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3 Energy Mergers That Need to Happen

Matthew DiLallo, The Motley Fool

There have been several notable deals in the energy midstream sector this year. In February, NuStar Energy agreed to buy its parent, NuStar Energy Holdings. Not more than a month later, Tallgrass Energy sealed a deal to buy Tallgrass Energy Partners. Meanwhile, last month, there was a wave of mergers in the sector as Williams Companies (NYSE: WMB) agreed to acquire Williams Partners, while both Cheniere Energy and Enbridge (NYSE: ENB) offered to buy out their publicly traded affiliates. Those deals make it increasingly likely that the rest of the industry will fall in line by announcing similar deals where affiliated midstream companies combine into one single entity. Here are three deals that should happen next.

Just waiting for the press release

On the company's first-quarter conference call, the management team of Energy Transfer Equity (NYSE: ETE) and Energy Transfer Partners (NYSE: ETP) let investors know they're working on a transaction to simplify their corporate structure. CEO Kelcy Warren stated that the deal would "most certainly be a structure whereby ETE acquires ETP." That's because they've "looked at every scenario possible to us," according to Warren and "don't see any mathematical scenario that makes any sense other than that one."

People shaking hands overlaid with arrows pointing upward.

Image source: Getty Images.

Those comments make it abundantly clear that Energy Transfer Equity plans to announce a simplification transaction sooner rather than later. The holdup is that the combined company needs to get its leverage ratio down so that it receives an investment-grade credit rating. That should happen naturally over the next few quarters as the $10 billion of expansion projects Energy Transfer Partners has under construction start generating earnings, which would boost that side of the leverage equation. Once the companies get the all-clear from credit rating agencies that they're safely within investment-grade territory, they'll likely announce this deal. 

A broken vessel with only one viable option

For years, Canadian pipeline giant TransCanada (NYSE: TRP) has used its master limited partnership (MLP) TC Pipelines (NYSE: TCP) as a source of capital by dropping down assets to that entity in exchange for cash. However, a regulatory policy change earlier in the year hit TC Pipelines hard, which caused the MLP to slash its distribution to investors. These changes have weighed heavily on the MLP's valuation and access to capital. Because of that, TransCanada no longer believes it can use TC Pipelines as a viable funding option.

That leaves TransCanada with only one alternative: Join fellow Canadian pipeline giant Enbridge in buying out its MLP. That would not only reverse the impact of the policy change on the cash flows of the pipelines owned by the MLP, but simplify TransCanada's corporate structure. While TransCanada might wait for the dust to settle on Enbridge's consolidation before announcing a deal for its MLP, it seems like only a matter of time before the company makes this move. 

The next logical step 

Two years ago, Plains All American Pipeline (NYSE: PAA) and Plains GP Holdings (NYSE: PAGP) took a step to simplify their corporate structure by eliminating the costly incentive distribution rights (IDRs) that Plains All American paid to Plains GP. In exchange, Plains GP acquired a 34.8% stake in the MLP. While that deal was certainly a step in the right direction, the companies could eventually take the next logical progression by combining into one entity.

That's the path both Williams Companies and Enbridge have taken over the past year. The pipeline giants initially eliminated the IDRs paid by their MLPs in exchange for a larger stake in those entities before making offers this year to combine into a single company. It's a blueprint that makes sense for Plains to follow, because it would have similar benefits by reducing the combined company's cost of capital, which would make it cheaper to secure funding to finance future expansion projects. While Plains hasn't hinted that it's considering this move, the company still might announce it by early next year, which is when Plains expects to achieve its leverage target and announce plans for distribution growth going forward. 

Stronger companies should yield better returns

The reason so many midstream companies are combining is that these deals will make them stronger by reducing costs and increasing their access to capital, which should enable them to make more money for investors in the coming years. That's why we'll likely see more deals announced in the coming months as additional companies realize the benefits of simplifying. As those deals happen, it should make the midstream sector a better place for investors.

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Matthew DiLallo owns shares of Enbridge. The Motley Fool owns shares of Enbridge. The Motley Fool has a disclosure policy.