Feb 2, 2017
Executives
Michael N. Mears - Magellan Midstream Partners LP Aaron L.
Milford - Magellan Midstream Partners LP
Analysts
Kristina Kazarian - Deutsche Bank Securities, Inc. Brian Zarahn - Mizuho Securities USA, Inc.
Theresa Chen - Barclays Capital, Inc. Gabriel Moreen - Bank of America Merrill Lynch Shneur Z.
Gershuni - UBS Securities LLC Jeremy B. Tonet - JPMorgan Securities LLC Faisel H.
Khan - Citigroup Global Markets, Inc. John Edwards - Credit Suisse Securities (USA) LLC Tom Abrams - Morgan Stanley & Co.
LLC James Meyers Jampel - HITE Hedge Asset Management LLC Jerren A. Holder - Goldman Sachs & Co.
Operator
Good day, and welcome to the Magellan Midstream Partners Fourth Quarter 2016 Earnings Results Conference Call. Today's conference is being recorded.
At this time, I would like to turn the conference over to Mr. Mike Mears.
Please go ahead, sir.
Michael N. Mears - Magellan Midstream Partners LP
All right, thank you. Well, good afternoon, and thank you for joining us today to discuss Magellan's fourth quarter financial results and our outlook for 2017.
Before we get started, I'll remind you that management will be making forward-looking statements as defined by the SEC. Such statements are based on our current judgments regarding some of the factors that could impact the future performance of Magellan.
You should review the risk factors and other information discussed in our filings with the SEC and form your own opinions about Magellan's future performance. As announced this morning, we generated record quarterly distributable cash flow during the fourth quarter of 2016, closing out another strong year.
The full year was also a record, generating DCF of $947 million and successfully reaching our goal of increasing cash distributions to our investors by 10% for 2016, while achieving a coverage ratio of 1.25 times. In addition, 2016 was an important year for us due to the completion of a number of significant growth projects.
Most notably, we successfully started up our Little Rock pipeline during July and the Saddlehorn pipeline during September and continue to hear positive industry feedback for their long-term strategic value. We also recently completed construction of our condensate splitter in Corpus Christi, which has been operating and generating products meeting market specifications.
I'm sure you noticed in the earnings release this morning that we've mentioned an emerging issue related to our splitter. Specifically, our customer provided notice to terminate its contract with us just a few days ago.
In our opinion, this termination is not valid under the terms of the contract, and we have initiated legal action. While our legal dispute runs its course, we are in discussions with other potential customers for the splitter and are optimistic we'll reach a satisfactory outcome to this situation.
In our view, this facility has current and future economic value, especially with the expected growth of condensate production in the Permian and Eagle Ford Basins. While we are happy to answer your questions as best we can on this topic, I hope you can appreciate that this is an emerging issue and we are in the process of working through our alternative.
I'll now turn the call over to our CFO, Aaron Milford to review Magellan's fourth quarter financial results in more detail. Then I'll be back to discuss our guidance for 2017 and review the status of a few of our other larger expansion projects before opening the call for your questions.
Aaron L. Milford - Magellan Midstream Partners LP
Thanks, Mike. Today, I will be making references to certain non-GAAP financial metrics, including operating margin and distributable cash flow.
We've included exhibits to our earnings release that reconcile these metrics to their nearest GAAP measure. We reported fourth quarter net income of $213.3 million or $0.93 per unit on a diluted basis earlier this morning, which is higher than the $207.1 million or $0.91 per diluted unit reported for the fourth quarter of 2015.
Excluding the impact of mark-to-market futures contract activity in the current quarter, adjusted diluted earnings per unit of $1.04 exceeded our guidance of $0.91 provided back in November. We also generated record quarterly distributable cash flow of $277.2 million for the current quarter compared to $256.9 million reported for the fourth quarter of 2015.
For the year, we reported net income of $802.8 million or $3.52 per unit on a diluted basis, which was down from the $819 million or $3.59 per unit on a diluted basis reported for 2015. 2016 distributable cash flow of $947.5 million was higher than the $942.9 million reported for 2015 and represents an annual record as well.
2016 results were strong, as increasing cash flow from growth projects being placed into service, combined with continued strong performance from our fee-based businesses has allowed us to overcome lower overall margin contribution from our commodity related activities and higher maintenance capital expenditures made in 2016. I will now move to a brief discussion of the quarterly performance of each of our business segments.
Our refined products segment generated $191.1 million of operating margin in the fourth quarter of 2016 compared to $203.8 million for the same period in 2015. This $12.7 million decrease from the fourth quarter of 2015 is primarily a result of unrealized losses on our futures contract positions used to hedge our commodity-related activities, whereas the 2015 quarter benefited from significant unrealized gains.
Our fee-based activities within this segment generated margins that were essentially flat to the fourth quarter of 2015 with higher transportation and terminals revenue being offset by higher operating expenses. Transportation and terminals revenues increased $11.1 million compared to 2015 quarter.
This increase was driven by 3% higher base business volumes and increased volumes associated with growth projects coming online, including our Little Rock pipeline, which when combined resulted in approximately 6% higher volumes in total in the current quarter compared to last year's quarter. Revenues were also positively impacted by rates that were 2% higher than the 2015 period as a result of our mid-2016 tariff rate increases.
We continued to see strong gasoline demand on our system and our diesel volumes were virtually flat compared to the 2015 quarter. Operating expenses increased $11.3 million compared to the fourth quarter of 2015, which offset the increase in revenues.
This increase was primarily attributable to increased operating cost related to Little Rock pipeline, increased accruals related to pipeline releases occurring in the quarter and less favorable product gains, which reduced operating expenses. Product margin decreased by $12.3 million compared to the fourth quarter of 2015 as a result of unrealized losses related to our futures contract hedging activity compared to the 2015 quarter.
When we evaluate our cash margin, which takes into account when we physically sell product that normalizes for these unrealized gains and losses, the current quarter's cash margin performance was slightly lower than the fourth quarter of last year, with higher blended volumes in the current quarter being offset by lower realized margin. For our crude segment, operating margin of $111.7 million was $16.5 million higher than the fourth quarter of last year and represents a quarterly record for the crude business segment.
This increase was primarily driven by higher storage revenue at our East Houston facility, resulting from additional storage contracts and higher commercial capacity, higher contributions from our non-controlled joint ventures, including BridgeTex and our Saddlehorn joint venture, which began operations in September of 2016 as well as slightly lower operating expenses, primarily resulting from lower tank maintenance costs and more favorable product gains. For the quarter, volumes on our Longhorn pipeline averaged approximately 250,000 barrels per day and averaged 260,000 barrels per day for the year, which was consistent with our full year expectations.
BridgeTex volumes averaged approximately 220,000 barrels per day during the fourth quarter of 2016, as some of the volume benefit BridgeTex experienced in the third quarter of 2016 due to competing pipeline issues carried over into the fourth quarter. As a reminder, our committed volumes totaled 210,000 barrels per day.
Our Saddlehorn joint venture began operations in September 2016. For the fourth quarter, volumes averaged approximately 40,000 barrels per day, which is consistent with our volume commitment.
And finally, volumes on our Houston Distribution System were lower in the fourth quarter of 2016 compared to the 2015 period. However, slightly higher average rates earned on the system combined with a deficiency payment recognized as a result of a customer not meeting its minimum volumes more than offset the financial impact of lower volumes.
Finishing up my discussion of our segment performance, our marine segment set a quarterly record, generating $35.1 million of operating margin in the current quarter compared to $29.2 million in the fourth quarter of last year. Revenues were $4.7 million higher as a result of higher storage rates overall and additional capacity at our Corpus Christi terminal.
Operating expenses were lower compared to last year's quarter as a result of lower environmental accruals. Now moving to other net income variances to last year's quarter, our G&A expenses decreased by $3.7 million, primarily due to lower bonus accruals and equity-based incentive compensation.
And depreciation and amortization expense increased slightly compared to the 2015 period due to expansion capital projects placed into service. Net interest expense increased by $9.8 million due to a slightly higher weighted average interest rate of 4.9% and a higher weighted average debt balance of $4.1 billion being partially offset by higher capitalized interest related to project spending.
Other income increased by $4.2 million due to a non-cash gain recognized due to the change in value of a fair value hedge in place to hedge the price exposure related to certain crude oil tank bottoms. I will now move to a discussion regarding our balance sheet and liquidity position.
As of December 31, 2016, we had $4.1 billion of long-term debt outstanding, including $50 million of commercial paper. Our leverage ratio was approximately 3.4 times debt to EBITDA.
We also have $1.25 billion of credit facilities, with $1 billion backing our commercial paper program, with no outstanding borrowings. We continue to enjoy a strong balance sheet, considerable excess cash flow above declared distributions, have ample liquidity, and remain well below our targeted 4 times maximum leverage ratio.
During the fourth quarter, we filed a shelf registration statement for up to $750 million of equity in support of the ATM equity program we plan to put in place. As you can see from our current credit metrics, there is not an immediate need to issue equity, but we're putting this program in place so that as we continue to grow and potentially land large organic growth projects, we have all the tools that we may need to appropriately manage the capitalization of our business into the future.
I will now turn the call back over to Mike to discuss our guidance for 2017 as well as the status of our growth project.
Michael N. Mears - Magellan Midstream Partners LP
Thanks, Aaron. We provided 2017 DCF guidance for the first time this morning and expect to generate annual DCF of $1 billion.
Our goal is to increase distributions by 8% for 2017, which results in coverage of 1.2 times. As usual, I'd like to briefly walk you through the building blocks we used for our 2017 projections.
Starting with our refined products segment, we expect total refined products pipeline volumes to increase by about 6% in 2017, primarily related to incremental volume from growth projects such as our Little Rock pipeline and new pipeline connections between our South Texas and Central Texas refined products pipeline systems. Excluding growth projects, we expect base refined products volume to remain relatively flat between years.
Even though the commodity environment has improved over the last year, we remain cautious for guidance purposes on demand for distillates in our markets, especially after seeing a decline during 2016. The other key component for our refined products pipeline is the average tariffs we charge.
You're probably aware that the current FERC indexation methodology is based on the change in the Producer Price Index plus 1.23%. The preliminary change in PPI for 2016 is negative 1%, which will result in basically flat rates for those markets that follow the index.
As a reminder, roughly 40% of our refined products system is deemed to be less competitive by the FERC, so we follow the index in those markets, resulting in 40% of our refined tariffs remaining relatively flat in mid-2017. However, the remaining 60% of our refined markets are not subject to the index methodology because they are either intrastate movements or deemed to be competitive by the FERC.
As a result, we can adjust rates in these markets as deemed appropriate. Our commercial team is analyzing our markets at this time, but we intend to increase rates in our competitive markets by 3% to 4% in mid-2017.
For modeling purposes, please keep in mind that our point-to-point pipeline movements have an impact on the average rates that you see in our operating statistics. Even though we intend to raise tariffs an average of 2% in mid-2017, our forecast expects overall rate per barrel to remain relatively flat between periods due to anticipated shorter haul movements.
The other key assumption that significantly impacts the refined products segment is the commodity price environment in particular as it relates to our butane blending activities. We have about 40% of our expected 2017 butane blending sales volume hedged at this point with the vast majority of our spring blending margin locked in.
As is typical for us, we use the forward commodity price curve to forecast the expected margins for our unhedged volumes. All in, we expect our average blending margin to be around $0.40 during 2017, which compares to an average margin closer to $0.50 in 2016.
While crude pricing does not have an exact correlation to butane blending margins, it can provide a benchmark that we all tend to track. For perspective, our guidance assumes an average crude oil price for 2017 of approximately $55 per barrel, consistent with recent NYMEX futures pricing.
Moving to our crude oil segment, we expect our base crude oil transportation volumes to remain consistent with 2016 levels. Our Longhorn pipeline remains fully committed and we expect to average around 260,000 barrels per day again in 2017 with no spot shipments.
We do expect increased volume on our Houston distribution system, primarily due to growth projects such as our recent Houston Link connection. Including these growth projects, we expect all-in crude oil pipeline volume growth of around 6%.
We also expect BridgeTex pipeline volumes to be consistent between years, averaging around 215,000 barrels per day in 2017, similar to our 2016 results. We expect our committed shippers to move at their 210,000 barrel a day commitment levels, and we expect to begin seeing incremental volume through our new Eaglebine origin, which is scheduled to start up next quarter.
On the tariff side of things, we expect average rate per barrel to be relatively flat between periods as well. Our Longhorn and BridgeTex systems have customer contracts that are correlated to the FERC index.
As a result, we expect those rates to be flat between years. And of course, we expect a benefit from a full year of operating results for the Saddlehorn pipeline.
Year one commitments averaged 40,000 barrels per day and our forecast assumes our customers ship at their minimum commitment levels. The economics for the Saddlehorn pipeline have continued to improve due to lower construction cost and lower operating expenses than originally projected.
As a result, we now expect the average EBITDA multiple to be close to 7 times based on committed volumes only. Finally, based on the current status of the splitter that we've already discussed, our 2017 guidance conservatively assumes no revenue contribution from the splitter even though we fully expect some level of profitability this year once we have an opportunity to work through our alternatives.
With regards to maintenance capital, we expect to spend approximately $90 million in 2017, which is more in line with our historical spending level. You may recall that our 2016 maintenance capital spending was higher than usual due to a number of one-time issues that emerged during the year including significant flooding in both Texas and Kansas that required pipeline relocations.
Regardless of the accounting treatment between expense or maintenance capital, we spend more than $200 million in total each year to maintain our assets. Safe operations are important to Magellan and we allocate sufficient resources accordingly to maintain the safety of our operations.
So, assuming the reasonableness of these key assumptions, we expect to generate DCF of approximately $1 billion in 2017. These assumptions provide us confidence in our annual distribution growth target of 8% for 2017, while leaving us with a healthy 1.2 times coverage ratio and approximately $180 million of excess cash flow for the year.
And while we do not plan to provide DCF guidance for periods beyond 2017, we are targeting annual distribution growth of 8% for 2018 as well, while maintaining distribution coverage in the range of 1.1 to 1.2 times. We're providing a range for 2018 at this point, primarily due to the current uncertainties of the splitter.
As was mentioned earlier, we are optimistic that the splitter will begin contributing to cash flow in 2017, which would then put us at the high end of the distribution coverage range in 2018. Concerning expansion capital, we spent a record $736 million on organic growth construction projects during 2016.
Based on the projects currently under construction, we expect to spend $550 million during 2017 with an additional $350 million in 2018 to complete the projects now in progress. We recently announced a few key projects that are included in today's spending estimates.
For instance, we have announced plans to increase the scale of Seabrook Logistics, which represents a key asset for our crude oil marine strategy. Phase one of this joint venture is scheduled to come online next quarter and is backed by a long term import throughput commitment from a Gulf Coast refiner.
The recently announced second phase of Seabrook Logistics represents construction of 1.7 million barrels of storage and connectivity to our Houston distribution system, providing attractive optionality for our long haul crude oil pipeline customers to access the new crude oil export facilities. We expect this next phase of our Seabrook Logistics joint venture to be operational in mid-2018.
We're also separately investing in a new pipeline within our Houston distribution system to ensure we are prepared to handle incremental volume headed to the Houston Gulf Coast area. Combined, Magellan plans to spend about $200 million on these two projects.
We also recently announced plans to expand the capacity of BridgeTex from 300,000 barrels a day to 400,000 barrels a day. While we have available capacity today, we believe this expansion is prudent to ensure BridgeTex is adequately prepared to move projected incremental Permian Basin production.
The expansion is very cost effective at just a few million dollars to primarily modify existing pumps and will be available next quarter. And as we've stated in the past, with Magellan's solid balance sheet and low leverage ratio, we do not anticipate any need to issue equity in the near future to finance the growth projects we are constructing at this time.
As Aaron mentioned in his comments, we are in the process of establishing ATM program, but given what we see right now, we do not anticipate the need to use the program until material new organic projects are announced. As always, we continue to evaluate well in excess of $500 million of other potential organic growth opportunities.
Our list remains quite lengthy with a variety of opportunities for each of our segments. We've been testing some of these potential projects with you such as a further build-out of our new Pasadena terminal that's currently under construction, as well as additional phases of our Seabrook Logistics joint venture.
In addition, we have a refined products open season underway to assess interest in the potential expansion of a refined products pipeline in Texas. Again, these are just a few of the many opportunities under consideration, and then we will provide further details on significant new projects once it becomes clear we are moving forward on them.
We also remain active in evaluating acquisition opportunities. However, we continue to hold to our conservative pricing approach, which is why you haven't seen us close any transactions to date.
And with that, operator, I'll now turn it over for questions.
Operator
We will take our first question from Kristina Kazarian from Deutsche Bank. Please go ahead.
Kristina Kazarian - Deutsche Bank Securities, Inc.
Afternoon, guys.
Michael N. Mears - Magellan Midstream Partners LP
Hi, Kristina.
Kristina Kazarian - Deutsche Bank Securities, Inc.
Can you guys just remind me, when I'm thinking about the remainder of this year, what – and you gave a lot of good project updates, but just what the next set of catalysts me and you guys are watching for, is it incremental project update or just how do I play out the rest of this year in my mind?
Michael N. Mears - Magellan Midstream Partners LP
Well, that's a pretty open-ended question. First of all, I've kind of highlighted what we have included in our guidance.
And so what's not included in our guidance is any incremental crude oil throughput on BridgeTex, for instance, or any spot shipments on Longhorn. And we've given pretty conservative guidance with regard to that just in our minimum levels.
And the same would be true for Saddlehorn, we haven't layered in any incremental volumes of note. Even though we are going to start up the Carr extension and we are hopeful even though we don't have commitments that we're going to get volumes moving through that line once it's up and running.
The highlight there I think is that we've got some very conservative assumptions in our view with regards to crude oil movements on our long haul pipes. Other than that, we're just looking to execute on the growth projects that we have targeted to complete this year.
Clearly, the splitter is an open item. I'm sure I'm going to get a number of questions on that today.
Our guidance assumes no contribution from the splitter, which we think is very conservative, because we do think we will have it up and running before the end of the year contributing. So that's probably the most significant item in front of us through the course of this year.
Kristina Kazarian - Deutsche Bank Securities, Inc.
Perfect. And then my follow-up will be, we've had a lot of Permian announcements since last quarter alone, if it's you guys with BridgeTex, if it's Cactus, Midland-to-Sealy fully ramping.
Can you just remind me what your latest thoughts are in terms of where the Permian market stands and any thoughts on timeframe about incremental contracts on BridgeTex or potential early re-contracting on Longhorn?
Michael N. Mears - Magellan Midstream Partners LP
Yeah. If you look, clearly, as we here today, there's still significant excess capacity, pipeline capacity coming out of the Permian.
And the differentials were down below $1 between Midland and Houston just in the recent weeks. And so that's an indicator there's still significant excess capacity.
We are probably less bullish as a lot of other folks are that we're going to be reaching 100% utilization on existing capacity late this year, early next year. We certainly would expect to start to see some incremental movements on the pipes.
And we are actively talking to customers about incremental shipments on BridgeTex in the available capacity we have. It is very difficult and it's probably unlikely in this market to get anyone to contract for that space.
So, you're really chasing spot barrels. And we would expect to see those potentially start to ramp up towards the end of the year and into 2018.
As I said, we don't have any of that in our guidance. With regards to – and just let me make a comment on the BridgeTex expansion.
Based on those comments, one might say, well, you're expanding BridgeTex a little too early. We're expanding BridgeTex because it was literally $2 million to expand BridgeTex to be prepared.
And so it wasn't a significant capital investment. If you have any upsets in the market, if production happens to ramp quicker than we're projecting, we want to be prepared.
And with such a low capital investment to expand, we felt we'd just go ahead and do that. With regards to building new pipes out of the basin, I think we agree with everyone else that is probably needed at some point in the future.
But it's probably too far in the future for us to plan for at this two seconds.
Kristina Kazarian - Deutsche Bank Securities, Inc.
All right. Thanks, guys, and nice job on the updated guidance.
Michael N. Mears - Magellan Midstream Partners LP
Thank you.
Operator
And we will take our next question from Brian Zarahn from Mizuho. Please go ahead, Brian.
Brian Zarahn - Mizuho Securities USA, Inc.
Good afternoon.
Michael N. Mears - Magellan Midstream Partners LP
Hi, Brian.
Brian Zarahn - Mizuho Securities USA, Inc.
Just on the Houston transportation system, is that more of a fourth quarter related event in terms of the volume impact?
Michael N. Mears - Magellan Midstream Partners LP
You're talking about the reduced volumes on the system?
Brian Zarahn - Mizuho Securities USA, Inc.
Yes.
Michael N. Mears - Magellan Midstream Partners LP
Yeah. It's really kind of a – we battle this almost every quarter.
The way we record volumes kind of skews what's happening really there on the system. If you look at what's really happening there, the volumes – the actual physical volumes move haven't dropped off that dramatically.
What's happening is we have Longhorn tariffs that are from the origin, Crane, all the way to destination points and we have Longhorn tariffs just to East Houston. And if a shipper ships to East Houston and stops and then, at a later date, ships to Texas City for instance, we count that as a volume – as a barrel on the distribution system.
If he doesn't do that, if we just ships from Crane all the way to Texas City, we don't show that as a volume on the distribution system. And so, there's some noise in there as how we count that, but there hasn't been significant drop off in the actual barrels being moved on the distribution system.
Brian Zarahn - Mizuho Securities USA, Inc.
Okay. And then, I guess turning to the M&A market and as more assets become available, how do you view the opportunity in 2017 to potentially add to your asset base?
Michael N. Mears - Magellan Midstream Partners LP
Well, the opportunity is, I think, significant. I think there's, even though, some Permian systems have transacted here in the last few months, there's still a number of those that are coming to market that we're interested in.
But, as we've said before, we're going to continue to evaluate those the way we've always evaluated assets and whether we can be successful in this environment or not remains to be seen. It's probably all I can say about that.
Brian Zarahn - Mizuho Securities USA, Inc.
And then on the splitter, I know it's a fluid situation, but was the cost still in the $300 million range for the project?
Michael N. Mears - Magellan Midstream Partners LP
That's correct.
Brian Zarahn - Mizuho Securities USA, Inc.
Okay. And then, what gives you some confidence that this could be re-contracted and, also, what is a sort of worst case scenario for the splitter?
Michael N. Mears - Magellan Midstream Partners LP
Well, there's a couple of things that give us confidence. First of all, if you just look at that the current, for lack of a better term, crack spread for the splitter, it's profitable to run even now.
One would expect as the abundance of condensate production is forecast in the Permian primarily and also the Eagle Ford happens that that spread would get bigger. Secondly, we have started discussions with other potential customers and those discussions are very early, but they're fairly positive at this point.
So that gives us some confidence also. Clearly, the worst case scenario would be we don't run it.
I think that the probability of that is extremely low. If there is value there, I think we'll find a way to extract it and there is value there.
But until we have a little bit more time, and as I mentioned in my comments, this just happened last week. So we have not been talking to other customers until this week.
So it's very, very early and I really – I would share more with you, if I could, but it's just too early in the process.
Brian Zarahn - Mizuho Securities USA, Inc.
Understood. Thanks, Mike.
Operator
And we'll take our next question from Theresa Chen from Barclays. Please go ahead.
Theresa Chen - Barclays Capital, Inc.
Hi there. First question is related to your updated CapEx guidance and the $250 million increase in 2017 from previous guidance and then $100 million increase in 2018; just wanted to get like a more detailed breakdown of those deltas.
I think, Mike, you mentioned that $200 million was due to Seabrook expansion, which I think is $125 million and itself, and then also the Huston distribution system pipeline, and then $2 million for BridgeTex what makes up the balance of $150 million increase?
Michael N. Mears - Magellan Midstream Partners LP
Well, one big piece of it is just carryover from 2016 to 2017. If you look at what we had forecasted we're going to spent in 2016, we didn't spend that level.
We were probably a $100 million light. And that's just timing, so that's moved over into the 2017.
So that's a big part of the variance. The rest of it's a just number of smaller projects that we've initiated.
Theresa Chen - Barclays Capital, Inc.
Okay. And then on your crude segment, I think you said it was 6% anticipated volume growth for 2017, including the projects.
What's your estimate for just base volume growth?
Michael N. Mears - Magellan Midstream Partners LP
It's flat.
Theresa Chen - Barclays Capital, Inc.
Okay. And then on the butane blending comments, what is the – so for the unhedged portion that's moving from $0.50 to $0.40, what's the net hit to EBITDA on that or, alternatively, what's your volume assumption for butane in 2017?
Michael N. Mears - Magellan Midstream Partners LP
I don't have that number off the top of my head. I can tell you that it's factored into our guidance; that our $1 billion guidance takes into account the lower margins we expect this year on our unhedged volume.
But I can't tell you off the top of my head, what that $0.50 to $0.40 is. Well, I'm being told it's about $10 million of EBITDA, and that's being partially offset by our blending volumes are going up.
Theresa Chen - Barclays Capital, Inc.
Great. Thank you very much.
Operator
And we'll take our next question from Gabriel Moreen with Bank of America. Please go ahead.
Gabriel Moreen - Bank of America Merrill Lynch
Hey, good afternoon. Not to hit on the splitter again, but I will.
Can you just maybe walk us through kind of what Trafigura's arguments are if you just found this out last week? Is there some sort of knockout provision they're claiming in the contract?
And then, I was just wondering, practically speaking in terms of the splitter, is that something you'd prefer to operate yourselves and is the splitter something where, hey, you're just looking at, as you termed it, Mike, for lack of a better term, crack spreads on a day-to-day basis as to whether to operate it or not? Or is it something where you're kind of like a full-fledged refinery and you've got to operate for a couple – for some time and kind of have turnarounds every once in a while?
Michael N. Mears - Magellan Midstream Partners LP
Well, to your first question, since we've initiated legal action, really not like to talk about it. The lawsuit is public document.
So you're free to go read that as to what's in there, but I probably shouldn't talk about that too much, so – and my counsel is nodding his head and agreeing with me. As far as our preference with regarding the splitter is to run it with a tolling arrangement like we originally intended.
That's not the only option. That's our preferred option if we can make it work.
There's a number of hybrids there all the way to the other extreme, which is we just essentially run it for our own account, purchase feedstock and run it and sell the resulting products that would be exposed to the crack spread. That we believe would be very profitable, but that's probably our least preferred option just given the variability in the earnings stream.
So that's where we're at.
Gabriel Moreen - Bank of America Merrill Lynch
Got it. Thanks, Mike.
And then, in terms of some of the Permian deals we've seen, it seems like a couple of those have been relatively creatively structured. I know that you're a stickler on price and have talked about your discipline there, but maybe can you talk about conversations in terms of structuring these deals, to what extent it may not be just a question of price per se?
Michael N. Mears - Magellan Midstream Partners LP
Well, I feel like you're trying to get to a specific issue and I'm not sure what it is. As far as structure, for instance, there was a recent transaction that just took place that had a low upfront price and then an earn-out.
We're very interested in those kinds of structures. However, most of the sellers to-date haven't been with the exception of the one party that did do it apparently.
So, yeah, we're interested in that kind of structure. Other than that, I think most of the sellers are primarily focused on price and so – rather than any other kind of contributions you can put out there.
So if that's what you were talking about, we're very interested in that. But, of course, that only works if you don't have somebody who's willing to pay the premium price without an earn-out and we haven't run into that opportunity yet.
Gabriel Moreen - Bank of America Merrill Lynch
Got it. No, that was helpful.
And then last question for me is just on butane blending and, again, I know it's not a huge driver here, but clearly the market got a little bit crazy in December on the price of butane. To what extent do you think that volatility was temporary, did it have an impact in December and I guess, as the butane market gets tighter, do you think more of that happens and has an impact?
Michael N. Mears - Magellan Midstream Partners LP
I think that was an unusual anomaly. We're not seeing it right now.
Clearly, as what we've assumed in our guidance, the butane market has changed versus what it has been just a few years ago with the exports of butane. And so, the margins are probably going to be a little bit less robust than they have been historically, but we've factored all of that into our guidance.
That being said, we do think, as commodity prices improve, that the margin will widen. I just don't know that it will ever get back to the dollar plus kind of margins we were seeing back in 2014.
Gabriel Moreen - Bank of America Merrill Lynch
Got it. Thanks, Mike.
Michael N. Mears - Magellan Midstream Partners LP
Sure.
Operator
And we'll take our next question from Shneur Gershuni with UBS. Please go ahead, sir.
Shneur Z. Gershuni - UBS Securities LLC
Hi. Good afternoon, guys.
Just not to hit on this traffic or contract again, I was wondering if you can sort of talk about whether it's a broader issue, about whether there is a need for splitters at all or is this really something that's just specific between yourselves and a counterparty. Should we see more contracts being cancelled with other trading counterparts and splitters elsewhere or do you think this is really just a unique situation?
Michael N. Mears - Magellan Midstream Partners LP
Well, from our perspective, it's a unique situation. We don't think that this is a commentary on whether this splitter is needed.
Again, as I mentioned, if you look at the current available margins to operate a splitter, they're positive right now. And so from our perspective, this is a unique situation and it's – I would not translate it into a broader view as to whether this splitter is needed.
I know you phrased it as splitters; clearly, there's a point where you could have too many splitters. We certainly don't think that's the case, and that this splitter in this environment with the current level of condensate production and the expected level of condensate production is needed.
Shneur Z. Gershuni - UBS Securities LLC
Okay. So, basically economically, it sounds like it should still be there since there's positive economics.
It's just – I guess we'll leave it to the lawsuit. I was wondering if we can talk about kind of your – I guess your CapEx backlog or your shadow backlog.
You're expecting to grow your distribution 8% this year and next year. How much do you feel that you'll need to spend on an annual basis to maintain that level, let's say, 19%, 20%, 21%, and have you identified a backlog of capital that would sustain that type of growth?
Michael N. Mears - Magellan Midstream Partners LP
Well, clearly, the amount you need to spend depends on what kind of returns you get on your spending. I think the math would say you'd probably need to be, on the low end, $400 million plus to – assume you're getting a reasonable multiple of $700 million or $800 million, you'd probably need to be in that range given the size of our company to grow at 8% a year.
I can tell you and we mentioned a few of the projects that are in the backlog. They're material projects and those projects alone can generate at least the ones that are visible for us right now, if we can execute on it, can give us some continued trajectory of that kind of distribution growth if they happen.
But when you start talking about 20% and 21%, that's too far out on the time horizon to really identify what those growth opportunities are. In our case, if you look at history, most of our largest growth projects that we've implemented in the 15 years we've been in existence, if you backed up three years before we actually start on those projects, many of them weren't on our radar screen.
So these projects develop over time and so it's very difficult for anyone, I think, to give you any kind of guidance beyond three years or so as to what the growth opportunities are going to be simply because the market changes and competition changes and administrations change, and so it's – I can't give you guidance beyond that, but I can tell you that we've got a strong backlog at this point in time that gives me confidence that we're going to be able to execute on some of those and be able to keep growing the company.
Shneur Z. Gershuni - UBS Securities LLC
When you think about your – kind of your business segments as to where some of these projects could develop, I was wondering if you sort of had a sense there. When we think about where crude production was in 2010 and what it got to you by 2014, I think it's fair to conclude that the next phase of recovery that, hopefully, we're currently in right now is probably not going to be as big in magnitude, so would assume less projects, let's say, on crude pipes.
Do you see the refined product business, do you see it as an area where you can grow? Is it going to be on the port side or exports?
I was wondering if you can sort of direct us to how we should be thinking about it.
Michael N. Mears - Magellan Midstream Partners LP
Yeah, the refined products side, clearly, there is a big focus on exports, and we've initiated a project in that regard. We've got the ability to expand that facility and we're in discussions with customers to fully expand it, different levels of maturity of those discussions, but filling it up is entirely possible, which could generate just in that one project alone $600 million to $700 million of incremental capital opportunity for us.
But, on the other side of the coin, pipeline transportation opportunities for refined products haven't gone to zero either. We just completed a line to Little Rock.
We're making a connection from that line into a line going into Memphis. We have an open season outstanding right now to build a new line to better serve the Central Texas market, the Dallas market.
There's a number of opportunities there in the refined products side that are being made available really by the change in logistics and where people want to move their products. I mentioned this before.
If you look at the Mid-Continent and kind of the core of our system, if you're in an environment of flat to slow decline in refined product demand, which I would highlight is primarily expected to happen because of the CAFE standards. One might state that CAFE standards may be under review under the current administration, which would be a significant positive for our industry.
But even absent that, if you got a slow decline in demand, the Mid-Con refiners need new places to take their physical product, which gives us opportunities. That was the driver behind – primary driver behind the Little Rock project, and there may be other opportunities related to that over time.
Shneur Z. Gershuni - UBS Securities LLC
Okay. Perfect.
I really appreciate the color. Thanks for outlining it.
Michael N. Mears - Magellan Midstream Partners LP
Sure.
Operator
And we'll take our next question from Jeremy Tonet. Please go ahead.
Jeremy B. Tonet - JPMorgan Securities LLC
Good afternoon.
Michael N. Mears - Magellan Midstream Partners LP
Good afternoon.
Jeremy B. Tonet - JPMorgan Securities LLC
Just want to follow up on the marine storage a bit here, and was wondering if you could break out a bit the revenue step up, how much of that was capacity additions versus higher rate?
Michael N. Mears - Magellan Midstream Partners LP
Most of its rate; I don't have the breakdown for you, but the majority of that is rate increases.
Jeremy B. Tonet - JPMorgan Securities LLC
Got you. Thank you.
Aaron L. Milford - Magellan Midstream Partners LP
Yeah. So rates are two thirds of it and we had some additional activity, just throughput fees and those sorts of things that drove it, that's two thirds of it.
Jeremy B. Tonet - JPMorgan Securities LLC
Okay, great. Thanks.
And then, I just want to make sure I'm thinking about the guidance the right way where it's 1.2 times cover this year and then next year, 1.1 times to 1.2 times cover with 8% growth. Does that mean, you don't expect a lot of DCF per LP unit growth at that point next year?
Is there a kind of a ramp to it? Is the 8% growth kind of pulling down coverage in that scenario?
Michael N. Mears - Magellan Midstream Partners LP
Let me tell you the kind of a high level way to look at it. When we're talking about 2018, again, we very conservatively give guidance.
We're not building in a significant crude oil volume growth on our pipes. We don't – let me just give some framework behind the 1.1 times lower level of that range.
So assuming we don't have significant incremental volume on our Permian pipes, assuming we don't start up the splitter, assuming commodity margins don't get any better and we don't see improved profits out of our blending business. If you assume all those things, we will likely be closer to the 1.1 times if we raise our distribution 8%.
If you assume that we're running the splitter that alone can move you up closer to the 1.2 times coverage ratio next year. So that's why we gave a range.
There's a number of unknowns, but we think the worst case scenario is the lower end of the range, but the more likely scenario is to be at the higher end of the range.
Jeremy B. Tonet - JPMorgan Securities LLC
So, if all those things go right, could you continually be above the 1.2 times or any thoughts you can provide there? I mean, 1.25 times or...
Michael N. Mears - Magellan Midstream Partners LP
Sure. We can lay out some very plausible scenarios where we're above 1.2 times.
We don't – we're not giving that as guidance, but you can lay out some very plausible scenarios when that would happen.
Jeremy B. Tonet - JPMorgan Securities LLC
Okay. Great, that's it from me.
Thank you.
Operator
And we'll take our next question from Faisel Khan with Citigroup. Please go ahead.
Faisel H. Khan - Citigroup Global Markets, Inc.
Thanks. It's Faisel from Citi.
Few questions. First, just on the splitter, what's the product yield that you guys get out of your splitters?
It's sort of the same thing we see out of other conventional splitters in the U.S. and around the world or is it something a little bit different?
Michael N. Mears - Magellan Midstream Partners LP
It's going to be consistent with what you see around the world. It does vary by the specifications of the condensate feedstock, which can vary the percentage of naphtha as you get in diesel fuel, but it's not any different really than any other splitter.
It's going to produce in the same kind of ranges.
Faisel H. Khan - Citigroup Global Markets, Inc.
By the third naphtha – third distillate or diesel, I should say, and the third some sort of fuel oil or atmospheric gas oil?
Michael N. Mears - Magellan Midstream Partners LP
That's roughly in the ballpark, yes.
Faisel H. Khan - Citigroup Global Markets, Inc.
Okay. And then, when you guys talk about it being profitable even in today's market.
So when I look at today's condensate pricing, about $4 under TI, that's sort of the number we should look at as in terms of where it could be profitable?
Michael N. Mears - Magellan Midstream Partners LP
I don't have my chart in front of me, but if that's – that's, yes.
Faisel H. Khan - Citigroup Global Markets, Inc.
Okay. Okay, understood.
And then, the types of projects you were talking about in the Magellan system, the one into the Dallas market, how large of a project could that be?
Michael N. Mears - Magellan Midstream Partners LP
Maybe $300 million range.
Faisel H. Khan - Citigroup Global Markets, Inc.
Okay, understood. And then just trying to understand the operating leverage to the Permian; as you talked about Longhorn and BridgeTex and you talked about the $2 million, I guess, expansion on the pipe at BridgeTex.
What kind of slack do you have in systems and how much excess capacity you think you have to sort of soak up in terms of what we could see over time as the Permian production growth?
Michael N. Mears - Magellan Midstream Partners LP
Well, on Longhorn right now, we don't have a lot of excess capacity. It's 10 or 20 a day.
On BridgeTex, we're shipping 210,000 barrels a day and we're just expanding it to close to 400,000 barrels, so...
Faisel H. Khan - Citigroup Global Markets, Inc.
Okay. That makes sense.
Okay.
Michael N. Mears - Magellan Midstream Partners LP
...a lot of available capacity on BridgeTex.
Faisel H. Khan - Citigroup Global Markets, Inc.
Okay. And then last question for me; the marketing affiliate that you guys had setup is there any sort of movement on that in terms of what you guys are doing or any activities that you're getting involved in after you sort of embarked on that new venture?
Michael N. Mears - Magellan Midstream Partners LP
Well, we haven't set one up yet. We're still evaluating it.
It's more likely than not that we will have one here in the future. The question with regards to the PDO we filed with FERC is really what the activities are that are allowed within the marketing affiliate, which will give us some guidance what we can do within the marketing affiliate.
But the marketing affiliate, we do think we'll have a useful role for us going forward with regards again to being able to collect the barrels and direct those to our long haul pipes.
Faisel H. Khan - Citigroup Global Markets, Inc.
Okay, got it. Thanks for the time.
Appreciate it.
Michael N. Mears - Magellan Midstream Partners LP
Sure.
Operator
And we'll take our next question from John Edwards with Credit Suisse. Please go ahead.
John Edwards - Credit Suisse Securities (USA) LLC
Yeah. Good afternoon.
Thanks for taking my question. Just to confirm, in terms of the guidance with the splitter not being there, we're kind of backing into it estimating roughly $80 million or so, maybe $75 million is how much of it – if it was in service and producing in for the customer, that's how much higher your guidance would have been, is that a fair number?
Michael N. Mears - Magellan Midstream Partners LP
You mean under the old contract or at the current spread?
John Edwards - Credit Suisse Securities (USA) LLC
On the current contract, if this contract cancellation hadn't happened, would the guidance to be somewhere around $75 million higher?
Michael N. Mears - Magellan Midstream Partners LP
That's – I don't really want to give out the contract numbers. That's a little high.
John Edwards - Credit Suisse Securities (USA) LLC
Okay. All right, fair enough.
And then, just in terms of the BridgeTex expansion, I'm just wondering, you indicated you're assuming flat volumes this year. So I was just wondering when you might expect those volumes to increase and maybe if you have a view on the trajectory of that increase for filling up the rest of the pipe?
Michael N. Mears - Magellan Midstream Partners LP
Well, that's the $64 million question, isn't it? As we've stated in our guidance, we have not guided to any significant incremental volumes on the system this year.
There is a possibility as we get near the end of the year that we could start seeing volumes and, certainly into 2018, we would expect to see the opportunity for incremental volumes to start ramping up through 2018. You then have kind of the step function there when Enterprise's line starts up that could kind of reset you a little bit and then have to build back up from there.
So our views is it's probably more materially a 2018 event than it is a 2017 event where we're going to start seeing incremental volumes. But we hope we're wrong, we hope it's sooner.
John Edwards - Credit Suisse Securities (USA) LLC
Okay. And then do you – given all the activity on the Permian, is it your view that you ultimately expect BridgeTex to fill?
Michael N. Mears - Magellan Midstream Partners LP
Yes.
John Edwards - Credit Suisse Securities (USA) LLC
Okay.
Michael N. Mears - Magellan Midstream Partners LP
We do. Again, it's a question is that a 2018 event or is that a 2020 event?
And you guys can look at various projections from different people and you'll get different answers all across the board. But we do think that BridgeTex will ultimately be full, yes.
John Edwards - Credit Suisse Securities (USA) LLC
Okay. That's helpful.
And then just in terms of the guidance, I don't know if you can get into this detail. Just curious, to what extent are there deficiency payments in the guidance, and then to the extent there are, when you expect that to not be the case.
We're assuming probably next year, but I was just curious.
Michael N. Mears - Magellan Midstream Partners LP
I don't have the number, but it's very, very small.
John Edwards - Credit Suisse Securities (USA) LLC
Okay.
Michael N. Mears - Magellan Midstream Partners LP
It's not a material number.
John Edwards - Credit Suisse Securities (USA) LLC
Okay, got it. Okay, that's it.
That's it for me. Thank you so much.
Operator
And we'll take our next question from Tom Abrams with Morgan Stanley. Please go ahead.
Tom Abrams - Morgan Stanley & Co. LLC
Hey, thanks for hanging in there with us. Question, as you talk people about Seabrook Logistics export opportunities, are they hung up at all on border tax issues and uncertainties such that if that was ever resolved, you might get a few things across the finish line?
Michael N. Mears - Magellan Midstream Partners LP
We haven't heard a lot of that yet. Of course, that's such a brand new issue that I think people are still trying to figure that out.
And I'm really not an expert on it. I'm not sure that that applies to exports, that was more of an import issue.
So, I don't think it's on a lot of people's radar screens. But, on that point, I can tell you that the market is very, very interested and excited about our export facility.
And so, we're not concerned at this point at all with the market interest in the Seabrook facility.
Tom Abrams - Morgan Stanley & Co. LLC
All right. And the other thing, I wanted to swing up to the DJ and just ask about the, as you've ramped up, if the competitive situation for uncontracted barrels, has it been pretty stable?
And then also, in as much as you see the Permian volumes growing in 2018, do you see a similar ramp in the DJ?
Michael N. Mears - Magellan Midstream Partners LP
The competitive situation has stayed pretty stable. We would expect to see a ramp in – of course, we have a contractual commitment ramp that's going to happen on our pipe just with our contracts.
But we would – the ramp, we're not expecting to be nearly as dramatic as it is out of the Permian. And we're probably going to be more leveraged to the growth from our two anchor customers than we are the other producers out there, even though we're aggressively marketing to the other producers.
Tom Abrams - Morgan Stanley & Co. LLC
All right, great. Thanks a lot.
Operator
And we'll take our next question from the Lin Shen at HITE. Please go ahead.
James Meyers Jampel - HITE Hedge Asset Management LLC
Hi. It's actually James Jampel from HITE.
And thank you for taking our question at the end here. On the ONEOK call, there is quite a bit of interest in the synergies between refined products pipelines and NGL pipelines, the potential for batching, and I was wondering if you guys look at that at all or what you think of that opportunity and how large do you think the synergies might be.
Is that something you could be interested in?
Michael N. Mears - Magellan Midstream Partners LP
Well, there's certainly the capability to batch refined products and NGLs. We do it today.
It's really just a matter of whether the pipes are in the right place to do that. So I'm not sure exactly what ONEOK was talking about, but we take advantage of those synergies today.
James Meyers Jampel - HITE Hedge Asset Management LLC
But is it something when you look at the maps that you would be excited about if the opportunity presented itself, perhaps with a partner of some kind?
Michael N. Mears - Magellan Midstream Partners LP
Well, I'm really not sure what partner we would talk about. But, certainly, if the opportunity was there, we'd be interested in it.
We feel like we've optimized that opportunity around our existing asset base to-date. If the question is, are there other assets out there that it makes sense to expand this into, I don't know the answer to that question.
There might be.
James Meyers Jampel - HITE Hedge Asset Management LLC
And lastly for me, if you look at potential acquisition targets, what types of businesses are most appealing to you when you look at that?
Michael N. Mears - Magellan Midstream Partners LP
Well, just on a high level, we're interested in businesses that are more like us, stable, fee-based businesses. That's kind of a high level deal.
We're not real interested in getting into the processing business or getting into businesses that have more commodity volatility. In particular, we've talked about before what we're interested in assets in West Texas, gathering systems that can provide synergies with our existing long haul pipes, and that's what we've been actively looking.
The market is pretty frothy out there in that environment right now, but those kinds of assets are attractive to us also.
James Meyers Jampel - HITE Hedge Asset Management LLC
Okay. Thank you very much.
Michael N. Mears - Magellan Midstream Partners LP
Sure.
Operator
And we'll take our next question from Jeremy Tonet from JPMorgan. Please go ahead.
Jeremy B. Tonet - JPMorgan Securities LLC
Hi. Thanks for the follow-up.
I'm not sure if you'll be able to comment, but I was just curious if you could say anything regards to the issue with Trafi, if it involved any of the delays that came with the splitter? Is that something that you could comment on?
Michael N. Mears - Magellan Midstream Partners LP
I really can't comment on it. Sorry.
Jeremy B. Tonet - JPMorgan Securities LLC
Understood. Thank you.
Operator
And we'll take our next question from Jerren Holder from Goldman Sachs. Please go ahead.
Jerren A. Holder - Goldman Sachs & Co.
Hi, good afternoon. I know the previous question sort of touched on this, but outside of sort of Permian gathering acquisitions, obviously, you guys are spending a lot of CapEx in the Gulf Coast building and storage and infrastructure, is that an area where you're looking at M&A opportunities as well?
Michael N. Mears - Magellan Midstream Partners LP
We haven't been recently. We did look at a few things a few years ago and we couldn't make it work.
And the truth is we get better returns out of building organically, so that's what we're doing at Pasadena, that's what we're doing at Seabrook. I wouldn't rule it out.
If the right opportunity came across the desk, we would look at it, but we're not actively working on anything right now.
Jerren A. Holder - Goldman Sachs & Co.
Okay. Thank you.
Operator
And it seems we have no further questions.
Michael N. Mears - Magellan Midstream Partners LP
All right. Well, thank you.
I know it's a long call today, so thank you for spending your time and we're pleased with our results in 2016 and we're looking forward to 2017. So, thank you.
Have a good day.
Operator
This does conclude today's program. Thank you for your participation.
You may disconnect at any time.