No Longer A Keystone for TransCanada

Last month, the Nebraska Public Service Commission approved the northern leg of the Keystone XL pipeline, remobing the last major regulatory hurdle after the US State Dept signed off on the controversial project’s border crossing.

However, investors who still regard this project as the primary upside driver for TransCanada Corp (TSX: TRP, NYSE: TRP) should curb their enthusiasm.

The project still faces considerable opposition and must deal with landowners affected by the alternative route proposed by the Nebraska Public Service Commission. TransCanada also hasn’t made a final investment decision on Keystone XL’s cross-border segment.

The midstream giant has waged a nine-year battle to build what it initially envisioned as a 1,700-mile pipeline. The Obama administration approved the project’s southern leg, which transports crude oil from the hub in Cushing, Oklahoma, to Gulf Coast refineries but refused to authorize the cross-border segment.

Keystone XL’s southern extension has generated solid profits for TransCanada over the past few years while helping (at least until recently) to narrow the discount at which West Texas Intermediate (WTI) traded relative to Brent crude oil, an international benchmark.

Completing the pipeline’s northern leg would provide much-needed takeaway capacity to oil producers in Alberta and help to reduce the massive discount at which Western Canada Select trades relative to WTI and Mexican Maya.

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At present, limited pipeline capacity from Alberta to international markets forces about 700,000 barrels per day of Canadian crude oil to move via railcars—an expensive and less-safe alternative

Accordingly, we don’t expect TransCanada to abandon the project. The company also has until Dec. 20 to appeal the route change proposed by Nebraska regulators. Of course, opponents also have the right to appeal the Nebraska Public Service Commission’s decision.

A 210,000-gallon oil spill on one of the company’s pipelines in South Dakota could breathe life into the opposition, while the project has also become a cause célèbre for environmental advocates, ensuring plenty of funding for the inevitable court challenges.

Race to the Finish

Any legal or regulatory delays to Keystone XL’s final segment could prove fatal to the project because of growing uncertainty about how many new oil pipelines Alberta will need over the next five to 10 years to transport its heavy crude to market.

Under Prime Minister Trudeau, Canada approved four major pipeline projects over the past year to help alleviate the shortage of takeaway capacity in Alberta.

TransCanada shelved plans to build one of these pipelines—Energy East, which would have run from Alberta to Canada’s Atlantic Coast.

Meanwhile, Kinder Morgan Canada’s (TSX: KML) proposal to triple the capacity of the Trans Mountain pipeline, which would boost exports from Canada’s Pacific Coast, has also encountered stiff opposition. The company has warned that the project could face a nine-month delay as the company waits for the National Energy board to compel the mayor of Burnaby, British Columbia, to grant the necessary work permits.

The same goes for Enbridge’s (TSX: ENB, NYSE: ENB) Line 3 replacement and expansion project, which has become highly controversial in Minnesota because of leaks on other lines and questions about its necessity.

Securing the approval of Nebraska regulators presumably vaults Keystone XL into the lead when it comes to cross-border pipelines. The project’s economics should also improve as the start-up of Suncor’s (TSX: SU, NYSE: SU) Fort Hills oil-sands operation exerts pressure on WCS prices.

Of course, further delays to Keystone XL and breakthroughs for rival projects could turn this race on its head.

No Longer Mission Critical

Despite the high-profile nature of Keystone XL’s cross-border segment, the project is no longer critical to TransCanada’s growth plans or the stock’s value proposition for investors.

Since strong opposition made it clear that neither Keystone XL or Energy East would be a slam dunk, the company has built an impressive backlog of midstream and power projects that are expected to drive annual dividend growth of 8 to 10 percent in coming years.

TransCanada has delivered on its promises thus far, with the acquisition of Columbia Pipeline Group giving the midstream operator a new growth platform serving producers in the prolific Marcellus Shale.

The lack of a quorum on the Federal Energy Regulatory Commission (FERC) earlier this year temporarily halted approvals of new gas pipelines in the US. With the Trump administration finally seating new commissioners, FERC has started to approve projects expeditiously, including TransCanada’s WB Xpress, Mountaineer Xpress and Gulf Xpress.

Although the delay in FERC approvals have local and state opposition time to rally against some pipeline projects in the Northeast, TransCanada’s CA$24 billion (US$18.76 billion) backlog of expansion opportunities appear to be on track.

These successes stand in stark contrast to TransCanada’s efforts to build major crude-oil pipelines serving Alberta oil producers, vindicating management’s pivot to smaller projects that face less opposition.

Perhaps investors should ask why TransCanada would take a chance on resurrecting a project that has been a nine-year boondoggle?

A well-executed project would move the profit meter on its own, while the pipeline’s high profile would also help to attract investors. That said, TransCanada doesn’t need to move forward with Keystone XL if it doesn’t prove feasible.

A New Model for Master Limited Partnerships?

In US dollar terms, the Solactive Canadian Midstream Oil & Gas Index has outperformed the Alerian MLP Index by more than 15 percentage points so far in 2017 and almost 25 percentage points since the energy down-cycle began in mid-2014.

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Nine of the 10 Canadian midstream companies in our International Coverage Universe have increased their dividends at least twice since oil prices peaked in 2015. The lone exception, Kinder Morgan Canada, completed its initial public offering on May 30, 2017.

Equally important, none of these names have cut their payouts since energy prices started to break down in mid-2014—a remarkable feat when you consider the pain that Canadian oil-field service companies and producers have suffered relative to their US peers.

Cross-border transportation constraints, coupled with surging US energy production, have ensured that Canadian upstream operators’ price realizations on crude oil, natural gas and natural gas liquids come at a significant discount to prominent benchmarks.

The group’s outperformance and steadily growing dividends stand in marked contrast to the turmoil afflicting US midstream master limited partnerships (MLP), where many prominent names such as Energy Transfer Partners LP (NYSE: ETP), Plains All-American Pipeline LP (NYSE: PAA) and Williams Partners LP (NYSE: WPZ) have slashed their distributions at least once.

All told, the 25 companies in the Alerian MLP Infrastructure Index have reduced their aggregate quarterly distribution by 14.5 percent from year-ago levels and almost one-third since early 2016. These payout cuts have reduced investors’ income streams and resulted in sharp selloffs in their stock holdings. Even Enterprise Products Partners LP (NYSE: EPD) and other higher-quality names have underperformed, suffering for the sins of their profligate counterparts.

Energy & Income Advisor recently published a must-read report exploring why Canadian midstream stocks have outperformed the Alerian MLP Index and the aspects of their business model that could provide a model for their counterparts south of the border.

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