of energy behind EVs and their promotion. You’re seeing more of it, but I’m not sure that it’s a markedly different perspective or sort of pushed than what we’ve seen the last few years.
The question is really going to be, what is the actual adoption rate and what pace does that occur? It’s interesting when you look at EV ownership and adoption, I think what you hear is EV sales have doubled. Sure. They’ve doubled the 4% of the cars that are sold today. And I don’t mean that to be dismissive of EVs and folks that like them and want them. I don’t mean that. But the penetration is still, we think, going to be very slow. And they’re expensive. I think, I read an article the other day that the average EV buyer owns 2.7 cars. They’re not using their EVs very much for the most part. You can see that data in California as well, where you have a much higher penetration of EVs. But when you look at the actual vehicle miles traveled with EVs, it’s fairly insignificant overall.
So, it’s not that we’re again dismissing EVs and what they can bring. We just think their impact on our business is going to be measured over a very, very long time. And adoption rates that are built into demand curves today that you see from third parties, we think are a little bit on the aggressive side. I think most of them range from a 60% to 80% adoption rate by 2050, so may have a little higher in 2030, but it’s up in 2050.
If you hit — and those are really aggressive rates, 60% of the new cars, we say, even 20%, 30%, eight years from now, EVs, we think it’s going to be very difficult. Part of the reason it’s going to be difficult is the utility of the cars is not as high as a gasoline car today, frankly, or a diesel vehicle. But you can use them for what they allow you to do, there are limits to them. So there’s a lot that has to happen from an infrastructure perspective to really bring the utility curve, the actual machine that you’re buying up to what is available today at half the price. We’ll see where it goes. But our view hasn’t changed. It’s going to be much slower, we think than many believe. And we’re going to continue to be a pretty important part of the economy.
I would be remiss if I didn’t make one other comment. We also operate as a company primarily in the heartland. We like to refer to it as the heartland those from New York may differ with that opinion, but we call it the heartland, but it’s in the Mid-Continent part of the United States. And if you look at our EV adoption rates to this point, they’re about half of what they are on the coast. So when you think about where we operate and you overlay that to whether or not you agree with us or not on the longevity, where we’re at is even going to be slower than what the average is in the United States. So I’ll leave it at that. Short answer, no change in perspective.
Unidentified Analyst
Okay.
Aaron Milford
I thought for sure that, that might elicit some questions or comments.
Unidentified Analyst
So maybe to bring it — that’s a very long-term question, maybe just to bring it a little bit closer to home next year, 2023. There’s certainly some expectation that we could be in recession, mild recession, deeper recession, nobody really knows. I guess my question is, — how — I guess a couple of questions. One, when you’re planning for next year as a management team, are you taking a view on what you think — like what — if we’ll be in a recession, it will not, how bad it will be? And then can you talk about in prior recessions, how your refined product demand and volumes have sort of held up or not?
Aaron Milford
Yeah. And to the first part of your question, are we taking a view of how deep or the likelihood of recession, the short answer is not really. We’re evaluating the economic environment. It has an impact on our business overall. But I wouldn’t say that we’re just laser-focused on that question. So that really comes into our thinking more from a contextual perspective on what we think 2023 might look like, but it’s not specific to a recession. And part of that is no one really knows. We can all guess, each recession is a little different in how it impacts the economy.
But in terms of what has — what does a recession look like to Magellan in the past and what it looked like in the past, if you go back to 2008, 2009, think about that a recession that occurred. Our gasoline volumes were down between 7% and 8% for a few months and then came right back. So for us, recessions can have an impact on volumes in sort of that maybe high single-digit sort of impact, but they tend to be very temporary.
And the minute the economy starts coming back, we’re one of the — if you think about what we deliver, it’s transportation fuels. The minute the economy starts recovering were one of the first to come right back because we support people’s lifestyles and essentially their businesses. So it tends to be fairly short-lived. So it’s one of those things that we’ll be cognizant of. The impact in the grand scheme of things is usually quite modest, and it tends to come back very quickly.
Unidentified Analyst
[Technical Difficulty]
Aaron Milford
We’re definitely seeing, as I think most people are wage inflation. We think we’re managing that prudently. We’re also seeing certain specialties, anything that’s technology driven, and I don’t mean just maybe the typical IT you think about, but I’m thinking about technicians, the folks that work on all the equipment that we have out in the field it takes a little longer to find them. We tend to have really good jobs is to pay really well that people like to have, frankly. So it takes us a little longer to find people, but we’re usually typically able to find the folks that we need. So it’s not a risk of can we run our business, it’s really more of a function of how much more is it going to cost us.
But when you look at our expenses overall, we came into the year thinking our expenses, so not just personnel, but expenses generally would increase maybe 2% year-over-year. I think that’s going to turn out to be something in the mid single-digits or around there, 4% or 5%. So it’s going to be higher than what we thought. But it’s not going to be anywhere near the headline inflation that you’re seeing elsewhere in the economy, and there’s a lot of reasons for that. Part of it is we’re really trying to be cognizant of how we manage.
And we started in 2018, 2018 pre-pandemic, really looking at our business and how we run it efficiently. So those things that we started doing then are really paying off now in terms of being able to control overall expense increases. The personnel remain a challenge.
Unidentified Analyst
[Technical Difficulty]
Aaron Milford
Yes. I don’t disagree with you. That’s the reason in passing way I sort of try to mention each recession is a little different and how it impacts different areas can be different. Will this one looks like 2008, 2009? I don’t know. But you’re right. If it’s a recession at sort of a headline number, but that’s being driven by very specific sort of areas of the economy will be less impacted.
For us, it’s got to be a very broad almost industrial slowdown. So that’s a good point, but each one is different. We gave — I gave 2008, 2009, just as an example, as a reference, so you can think about what that felt like and what happened to us.
Unidentified Analyst
2008, 2009 results in the US was a major [Technical Difficulty]
Aaron Milford
Sure. Agreed.
Unidentified Analyst
Staying on this, if you talk about [Technical Difficulty]
Aaron Milford
Sure. So generally, volumes are steady. If you look at what we’re expecting for this year, we came into 2022 with an expectation that when you looked at our base business and some of the expansion projects, we’re getting some small expansion projects in markets that we already serve that our overall volume growth would be around 4% a year. And yes, I said volume growth would be over about 4% a year.
I think we’re tracking on a year-over-year basis. And I think we’re in that neighborhood. So when you look at the year 2022 versus 2021, we expect to see overall volume growth. So we think the base business is still fairly steady.
On the last earnings call, I did mention that we still do continue to see some weakness in some of our metropolitan areas. If you go back and look at 2019, pre-pandemic demand, we’re still a little behind that demand in the metropolitan areas that we serve, not all of them, but some of them. And I think we’re at the point now we’re far enough pass the pandemic did in some of the cities that we serve, I think we’re just seeing some behavioral changes that have happened.
Now how that changes going forward. If people get back into the office to their lives, kind of, go back to what it looked like in 2019. It’s possible, and there’s an opportunity for us if that happens. But outside of the spotty areas, those very specific areas, demand has rebounded from the pre-pandemic, and we think it’s going to be a very steady profile.
And then as we do things like expand our pipeline to El Paso, expand our pipeline to Colorado, expand pipelines to Albuquerque. And if you think about our network, we just slowly add incremental capacity to new and underserved markets, we think there’s the opportunity for us to a little bit of growth as well.
Unidentified Analyst
So probably the number one question we get these days on Magellan, so I definitely need to ask it.
Aaron Milford
I can probably guess that, but go ahead.
Unidentified Analyst
And I’ll just wait out. I think most — probably everyone in this room knows that you have inflation protected contracts where you have the ability to raise your rates based on a formula tied to PPI. And that number is going to be pretty darn big to come up here. And — but you also have said that you may bank some of that for future years may not pass that full increase to customers in one fell swoop in your tariffs. So I guess the question that on everyone’s mind is where are you on that? And what is the evaluation process? And when will you tell us?
Aaron Milford
So we give guidance for 2023 typically in February with our fourth quarter. So that’s when I would expect we would have more detailed discussions around assumptions that we’re making for 2023 and the guidance that we provided at that time. As we sit here today, we haven’t made any decisions exactly what we’re going to do. And there are a couple of reasons why we wanted to get the conversation started.
We started the conversation in many ways, and we wanted to start the conversation. Because first of all, the indexing, set the stage here just a little bit. I know many of you are failure with Magellan. But on the refined product side, about 30% of our markets are deemed less competitive, and therefore, we have to follow this regulatory regime of indexing. There’s an index that comes out. We all talk about it. So that’s 30% of our markets that whatever the index is we have to move on. I’m going to come back to this, our ceiling rate by that amount.
Then 70% of our markets are market space. They’re deemed workably competitive. So we can do — we have discretion with what we do with rates in those markets. There’s really two different market dynamics with 70% of our markets paying more market base, we can do have more discretion with it.
So the question that was asked is, what are you going to do with index rates. If you look at PPI, call it, 14% round numbers and do the math right now that would be the highest index rate increase, since this index was put in place in 1992. It’s never been as high ever. There have been some high years, but not this high. We talked a moment ago about what we expect on the cost experience side this year, maybe being up 5%.
So we’re going to have the situation where we can move our index rates by 14% by nature of the regulation. Our costs are going up 5%.
Now, let’s say, you’re one of our shippers. How do you think through that, right? So, we want to be cognizant of our shippers. How are shippers doing? Are they doing well? And if they are, and depending on what’s happening with the competitive environment that’s out there, we may take the full index in some markets. But there may be some markets we don’t, frankly. And it’s going to be a function of competition in those markets, because even in the indexed markets, I know some of you may think that we have a monopoly in these markets. We don’t. There’s at least one other competitor in every market we serve.
And I would tell you, there’s excess capacity in that market today. But we’ve differentiated our self with our network, how we – the service we provide, so people like using us. And we want to make sure that it continues. But we have to be cognizant of competitors in these markets and what they’re doing. So, it will be what our competitor is doing, what can the market sort of tolerate.
And then on the regulatory side, it’s also important to keep in mind that shippers can protest, shippers can complain, that’s always been the case. There’s always been a couple of mechanisms for them to do that. And if they look at your earnings, so to speak, and they say the pipeline company is charging too much. They have the ability to protest – so you put all that together, highest index ever, shippers can protest competitive dynamics.
We want to make sure that, we’re operating thoughtfully over the long-term mindset. And so we’re going to be thoughtful about whether or not and what markets we follow the index and where we don’t in that 30% of the market, and 70% will have the discretion to do what we’d like. The takeaway should be – two things.
One is, it’s going to be a healthy tariff increase for our company and likely everyone in our industry. It’s going to be healthy. It may not be the full index. But if it’s not the full index, we’ll have the ability to catch that up in pretty short order next year, year after that as we are able to see how the market evolves.
So it’s not like it’s lost. The opportunity is not lost, but we’re really thinking long term and trying to be thoughtful about, again, competitors, customers and sort of the regulatory regime that we operate in, and make sure that we’re comfortable we’re doing the right amount of move now as we can be. So it doesn’t necessarily answer your question of what we’re going to do. I understand – but at least hopefully, you can understand the thought process that we’re going to use when we do tell you what we’re going to do in likely February.
Unidentified Analyst
Got it. Yeah. That’s helpful. So this is like maybe just stay on refined products for one more question. Quarter-to-quarter, your long-haul versus short-haul shipments will vary. I think clearly, I think you make more money when you have longer haul shipments generally speaking. Can you just talk through kind of what drives that quarter-to-quarter? And specifically, you’ve had some refinery shutdowns over the last few years. Like what’s changing in the industry that would push that one way or the other?
Aaron Milford
So I think there’s a couple of time horizons we have to think about. The first one is the quarter-to-quarter what I’m going to call the short-term time horizon. Because when we put our guidance and our plans out there, we have an expectation about what sort of the average move in our system is going to look like, much like you guys probably do, we model it out origin destination and that results in a rate that we earn. And that’s what we build into our guidance.
From quarter-to-quarter, we can do better than that guidance. And generally, what drives that will be market dynamics or disruptions. We’ve had fire Toledo. You think well, how has Toledo impact Magellan? Well, to the extent Chicago barrels need to start backfilling Toledo, they used to be sort of supplying Mid-Continent. It creates sort of a hole in the Mid-Continent, right? And we’re there to backfill that hole, they usually from further away than Chicago.
We’ve had some issues at Whiting. We’ve had just some short-term disruptions. We’ve had inventory tightness in the group, which encourages barrels to be valued higher in the group versus maybe the Gulf Coast from time to time when that happens, that tends to pull barrels from the Gulf Coast into the Mid-Continent.
And as that happens, the average haul so to speak, elongates. And that’s where you’re seeing sort of the longer haul dynamic. And that’s what can happen over the short-term. We don’t know what disruptions are going to happen or not happen. But when they do happen, we tend to get longer – longer hauls out of it.
As you think longer-term, with the expansions to El Paso that we’re doing with the expansions to Denver that we’re doing, even Albuquerque, as we build into our own guidance and our own financial models, the haul in our system should get longer, just as a base – as a base event. But you’re still going to have the potential for disruptions to even exceed that at times. So that’s the dynamic.
The short-term nature is all about disruptions and markets trying to rebalance and we’re in the middle of most of those markets, and it usually provides opportunities. Longer-term, as we tend to expand towards the extremities, particularly West on our system, the hauls will get longer. So that’s in a nutshell.
Unidentified Analyst
Okay. Perfect. Questions out there? So maybe let’s — let me talk a little bit about the Permian on the crude side. So yes, I guess, like high-level question I’d have is, I mean you’re involved in the basin. I think there’s no secret that there’s a gas takeaway issue or at least it’s tight, it’s going to be tight for at least over the next, I don’t know, 12 months plus. Do you see that impacting oil production ultimately being a constraint on oil production, or do you think the Permian is going to do what it’s going to do. That’s kind of like the first question.
Aaron Milford
I think first of all, we don’t take necessarily a house view on Permian oil production. We look at a lot of the external forecast. I mean you probably look at and apply our knowledge over the top of it and sensitize a little bit, but we’re basically starting in the same place. You all are, which you would call for Permian oil production been 400,000 to 600,000 barrels a day on an exit rate basis year-over-year.
So from the year-end 2021, year-end 2022, 400,000 to 600,000 barrels a day Permian growth, we think that’s probably a reasonable expectation. Natural gas takeaway and the impacts on drilling can be significant. But it’s hard to know if they’re so significant that it’s going to dramatically impact that trend over the horizon that we’re thinking about, frankly.
Maybe more of a shorter-term issue, but we’ve got contracts and people need to move oil. So in the short-term, there’s probably less of an issue for us. But longer-term, I just don’t know if that’s going to – there’s going to be too much of an incentive to solve the problem over sort of the intermediate to longer-term macro view that we would have.
Unidentified Analyst
And I guess as you think about right now on the oil side, Permian takeaway, there’s plenty of excess — there’s some excess capacity. It seems like there will be for some time. I think your Longhorn tariffs are in like the $1.50 to $2 per barrel range, roughly. As those — I think on the last call, you said you had some contracts that were rolling over in that 2024 to 2026 timeframe when the market could be tightening up, I mean I guess no one really knows, but based on the current run rate of growth in the Permian, do you think it would start to get tighter by then. How do you think about what that will do from a tariff re-contracting perspective once you get out in time?
Aaron Milford
Well, it’s certainly — we certainly feel better about having contracts that are going to be up for negotiation in that 2024 to 2028 timeframe depending on what pipe you’re talking, not just Longhorn but Permian in general. We certainly like the idea of re-contracting them based on what we see then re-contracting right now.
So, that we think that’s positive for us. What that actually — what that ultimately looks like, it’s really going to be, frankly, very hard to predict. That’s a long time in the crude business. But we do think the tightening is a real possibility and most expectations are that it will get tighter. What’s going to be interesting is, as it gets tighter, are we going to see higher rates, or are we going to see folks expand pipes again?
That’s how we got into sort of this oversupply was really aggressive investments out of the Permian to build capacity to export it with the idea of being that we need to be able to capture the peak. The peak never occurred. So, we have a lot more capacity than we need.
So, we’re happy that that will be out in the time. It looks like it’s going to be sort of green or faster than it is today, for sure. And we’re certainly really happy that we’ve got between 70% and 80% of our capacity under contracts with good counterparties, depending on which pipe you want to look at for the next several years. So, we like that combination of things, for sure. But what does it mean for rate? It’s hard to say.
If you look at forward curves, they would all suggest rates are going to be better than they are now, but not back to what we originally were able to earn when we originally reversed Longhorn, they’re not looking that robust, but they’re certainly a lot better than they are today.
Unidentified Analyst
Questions out there? All right. Maybe a question on capital allocation. So, I think you’ve kind of differentiated yourselves from your peers, I would say, in terms of maybe having more of a balanced approach between buybacks and distribution growth with more buybacks than most of your peers.
It seems like, at the same time, many in the industry are now actually leaning more heavily towards distribution growth and even further away from buybacks than they have been over the last couple of years. I’m curious for your kind of A, feedback you’ve gotten from investors on what you’ve done in 2022? And do you — is that — are you going to stay the course in 2023, or do you — is that something you’re evaluating?
Aaron Milford
Well, it’s something we continually evaluate. The general feedback to our approach on share buybacks has been positive. Sure, we have a subset of investors that would like to see us grow the distribution a little more. frankly, we understand that. We have some investors that would hate us to grow the distribution a little more at the expense of buybacks, we understand that, too. So for us, it’s not really making a decision. Do we want to be more distribution heavy or buyback heavy? It’s really a function of where — what is the most valuable or the best way to return capital when we have the opportunity to do so. It’s just so happened that, in our opinion, the last, really, almost two years, 18 months, it’s made a lot of sense for us to buy our units back and that’s the reason we’ve been doing it at such a clip. Well, at the same time, at least growing our distribution a little bit. We can debate whether or not 1% is meaningful or not, we think that stable and slightly growing distribution is a good thing to have in all environments. So we’re trying to — we’re doing both a little bit, but it’s certainly the emphasis on buybacks.
We’ve also tried to be really clear that, when we’re thinking about, how we’re going to allocate capital, the first step for us is, what is the opportunity set to invest capital in projects to generate really good returns. If we have those, that’s what we want to go do. The reality has been of late, we haven’t had near the opportunities that we’ve had, say, over the previous decade. So the opportunity set is just smaller. So, okay. So now, we have a smaller opportunity set. How do we want to return capital between distribution — distributions, capital or stock buybacks, unit buybacks? And we’re going to evaluate which of those we do based on the fundamentals to receive value and buying units back.
If we do, that’s probably where we’re going to stay focused. And it’s very much what’s happening at the time and what do we think the most valuable thing for us to do over the long term is for our unitholders, and that’s what we’re going to do. So we don’t have a — we want to weight the distribution more than the buyback. We’re not trying to make that sort of a policy decision. It really is much more, what is the most efficient, most effective way to return capital to unitholders, if we don’t have opportunities and that can change. It can ebb and flow. So, if it ever changes, it’s just making different decisions because we think the time is called for it. But the idea is, invest in really good projects. We can’t do that most efficient way, most valuable way to return capital to unholders. That’s the equation.
Unidentified Analyst
Got it.
Aaron Milford
Subject to a healthy balance sheet.
Unidentified Analyst
I didn’t even ask you about the balance sheet because it’s so clean that there’s no questions to ask. I think, we’ve hit the end of our session. So thank you very much, and we appreciate it.
Aaron Milford
Thank you, Michael. Thank you all for being here.
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