Is the first midstream MLP offering by an oil major a forerunner of spinoffs to come?

On June 18 Royal Dutch Shell (NYSE: RDS-A) filed paperwork with the Securities and Exchange Commission (SEC) to form Shell Midstream Partners (which will trade as SHLX). Shell Midstream Partners was recently formed by Shell Pipeline Company (SPLC), a midstream subsidiary of Royal Dutch Shell. The offering is expected to raise no more than $750 million, and the preliminary filing suggests Shell will retain a 2% general partner interest along with 49% of limited partner units.

Shell has yet to announce a date for the IPO, though it is expected to launch this year. Nor has the sponsor provided a suggested offering price or specified a minimum distribution. However, the company has identified the assets it will transfer to Shell Midstream Partners before the IPO.

Initial assets of Shell Midstream Partners will include interests in two refined products pipelines and two crude oil pipelines:

• A 49% interest in Bengal Pipeline Company, which owns a refined products pipeline that connects four refineries in Louisiana

• A 1.612% ownership interest in Colonial Pipeline Company, which runs a major finished product line connecting the Gulf Coast to the East Coast

• A 43% interest in Zydeco Pipeline Company, which will own the Houston-to-Houma crude oil pipeline system

• A 28.6% interest in Mars Oil Pipeline Company, which owns the Mars crude oil pipeline

The Bengal Pipeline is operated by SPLC and connects four refineries in Louisiana with the Plantation and Colonial pipelines, providing market outlets to the East Coast. As of March 31, approximately 67% of Bengal’s capacity was subject to minimum volume commitments under ship-or-pay contracts with an average remaining term of approximately three years. The Bengal Pipeline is forecast to provide 13.1% of the partnership’s forecasted cash available for distribution for the 12 months ending June 30, 2015. SPLC will retain a 1% interest in Bengal.

 Colonial Pipeline Company (Colonial) operates the largest refined products pipeline in the United States. The pipeline runs from Houston to Linden, New Jersey, traversing 11 states across the southeast and eastern seaboard. Colonial transports more than 100 million gallons per day of refined products, or approximately 50% of refined petroleum products consumed in the East Coast region of the United States, through its 5,500 mile system. The pipeline ships more than 40 different refined products (primarily gasoline, diesel fuel and jet fuel) and directly connects to major airports in Atlanta, Nashville, Charlotte, Greensboro, Raleigh-Durham, Dulles and Baltimore-Washington. The Colonial Pipeline is projected to provide 4% of the partnership’s forecasted cash available for distribution for the 12 months ending next June. SPLC will retain a 14.508% interest in Colonial. 

Colonial Pipeline System.

Source: Colonial Pipeline Company

Zydeco Pipeline Company (Zydeco) is currently owned by SPLC. Zydeco will own the Houston-to-Houma, Louisiana crude oil pipeline system (Ho-Ho), and is projected to provide 64.3% of the partnership’s forecasted cash available for distribution through next June.

In December Shell completed Phase 2 of a project to reverse the flow of Ho-Ho, which would allow crude oil production from the Eagle Ford and Bakken to flow from Texas to refineries in Louisiana. Additional expansion projects are underway, and when completed approximately 87% of the expanded capacity of Ho-Ho will be subject to ship-or-pay contracts with a weighted average remaining term of more than eight years. SPLC operates Ho-Ho for Zydeco, and SPLC will retain a 57% interest in Zydeco. 

The Mars Oil Pipeline Company (Mars) operates a major crude oil pipeline originating approximately 130 miles offshore in the Gulf of Mexico and terminating in salt dome caverns in Clovelly, Louisiana. Mars transports offshore crude oil production from the Mississippi Canyon area to trading hubs in Louisiana. Mars is forecast to provide 18.6% of the partnership’s cash flow through next June. SPLC operates the Mars pipeline system and retains a 42.9% interest in Mars.

SPLC will own the general partner, a significant limited partner interest, and all incentive distribution rights. The partnership agreement will entitle the general partner (SPLC) to initially receive 2% of distributions. The incentive distribution rights will entitle it top a rising percentage (13%, 23% and 48%) of quarterly distributions per unit above thresholds that have yet to be specified.

The partnership projects cash available for distribution for the 12 months ending June 30, 2015 of at least $96.5 million, which is $51.9 million more than the pro forma cash available for distribution generated for the 12 months ended March 31 and $59 million more than the pro forma cash available for distribution generated during 2013. The projected increase in the cash flow stems from the completion of the Ho-Ho reversal and additional Ho-Ho expansion projects.

Shell Midstream Partners intends to grow by acquiring more of Shell’s extensive portfolio of midstream assets, carrying out expansion projects on the initial portfolio of assets, and potentially pursuing strategic acquisitions from third parties. In all likelihood, as with other midstream dropdowns, much of the future distribution growth will rely on the acquisition of additional Shell midstream assets, and Shell has a very large portfolio of those assets that can drive the growth of the partnership for many years to come.

We won’t be making a formal portfolio recommendation until an updated registration statement before the IPO fleshes out the expected distribution numbers and the scale of the offering. But we expect the IPO to be in great demand and anyone who can secure a brokerage allocation would probably be wise to take the plunge.

Not only are the initial assets Shell is offering strategic and lucrative, but institutional interest in them could set the stage for similar offerings by the likes of ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX). The stars appear to be aligned for a low yield and a big pop on the first day of trading.