Operating pipelines and processing plants make for a rather boring business. Yet these operations provide substantial income to the MLPs that typically own these assets. However, not all midstream assets are equal, which is why investors interested in Eagle Rock Energy Partners, L.P. (NASDAQ:EROC) need to take a deeper look into the company’s bedrock midstream operations to get a better understanding of these assets.
Midstream overview
Eagle Rock’s midstream operations are concentrated in two core areas, the Panhandle and East Texas. Overall, the company has 8,134 miles of pipeline and 20 process plants:
It’s the Panhandle assets which offer a lot of potential growth. There are currently 68 active drilling rigs in the area and more than 550 wells have been permitted over the past six months. Because of this, Eagle Rock Energy Partners, L.P. (NASDAQ:EROC) has been busy both acquiring and building its assets in the area. The biggest recent acquisition was a $227.5 million deal for BP plc (ADR)(NYSE:BP)‘s Texas Panhandle Midstream System. The system, which won’t be accretive to its distributable cash flow until 2014, added significant scale and important fixed-fee revenue. The deal was also important to BP plc (ADR)(NYSE:BP), which was able to monetize a non-core asset, but was still able to use the asset as it signed a 20-year gathering agreement with Eagle Rock.
Rocky ground
The issue when it comes to Eagle Rock Energy Partners, L.P. (NASDAQ:EROC)’s midstream business is that two-thirds of its income is subject to commodity price volatility. That means that its income, and therefore its distribution, could be hit when commodity prices sink. The good news is that thanks to those new contracts, Eagle Rock’s midstream operations are strengthening:
However, for perspective, top midstream operator Enterprise Products Partners L.P. (NYSE:EPD) derives 81% of its gross operating margin from fee-based activities. That means that substantially more of Enterprise’s revenue and profits are rock solid which provides ample safety to its distribution. This is one reason why Enterprise has been able to raise its distribution for 36 strait quarters while Eagle Rock Energy Partners, L.P. (NASDAQ:EROC)’s payout is at risk of being cut.
More midstream operators are pushing for fixed-fee contracts to provide better stability. Another example of this is Atlas Pipeline Partners, L.P. (NYSE:APL), which currently has just 36% fixed-fee contracts. However, it recently acquired a business which had 80% of its contracts as fixed fee, which pushes the pro forma business to 42% fixed. By the end of next year, Atlas Pipeline Partners, L.P. (NYSE:APL) expects to have 50% fixed-fee contracts, which will make its distribution more secure. Because income security is important to investors, it’s good to see Eagle Rock move in this same direction of having more of its revenue tied to fixed-fee contracts, even if it still does have a long way to go.
Final Foolish thoughts
While Eagle Rock Energy Partners, L.P. (NASDAQ:EROC)’s operations are centered on areas with growth potential, way too much of its revenue is tied to volatile commodities. That can cause issues both with its debt and its distributable cash flow, meaning its high distribution might not be on solid ground.
The article Commodity Prices Drive This Company’s Success originally appeared on Fool.com and is written by Matt DiLallo.
Fool contributor Matt DiLallo owns shares of Enterprise Products Partners L.P. (NYSE:EPD). The Motley Fool recommends Enterprise Products Partners L.P. The Motley Fool owns shares of Apache.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
