Good afternoon. My name is Chris, and I will be your Conference Operator today. At this time, I would like to welcome everyone to the Tidewater Midstream and Infrastructure Limited second quarter results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Joel Vohra, you may begin your conference.
Thank you, Chris. Hello, everybody. On the call with me today, as usual, is Joel MacLeod, Tidewater's President and CEO. Before passing the call over to Joel for a review of the quarterly highlights, I'd like to remind everyone that comments made today may be forward-looking in nature based on current expectations, estimates or judgments, and projections. Forward-looking statements we may express or imply today are subject to risk and uncertainties, which can cause actual results to differ from expectations. Some of the information provided refers to non-GAAP measures. To know more about forward-looking statements and non-GAAP measures, please refer to our various reports, which are available at tidewatermidstream.com or on SEDAR. With that, I'll pass it to Joel MacLeod for a review of the quarterly highlights.
Thanks, Joel. Good morning, everyone. Thanks for joining our Q2 2019 conference call. We appreciate all the support from our shareholders, stakeholders and staff as Tidewater sits near all-time lows, and I personally have more conviction than ever to increase my shareholdings in Tidewater when conditions permit. Our second quarter feels like a typical Q2, which is not overly exciting, but in line with consensus and similar to Q1 at approximately CAD 22 million of EBITDA in both Q1 and Q2 2019. Our focus remains on our two large capital projects, where our Pioneer pipeline to TransAlta came online at the end of May, approximately four months ahead of schedule, and our Pipestone sour deep cut plant is currently being commissioned and is scheduled to be online in the next 30 days or so.
We remain confident in our ability to deliver over 50% EBITDA cash flow growth in the next 3-5 months with our two large capital projects being online in the next 30 days and our TransAlta pipeline take-or-pay kicking in in November. Our team has done an incredible job in transforming our contracts and customer base through the addition of over 10 new take-or-pay contracts ranging from 5-15 years and including adding over five investment-grade counterparties. Extending our two largest customers at Pipestone from five-year take-or-pays to 10-year take-or-pays is a huge accomplishment by the team and should give shareholders confidence in long-term contracted cash flows in one of the most active areas in Western Canada. The transformation of Tidewater's customers and contracts has been recognized by numerous infrastructure funds and private equity pools of capital.
Our balance sheet remains a key focus as we work to reduce leverage and focus on bringing leverage back down towards 3 times debt to EBITDA with our two large projects coming online. Also want to reiterate that we remain committed to not raising equity at current levels. We have more customer support than ever, and the focus over the next 60 to 90 days is our funding plan for Pipestone Phase 2 and the related potential formal investment decision to proceed with Pipestone Phase 2. We continue to have several options to fund the next CAD 200 million-CAD 400 million of capital, where our preference is not to issue equity at these levels and not to take on more leverage. On our Pipestone Montney deep cut sour plant, a quick update.
Our operations and engineering team has done an incredible job where our commissioning is in full gear, and we expect to be online in approximately 30 days. The project remains on time and on budget. Pipestone remains one of the most active areas in Western Canada, if not the most active, with over 80 wells spud in 2019 alone, and the area continues to be short processing capacity. We continue to be inbounded by producers looking for processing capacity at our Pipestone plant, where we feel we can offer the highest liquids yields netbacks in the area and also offers connectivity to gas storage. Unfortunately, we are fully contracted for Pipestone Phase 1, which is a great problem for Tidewater and our shareholders to have.
Again, we want to thank our customers Encana Pipestone, Advantage, NuVista, our two investment-grade customers, and a few others who wish to remain nameless for the time being. Your support means a lot to us. Our Pioneer pipeline to TransAlta came online in May, approximately four months ahead of schedule, and continues to test record throughput levels. We don't expect full EBITDA cash flow until November when our take-or-pay kicks in. We are actively working with our partner in TransAlta to expand the pipeline above 130 million cubic feet a day, where the pipeline does have capacity in excess of 400 million cubic feet a day with incremental capital compression. A big thank you to our partner in TransAlta, who has been an incredible partner, and we look forward to growing our partnership with them in the future. Our gas storage business continues to see record throughput and contracting.
Our gas storage team continues to do a spectacular job. We have recently extended contracts to as far out as 8 years with investment-grade counterparties. We see significant growth in our gas storage business. It acts as a natural hedge in a tough natural gas environment as we're seeing today. As we discussed on previous calls, our Brazeau River fractionation facility remains fully contracted. We continue to see record volumes. To wrap up, just want to reiterate, we remain confident in our ability to execute our plan, where EBITDA cash flow is expected to increase by greater than 50% in the next three to five months as our two large projects come online and related take-or-pay contracts kick in. With that, I'll pass it back to Mr. Vohra. He can walk you through some of the details around the financial side of our Q2.
Thanks, Joel. Hi, everyone. I'll walk through some of the results, then we can open it up for questions. Overall, revenue for the quarter up again, mostly related to the increased crude oil business pipeline and rail shipments on crude oil OpEx and revenue up about CAD 30 million. Continue to explore new markets, test new markets, and grow that business for opportunities in the future. That's the main driver behind the increase in revenue and OpEx. Operating margin, about CAD 25 million for the quarter. Adjusting for realized gains on commodity hedges, that'd be similar to Q1. To echo Joel MacLeod's comments, a quarter sort of in line with our expectations, similar to Q1.
With gas prices coming off, we do see a little bit of pressure on the processing business, which is largely made up for in the gas storage business and did have record throughputs in gas storage and probably a record quarter for gas storage, largely offsetting what we see as far as pressure on AECO prices. EBITDA, around CAD 22 million, which I think was close to consensus, probably in line with our expectations. A few pieces made up again for the decline in AECO gas prices, but also that volatility in commodity prices, we're able to capitalize in some areas, given pipeline rail connections, gas storage, and multiple end markets. Sometimes that volatility is a bit of a benefit.
Payout ratio, maintain a payout ratio for the six months around 25%, 29% for the quarter, around CAD 11.5 million, a little bit down, partly related to increased finance costs related to capital. That big piece is behind us now when we look at capital on the balance sheet and net debt around CAD 65 million of net cash spend for the quarter, which is starting to come down. Q1 would've been our most capital-intensive quarter by far in the history of the company. Q2 started to come off. Now with Pipestone Gas Storage, the Pioneer Pipeline, and the Pipestone Gas Plant all essentially either commissioned or near in commissioning, that capital-intensive period is sort of behind us. Great to see that we've been able to execute on the projects, and we'll start to realize that cash flow here in large part in Q4.
Subsequent to the end of the quarter, closed the Pipestone gas storage deal where those assets have now moved into a limited partnership. We've been funded by our joint venture equity partner, CAD 25 million. You'll see that short-term contribution liability sitting on the balance sheet. That'll go away. We've now been funded the non-recourse CAD 30 million non-recourse debt in the limited partnership related to gas storage. That came in subsequent to the quarter. I think most are aware, closing of the convertible debenture of CAD 75 million, which again further helps liquidity and balance sheets and helps round out the capital project. I think, with that, nice to see the most capital-intensive piece in the history of the company sort of behind us and looking forward to those cash flows coming online. I think with that, we'll open it up to questions.
Absolutely. At this time, I'd like to remind everyone, in order to ask a question, press star, then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question will come from the line of Rob Hope of Scotiabank. Please go ahead. Your line is open.
Hello, everyone. First question, just want to touch on the Pipestone Phase 2. Just as you're looking at your cost of equity and cost of capital, what financing alternatives are you looking for? Is it a private equity partner, or could we see customers given an option to participate like we did in Pipestone Phase 1?
Hey, Rob. Joel here. I think today all options are on the table. We want to find, I believe, the most attractive option for our shareholders. It's great to have the interest we do with various private equity groups and continue to spend time. I'm not going to directly answer your question, but I think we're evaluating various options and real happy with the amount of interest we've seen. Even extending the Pipestone Energy contract from five to 10 years with our recent acquisition was very helpful in cost of capital and options. We continue to work through options and are excited to attempt to move the project forward.
Then maybe a follow-up question just on Pipestone as well. If we go back to Pipestone Phase 1, you did sanction that with quite a bit of white space in the plan. Could we see you do something similar to that with Pipestone Phase 2? I'm just trying to get a sense that is it customer interest that's the gating factor, or is it your source of the capital?
Yeah, I would say today it's more towards the financing plan that we're happy with. We've got multiple options in front of us. Customer support would be, I'd say, similar to Phase 1 when we FID, where we were in that 60% customer support and maybe a little higher. When we see WTI move as much as we have, and then even some of our customers hitting all-time lows, we just want to reiterate that there's no guarantees that we will continue to have the customer support that we do. Right now, we've seen more customer support than we've ever seen. Pipestone Phase 1 has more interest in volume than we can handle and want to move while we have that customer support.
Thank you. I'll hop back in the queue.
Your next question will come from the line of Patrick Kenny of National Bank Financial. Please go ahead. Your line is open.
Hi, guys. Just maybe at a high level here, a lot of moving parts and various projects in various stages. I'm wondering if we can get a quick update on what % of, say, Q4 run rate EBITDA would be under take-or-pay agreements, and also what the weighted average contract life looks like exiting the year.
Good question, Pat. Obviously, with the Pioneer Pipeline coming on and the Pipestone gas plant, as well as storage, all three of those projects have significantly increased our weighted average contract life and take-or-pay. We'd be probably in the 60%-70%-ish range of take-or-pay type contracts and weighted average as a company. I'd have to think, but I know Pipestone gas plant weighted average is about 8-9 years. The Pipestone storage facility is six years, and then obviously the TransAlta pipeline piece is 15 years. Definitely has changed the base business and excited for those contracts to come online in the fourth quarter. They would be definitely our longest and strongest contracts, and even gas storage, having essentially all of the customers being investment-grade is big for us.
Just to confirm, you're still comfortable with the CAD 125 million-CAD 135 million of adjusted EBITDA for 2020, obviously prior to accounting for the Pipestone East Battery, and liquids infrastructure investments?
Yes.
Okay.
Having the projects behind us, I think is a key factor there. Yeah.
Great. BRC, currently flowing, I don't know, around 80 million a day, I believe, versus TransAlta looking to pull 130 a day through Pioneer by November. I assume what doesn't come from BRC will be tied in from NGTL. At some point, do you expect most of the volume to be pulled through BRC? Maybe put differently, is TransAlta incentivized in any way to contract with producers and go through BRC, or are they indifferent from taking it off NGTL?
Yeah, I think it's a good question. I think to the extent that we can draw producers to BRC, having gas storage too, and pipelines, a frac there, three NGL pipeline connections, is big. TransAlta has been involved in producer discussions and potential to bring additional producers to BRC. That being said, we do have a pile of options at BRC to fill that pipeline. One would be pulling off NGTL. Gas storage is another big piece, and then producers coming through BRC. I'd say that all of the above are in motion.
Great. You have some fractionation contracts also coming off of BRC in March of next year, I believe. Can you remind us what portion of the frac capacity this represents and maybe when you expect to have this portion recommitted and for what tenure?
Yeah, I think it's a good question. I think off the top of my head, maybe I won't give you a % of exactly what comes due in Q1 2020. I know we do have some longer-term three-year contracts there. Generally, though, we see those contracts sort of in the fourth quarter of the year get renewed, and generally on the NGL type season, similar to a gas storage season, where you're in that April to April timeframe. I'd say into the fourth quarter, we'd start to look at extending those contracts. We do have some are 12 months, but we do have some longer-term commitments up to three years there. I'd say maybe half, but don't hold me to that.
Okay, the last one from me, guys. Joel, maybe you can just walk us through your outlook on the leverage front here, where you expect to exit the year from a net debt and debt-to-EBITDA ratio perspective, and then how you see your leverage trending through 2020 relative to that three times target?
Yeah, I think now that we've got the big projects behind us, we'll start to see that leverage stabilize. Obviously, looking at the next phase of growth, but right now, barring any massive capital projects, and I wouldn't say that we aren't going to move forward with new capital projects or the new program. Barring that, we would be generating significant free cash flow, bringing leverage levels down through 2020, and to echo Joel MacLeod's comments, targeting that
Three times debt to EBITDA range. Obviously, with cash flow coming on with the new projects, we'll significantly deleverage there, where we've spent a significant amount of capital, obviously without the cash flow coming online quite yet. The target would be moving down closer to that three and a half, three times. That being said, we are evaluating the next phase of growth. I guess to answer your question, Patrick, in that three to three and a half times would be the target go forward.
Okay, great. That's it from me, guys. Thanks.
Thanks, Pat.
Your next question will come from the line of Robert Catellier of CIBC Capital Markets. Please go ahead. Your line is open.
Hi. I'd like to echo some of Pat's questions. If you can get the take-or-pay and the average contract life breakdown into your investor presentation, that would be helpful. I'd also like to have, on a similar basis, the investment-grade counterparty breakdown, if you have that, again, on the same basis, the run rate with the new assets you've added here.
No problem, Rob.
The one thing I noticed, you made reference to plans for the crude oil midstream business and the contract on capacity on third-party pipelines. I was wondering if you could walk through the strategy there a little bit and whether that's expected to consume any balance sheet capacity and how you would manage the commodity price risk on the marketing business? I think you're 50%-100% hedged, but any plans to take up that hedge if you have bigger commitments on pipes?
Yeah. Rob, our plans would be to dip our toe when we started to have to. I don't want any of our shareholders or the market to perceive us making a massive pipeline commitment. We do have some commitments that are small but we've done a really good job there and generated some significant EBITDA, and we back-to-back with refiners as buyers and then producers we know on the supply side. At this point, I don't think we necessarily want to get into the details. I think the main message would be they're immaterial or close to being immaterial, but we are considering adding, and we would back-to-back those with buyers, with refiners, and parties that we continue to grow our business with. We see them more as a tolling type of opportunity where we can offer egress for producers and lock in some margin and cash flow.
Okay. Effectively, what you're basically doing already, just a little bit larger.
Potentially, yes. With Enbridge Mainline and Anomset, I know we're going to participate there, but we review all open seasons and have been involved in a few and continue to evaluate. When you see Brent to WTI today at three, an example would be we've got a Brent to WTI hedge at CAD 9, very small volume. Just want to give perspective that we continue to evaluate opportunities and I think our team's done an incredible job in leveraging off our knowledge and our relationships to generate tolling EBITDA off our crude oil infrastructure.
Okay, last question from me is on the potential for Pipestone Phase 2. Have you given any more thought to scoping that, particularly what you might do, they might treat the sour gas?
On Pipestone Phase 2, current plan is to go to 8% H2S. That is not a guarantee, but we are looking to have a little more flexibility than what we have with Pipestone Phase 1. Pipestone Phase 1, as we've seen, was a bit of a race for us, and as a result of executing on that, we've got more interest than we can handle. Today, our plan is to move towards 8% H2S.
Would that be acid gas injection or sulfur?
You'll see public data will show we're currently drilling our second AGI well. If our second AGI well exceeds our expectation, there is an opportunity that phase 2 would be AGI. For now, we're planning for sulfur recovery.
Okay. Thank you.
Again, if you'd like to ask a question, press star, then the number 1 on your telephone keypad. Your next question will come from Robert Kwan of RBC Capital Markets. Please go ahead. Your line is open.
Good morning. If I can just go back to the financing side of things and all the different things you're looking at. Obviously, the total cost is probably going to be the governing factor. If you had your way, how do you think about joint ventures, whether that's taking a partner into a new project or selling down an existing asset versus just an outright sale of an asset to raise funds?
Good question, Rob. It's something we've been working through for six months. Ideally, we keep our story as straightforward and as simple as possible. When our plan is not to raise equity at current levels and not add debt, I think you get a sense that joint venture private equity capital is where we're going to head. We could sell down a working interest in Pipestone Phase 1 at a premium, or we could look to roll Pipestone into a joint venture. I would say we're evaluating those options. Complexity is something that we don't necessarily lean towards. If our cost of capital is, I don't know, 7%-9%, it's something we feel we need to evaluate.
Pipestone Phase 2 is an opportunity we don't want to pass on given we continue to be inbounded by competitors, private equity groups on being involved in Pipestone as it's, to us, the most active area and the wells continue to get better and better in the area.
Got it. How do you think about, you mentioned earlier, customer options? How do you go into it thinking about that, given there's no certainty that the option gets exercised and then you're stuck with the capital?
On, as far as customer exercises, so with our Pipestone Energy agreement, they no longer have the option to exercise. Our preference would be to no longer have producers that have the option to have an ownership. I guess depending on the customer, and I don't want to be negative to Kelt or others, but when private equity capital would rather deploy more rather than less capital, and even us, we'd rather own and operate 100% assets as we grow Tidewater to a point in three, five, 10 years where we become an attractive acquisition target. Our preference would be own and operate 100% versus having 80% or definitely a non-op situation is definitely not what we want to be into, but we'd like to own and operate 100% where possible.
Got it. Does the significant share price weakness that we've seen, does that change or cause you to rethink the capital allocation strategy? If so, what are some of the different things you're thinking about?
Not really. We've been sideways on our share price for four years. Moving down just reiterates our comments that we won't be issuing equity at these levels. If we were up at CAD 2, I think, yeah, absolutely, it would definitely probably lean to considering equity. Right now, it just reiterates our message. Great to have multiple strong large infrastructure funds that want to be involved in what we're doing, especially up in that Pipestone area.
Maybe I'll just finish, and it's a little bit along the same lines. Joel, you made the comment at the outset of the call that you've got more conviction than ever to increase your holdings. I guess I'm also wondering, though, have you considered monetizations of assets to raise capital to effectively invest in what you see as undervalued assets via share repurchases?
I would say we're evaluating all options, Rob, with our leverage and then our two projects coming online. I think step one is just focus, getting our cash flow growing. We are having those discussions. We had our board meeting yesterday as far as share repurchases, and at a point, we feel it would make sense. It's just step one is getting our cash flow online. Monetizing non-core assets, again, is something we're discussing with our board and would consider. We just don't want to set the expectation that we can sell non-core assets at a massive premium or being accretive to Tidewater where we're at today. Do want to be clear, yes, definitely evaluating disposition of non-core assets and would love to be buying more stock either personally or, and are starting to look through even Tidewater considering that.
Don't want to pound the table and say we are with X% certainty going to be stepping in with an NCIB, but it's something we have to consider with our share price where it's at today.
Great. Thank you very much.
Thanks, Rob.
Your next question comes from Elias Fasoulos of Industrial Alliance. Your line is open.
Good morning.
Hi, Elias.
Regarding Pipestone Phase 2, you have mentioned you plan on sanctioning or making a decision towards year-end. Have you publicly mentioned the potential size of that expansion?
Yeah, I think there's a range, Elias. It obviously depends on the day, commodity price, producer sentiment. It would be in the, today, 100 to 120 million cubic feet a day. That can change. As we see WTI move up on days like today, it could be greater than that, but today, that's the range we would be considering today.
Okay. Moving on to the Pioneer line. It had some flow in Q2 of, I'm going to say roughly running about 35%-40% capacity. Proportionally speaking, before it gets up to its 130 later in the year, would this be producing less EBITDA than its proportional throughput maybe due to some contractual nature? In other words, can we see a step up from one volume into some sort of pricing, or was this running at the rate that proportionally you would expect?
Yeah. For commissioning and startup, I'd say we've probably even exceeded our expectations. I believe we've been very clear that the take-or-pay doesn't kick in till November of 2019. Also on TransAlta's side, they've been great that they've tested both Sundance and Keephills. That's what the first five or so months here are to do, is test operationally what we can and can't do. I'd say everything's in line, and we're excited to step into November, December and see what we can do. Overall, I'd say going as planned.
Okay. Moving to the Pipestone East battery. I know you've inherited something that's existing, and also you plan to put some more capital into it. Is it going to be generating any cash flow in the interim period, or will we see really all of it coming in, as you said, 12-18 months?
Yeah, you'd see most, Elias, in 12 to 18 months. There's a little bit, but I wouldn't say it's material enough for us to change any projections or guidance. There is a little bit that comes on in the short term, but the majority would be once that facility is complete.
Great. That's it for me. Thanks a lot, and I'll turn the call back.
Thanks, Elias.
Your next question comes from Curtis Jensen of Robotti & Company. Your line is open.
Hey, good afternoon or good morning, fellas. Non-operations question for Joel MacLeod. Joel, I think as part of the convert offering, there was mention that your intention was to increase your ownership with the use of a loan where you were going to pledge your existing shares as collateral. Is that accurate?
Yep. Correct, Curtis, and legal counsel is advising me not to get into the weeds, but I can assure you, I have more conviction than ever and want to continue to add to my position. It'll be a function to when conditions permit, and there's a lot of moving pieces right now as far as what's material and what's not material information.
Well, you can not answer. Is there a mechanism in there that is essentially a margin call mechanism that if the stock keeps going down, your collateral would be called away?
There is, but the amount that I've pledged in margin, there's more than significant room for me to step in and happy to do so. I think I'm just trying to position myself where I can make one of the larger purchases that I have over the past four years and really believe in what we're doing and want to show our shareholders that we believe in what we're doing.
All right. Then maybe for Joel Vohra, just one quick one on. I don't know, is there a bridge between sort of your adjusted EBITDA and distributable cash? It seems like the gap was a little wider this quarter, and I don't know if it was related to working capital or I know you have sort of a written description of what each is, but if you could quantify it somehow, now or in the future.
Yeah. Curtis, the main pieces would be increased financing costs related to just draws on the facility commensurate with that capital program. That would be one piece. I think there was when you add together maintenance capital and some decommissioning pieces were in line with guidance, but we were a little light in Q1. We had CAD 16 or so million in distributable cash flow. A little more of that came in in Q2, and the other piece would be one-time FX rate moving. We hedge all FX exposure. When you have CAD, U.S. dollar moves right around period end, that can have an impact too. That would be one other impact. I'd say overall, when we're guiding to around a 25% payout ratio, that's still what we'd expect for the year.
All right. Thanks. Thanks a lot, guys.
Thank you, Curtis.
There are no further questions at this time. I will now return the call to Mr. MacLeod.
Well, thanks everyone. We really appreciate time, support, shareholders, staff, stakeholders, credit syndicate. Everyone have a good day, and thanks again.
This concludes today's conference call. You may now disconnect.