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Edited Transcript of SHLX earnings conference call or presentation 21-Feb-19 3:00pm GMT

Q4 2018 Shell Midstream Partners LP Earnings Call

HOUSTON Mar 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Shell Midstream Partners LP earnings conference call or presentation Thursday, February 21, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jamie Parker

Shell Midstream Partners, L.P. - IR Officer

* Kevin M. Nichols

Shell Midstream Partners, L.P. - President, CEO & Director of Shell Midstream Partners GP LLC

* Shawn J. Carsten

Shell Midstream Partners, L.P. - CFO, VP & Director of Shell Midstream Partners GP LLC

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Conference Call Participants

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* Derek Bryant Walker

BofA Merrill Lynch, Research Division - VP

* Jeremy Bryan Tonet

JP Morgan Chase & Co, Research Division - Senior Analyst

* Shneur Z. Gershuni

UBS Investment Bank, Research Division - Executive Director in the Energy Group and Analyst

* Spiro Michael Dounis

Crédit Suisse AG, Research Division - Director

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Presentation

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Operator [1]

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Good morning. My name is Gigi, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter 2018 Shell Midstream Partners Earnings Call. (Operator Instructions)

I will now turn the call over to Jamie Parker, Investor Relations Officer. You may begin your conference.

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Jamie Parker, Shell Midstream Partners, L.P. - IR Officer [2]

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Thank you. Welcome to the Fourth Quarter Earnings Conference Call for Shell Midstream Partners. With me today are Kevin Nichols, CEO; and Shawn Carsten, CFO.

Slide 2 contains our safe harbor statement. We will be making forward-looking statements related to future events and expectations during the presentation and Q&A session. Actual results may differ materially from such statements and factors that could cause actual results to be different are included here, as well as in today's press release and under risk factors in our filings with the SEC.

Today's call also contains certain non-GAAP financial measures. Please refer to the earnings press release and Appendix 1 of this presentation for important disclosures regarding such measures, including reconciliations to the most comparable GAAP financial measures. We will take questions at the end of the presentation.

With that, I'll turn the call over to Kevin Nichols.

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Kevin M. Nichols, Shell Midstream Partners, L.P. - President, CEO & Director of Shell Midstream Partners GP LLC [3]

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Thank you, Jamie. Good morning, everyone, and thank you for joining Shell Midstream Partners fourth quarter earnings webcast. Before I begin, I want to give a special recognition to our operating company, Shell Pipeline, which, as of this year in 2019, has been safely delivering America's energy for 100 years. This is an impressive milestone and it represents a strong legacy of operational excellence.

Now on today's call, I will take you through fourth quarter performance, then offer some full year 2018 highlights and finish by looking ahead to 2019, providing a brief operational outlook, discussing both opportunities and challenges that we see ahead. I'll then pass the call over to Shawn, who will walk you through the fourth quarter financials.

Three common themes that I'll reiterate today, which I hope you have realized throughout the year: we have delivered against our promises, our Gulf of Mexico corridor strategy is working, and we continue to capture organic growth.

Now beginning with the fourth quarter performance. We had another solid quarter, generating some $141 million of net income and around $179 million of adjusted EBITDA. Quarter-over-quarter, we saw an overall increase in volumes across the onshore and offshore systems.

Looking first at the onshore, results were largely driven by the Zydeco system, where volumes, again, were strong in the fourth quarter. The remaining onshore pipelines and terminals continued to deliver in line with prior quarter. A highlight for the quarter was growing our investment in the Permian in December. We have approved a project to extend the Nautilus system to provide gathering and processing services for Halcón Resources Company. The Halcón opportunity provides an accretive expansion of the Nautilus system to secure third-party business as we continue to grow in the Permian.

Moving to the offshore. Volumes were slightly higher quarter-over-quarter and results were driven by organic growth that we continue to capture in the Gulf of Mexico, and that's growth with little to no capital required. On Amberjack, we received first oil from Big Foot in November. And in December, the Claiborne tieback came online. This new production continues to drive volume and growth into the system. And on Proteus and Endymion, we saw an increase of 56,000 barrels per day, a 19% increase over the prior quarter. This increase was driven by 2 new wells from the Thunder Horse platform. And finally, in our Eastern Corridor, we continue to see strong activity around our footprint with 2 new tiebacks coming into the system in the fourth quarter alone.

Now some of this growth was partially offset by temporary operational impacts that we saw in the quarter. As you will recall, Hurricane Michael came through the Gulf of Mexico in October. And while we didn't shut down any of our operations, the storm impacted the Eastern Corridor for 2 weeks and producers reduced production, causing an impact of approximately $2.5 million. We also saw temporary production impacts on Amberjack and Mars. Both systems saw slightly lower volumes quarter-on-quarter as existing fields encountered temporary well performance issues, which was partially offset by the new fields coming online I spoke about just earlier. And along the Auger system, we saw unplanned maintenance from producers which slightly impacted volumes. All of these operational issues are temporary in nature and we expect the volumes to return.

As I turn from the fourth quarter performance and summarize the year, 2018 was another year that Shell Midstream Partners delivered on its promises. We set the expectation that we would deliver between $2.5 billion and $2.9 billion of acquisitions over the 2017 and 2018 time frame. And with Amberjack, in May, we met that acquisition guidance, delivering $2.7 billion of drops and setting the partnership up for continued success with a diverse set of assets. We also said that we would deliver 20% annual distribution growth through 2018. With the $0.40 per unit distribution we recently declared, we achieved the 20% annual growth rate, and we grew distributions some 146% over the previous 16 consecutive quarters since we launched the company. This continued delivery is underpinned by the strength of the Gulf of Mexico and capturing organic growth opportunities.

Examples of this growth for the year include Amberjack, which has grown in the short time since we've acquired the system has grown volume by around 40,000 barrels per day. The Mars system, which also has grown throughput some 30% year-over-year, driven by new wells and the Shell Kaikias tieback. And the Eastern Corridor, which had an impressive 8 new tiebacks come online in 2018.

And as we move into 2019 and beyond, I am confident in the future ahead for Shell Midstream Partners. We will continue to be anchored by 3 strategic pillars: a resilient framework with strong sponsor support, continued diversification across the portfolio and sustainable growth via strong cash flows and access to Shell's high-quality asset base. Before I close, let me give you a few 2019 operational updates, and Shawn will provide more detail on anticipated financial impacts in his section.

Fourth quarter, as you know, marked the last quarter with all 4 contracts on our Zydeco system in place. 2 contracts expired at the end of 2018 and the third contract will expire in the second quarter of 2019. As I explained in our last webcast, the market dynamics between Texas and Louisiana continue to evolve and are evolving. And while we continue our discussions with new and existing shippers, we will run the system on spot shipments for noncontracted capacity.

During this time, our volumes will be less predictable versus the take-or-pay contract structure we previously had in place. It is worth noting that in the first half of 2019, previously contracted shippers will have the ability to ship on earned credits. As such, we will recognize revenue for these movements; however, the cash was recorded in previous and prior periods. We expect that the majority of these earned credits will be utilized in the first quarter.

And switching to the offshore, we expect to have a number of producer planned turnarounds and connected system maintenance that will primarily impact us in the second and third quarters. With that said, our Gulf of Mexico outlook has not changed, and we remain bullish on our organic growth opportunities both now and into the future. In fact, the Energy Information Administration, EIA, has reported that 2018 was the third consecutive year for record production in the Gulf of Mexico. And they are forecasting this to continue into the future.

As proof points of this growth, we continue to see increased producer activity around our footprint. Much of this growth is driven by industry-wide efficiency gains, reducing breakeven pricing. Examples of this growth include Chevron, which anticipates the second Big Foot well coming online with continued ramp-up and flow into the Amberjack system. And further out, BP announced the discovery of an additional 1 billion barrels of oil in the Thunder Horse field, which is directly connected to the Proteus and Endymion system. And bringing it closer to home, Shell anticipates first oil from Appomattox in the third quarter of 2019, expecting to produce around 175,000 barrels of oil per day at full ramp-up. And this production will flow through the newly constructed Mattox pipeline, which is connected into the Proteus and Endymion system.

All of this continues to drive our confidence in the Gulf of Mexico and the growth that we see on the horizon. And that's growth for the partnership and growth for our unitholders. With that, I'll now turn the call over to Shawn to walk you through the financial performance for the quarter and the 2019 outlook. Shawn?

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Shawn J. Carsten, Shell Midstream Partners, L.P. - CFO, VP & Director of Shell Midstream Partners GP LLC [4]

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Thanks, Kevin, and good morning, everyone. As shown in today's press release, the fourth quarter was a solid quarter for Shell Midstream Partners. Our business continues to perform well supported by our diversified offshore and onshore asset base.

Now let me cover a key -- a few of our key financial metrics for the quarter. Our revenue was about $142 million, down roughly $11 million from the prior quarter, which is primarily related to lower allowance oil sales in the fourth quarter.

Operating expenses were approximately $70 million, an improvement of about $6 million from the prior quarter, driven by a lower cost of sales allowance oil, less project spend on Zydeco and a revision in our estimate of our asset retirement obligations, partially offset by a net realizable value adjustment on allowance oil inventory.

Income from equity investments was about $74 million, roughly even to the prior quarter. Dividend and other income was about $22 million, down slightly due to a decreased quarterly dividend from Colonial and Poseidon. In total, adjusted EBITDA attributable to the partnership was around $179 million, down approximately $8 million from the prior quarter.

After interest expense, maintenance capital and other adjustments, total cash available for distribution was about $156 million. Our partnership declared a distribution of $0.40 per LP unit, representing a 4.7% increase over the prior quarter and a 20% increase over the fourth quarter of 2017. All of this resulted in a very healthy coverage ratio for the quarter of 1.2x.

So now looking ahead to 2019, and related to the expired contracts on Zydeco that Kevin discussed earlier, we expect the impact to our first quarter net income and CAFD to each be in the range of $15 million to $25 million. In the offshore, we expect to have several producer turnarounds during the year. Now these turnarounds are expected to impact net income and cash available from distribution by approximately $20 million. Based on the current turnaround schedules, we anticipate this to break out roughly $10 million in the second quarter and a further $10 million in the third quarter.

Finally, in the CapEx space, we plan to spend about $48 million of capital this year, of which around $22 million will be growth capital. The growth capital is primarily related to continued expansion of the Permian gas gathering system, as previously discussed by Kevin.

So now for the partnership's balance sheet and liquidity. As of December 31, the partnership had total debt outstanding of about $2.1 billion, which equates to a debt-to-EBITDA ratio of 2.9x, based on an annualized Q4 adjusted EBITDA. We continue to be very comfortable with our debt levels. I'd also like to remind everyone that the previously announced IDR growth waiver will begin in the first quarter of 2019. Our sponsor, Shell, has waived $50 million of IDR distributions and this amount will be credited back to the partnership over the course of the year as follows: $17 million in each of Q1 and Q2 and then a further $16 million in Q3. We believe this reflects strong sponsor support and combining all of this affords us significant flexibility as we continue to grow our business.

To wrap it all up, reflecting on our continued delivery and growth since our IPO, combined with our solid operating results, our diversified portfolio and our strong sponsor support, let me reiterate our guidance of mid-teens distribution growth for 2019. And at the appropriate time, we will follow up with further guidance.

So with all that, I'll now -- we'll now take your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question is from Jeremy Tonet from JPMorgan.

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Jeremy Bryan Tonet, JP Morgan Chase & Co, Research Division - Senior Analyst [2]

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Just wanted to pick up on the last point that you said there with regards to distribution growth for 2019. Seems like there's been kind of a change in the market with regards to more of an emphasis on internally self-funding growth CapEx as opposed to trying to maximize distribution growth. Just wondering if you have any thoughts of whether or not it would make sense to moderate that level of growth? Or any updated thoughts on distribution philosophy there?

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Kevin M. Nichols, Shell Midstream Partners, L.P. - President, CEO & Director of Shell Midstream Partners GP LLC [3]

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Jeremy, this is Kevin. Thank you very much. We get that question both in the earnings calls like this and in investor conferences around, would we consider slowing down our growth rate. What I would say for 2019 is that we are reiterating our guidance, and we are committed to the mid-teens distribution growth. Since we have launched our company, one of the things that we have -- we're proud of and we've always done is deliver on our commitments and our promises to the marketplace, and we gave that guidance earlier. So we're going to stick with the mid-teens distribution growth. That said, we're hearing everything in the marketplace. We're evaluating all that. We specifically have not given guidance beyond 2019 and we'll take that into consideration as we look to roll out future guidance.

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Jeremy Bryan Tonet, JP Morgan Chase & Co, Research Division - Senior Analyst [4]

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And just kind of building off that, I guess, with the incentive distribution rights, we're seeing more simplifications or eliminations occurring in this space. And granted you guys have just come up with this -- with the agreement there with the IDR relief that kind of freezes the payment level as it is but wondering if you could share any new thoughts you have as far as IDRs are concerned. And when we should expect any kind of new development on that front?

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Kevin M. Nichols, Shell Midstream Partners, L.P. - President, CEO & Director of Shell Midstream Partners GP LLC [5]

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Yes. Thanks, again, Jeremy. No additional guidance that we're prepared to give today. But what I will say is that we continue to have dialogue with our sponsor. Our sponsor continues to evaluate all options that are available to them. I think the waiver was a good show of support that says, hey, while we're thinking about this, we're going to at least freeze the distributions to effectively reflect fourth quarter of 2018. So can't comment on the timing. But our sponsor and the company are having constant communications, and we'll provide guidance at the appropriate time.

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Operator [6]

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Our next question is from Shneur Gershuni from UBS.

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Shneur Z. Gershuni, UBS Investment Bank, Research Division - Executive Director in the Energy Group and Analyst [7]

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Just kind of wanted to build on the last few questions and maybe asking a little differently. In terms of your overall cost of capital, it sort of seems like it's kind of inefficient. And I was just kind of wondering if you were looking at ways to optimize it better. You consistently seemed to have leverage at around the 3x level; would it not make more sense to have it kind of at the 3.5x level, obviously, comfortably under 4x? And then secondly, do you foresee a structure in the future in terms of funding future drops where you use excess distributable cash flow as a piece of the pie chart as well as equity and getting there via slowing the distribution growth rate?

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Shawn J. Carsten, Shell Midstream Partners, L.P. - CFO, VP & Director of Shell Midstream Partners GP LLC [8]

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Thanks. This is Shawn. Good question. We saw -- highlight in our balance sheet, we still have about $1.1 billion of liquidity available to us. And our sponsor continues to be willing to take units back at that support into the -- into our MLP. So to your question on cost of capital, we hear you, and we do always try to maintain a relatively conservative balance sheet. So we can take advantage of opportunities in the market that might present themselves as well as -- and be able to work through whatever comes in future acquisitions whether it's third party or a parent in the long term. And so with that, I think your second question was around cash flow and whether we'd do that in the future. Certainly, that's in the cards, and we'll provide more guidance as appropriate in the future.

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Shneur Z. Gershuni, UBS Investment Bank, Research Division - Executive Director in the Energy Group and Analyst [9]

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I recognize that the sponsor is showing support by taking back units, but I mean, it's still cash leaving the entity at the end of the day via distribution. I was just sort of thinking of ways to optimize for a lower unit count where the amount of equity issued, whether public or to the sponsor, goes down and you decide to kind of commit to, let's say, funding 20% of all future drop-downs by retained DCF, something along those lines to help to optimize.

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Kevin M. Nichols, Shell Midstream Partners, L.P. - President, CEO & Director of Shell Midstream Partners GP LLC [10]

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Yes. So let me maybe piggyback on something that Shawn answered there, is that we've always had the view that over time as we built scale within the company that we would continue to look at building things and spending organic capital inside the entity. Let me remind you that Shell spends about 1/3 of its capital program overall in the United States, of which there's a need for infrastructure. And we have said that we will grow with our affiliates as we have with the Mattox pipeline and the Falcon pipeline and others and Crestwood. And to the extent that we can take advantage of some of those opportunities and fund those inside the MLP, that is the intention. But we'll always take a look at how long it takes for those cash flows to get turned on versus when the cash need is. But we'll -- that's an option.

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Shneur Z. Gershuni, UBS Investment Bank, Research Division - Executive Director in the Energy Group and Analyst [11]

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Okay. And then following up on the IDR question. I know that you've tipped your cards about trying to do something with the relief in hand, and you said that you had discussions with your parent and so forth. Have they advanced at all since the last time you updated us? Are they considering more options? Is it -- something that gives us some degree of comfort that there's kind of a light at the end of the tunnel on an IDR restructure.

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Kevin M. Nichols, Shell Midstream Partners, L.P. - President, CEO & Director of Shell Midstream Partners GP LLC [12]

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Yes, thanks. I appreciate that. And I know that it's on all of your minds. And I wish I could give you something more definitive at this time, but it's just not appropriate. What I can tell you from my perspective is that I'm comfortable from where I sit, looking at the discussions, the communication and activity and the work that's being done to continue to look at, not only the IDRs, but a holistic strategy and longer term. So I'm comfortable with what's being done at this date and we'll just have to wait until we can actually announce something to you.

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Shneur Z. Gershuni, UBS Investment Bank, Research Division - Executive Director in the Energy Group and Analyst [13]

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Okay. And final question. Just in terms of rotations of management of Shell X. Is there kind of a philosophy within Shell where people rotate on a fairly regular basis? Or can we expect to see some increased consistency in terms of who's communicating with the Street in managing the entity and so forth?

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Kevin M. Nichols, Shell Midstream Partners, L.P. - President, CEO & Director of Shell Midstream Partners GP LLC [14]

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Yes. There really hasn't been any change to any of those plans. I think when my announcement was -- came out as well as Shawn's announcement came out, I think we told the market that while it was appropriate at the time with the previous CEOs and people we had in place for their expertise, both Shawn and I were going to be here for a longer period of time. And we announced that, that would be in the range of at least kind of in that 6-year time frame, and there's no change to that.

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Operator [15]

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(Operator Instructions) And our next question is from Derek Walker from Bank of America.

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Derek Bryant Walker, BofA Merrill Lynch, Research Division - VP [16]

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Appreciate the kind of the color that you've given just around Zydeco and some of the potential turnarounds. Maybe just a little bit -- I know you're kind of just flipping it about drop-downs at some point. But does the mid-teens distribution growth for '19, does that assume a drop? And then as far as timing around that, just given, sort of, the IDR waiver, Zydeco sort of impacts and then turnarounds, is that sort of a back half of '19 sort of event? Just any sort of color that you might kind of share there would be helpful.

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Kevin M. Nichols, Shell Midstream Partners, L.P. - President, CEO & Director of Shell Midstream Partners GP LLC [17]

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Yes. So thank you. Appreciate it, Derek. We're not going to give specific guidance to acquisitions at this moment in time. A drop is not -- it is a possibility as part of what we may be looking at or can do sometime in the year, but we're not going to give guidance to kind of a win, what does that look like as far as that goes. But I'm comfortable, again, with the mid-teen distribution coverage with everything that we've talked about.

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Derek Bryant Walker, BofA Merrill Lynch, Research Division - VP [18]

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Okay. And then maybe on Zydeco. It sounds like you're just running more on spot these days, and just given kind of the volume growth in the quarter and it seemed like the revenue per barrel came in a little less Q-over-Q. I guess, how should we be thinking about that revenue per barrel sort of on a spot basis, kind of throughout 2019?

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Kevin M. Nichols, Shell Midstream Partners, L.P. - President, CEO & Director of Shell Midstream Partners GP LLC [19]

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Yes. So thank you. I think -- well first, we're very careful. It's not appropriate, and we don't plan to give guidance beyond Q1. At best -- at this time, the best that we can give you combined with everything that's going on in Zydeco, the ongoing commercial discussions and the credits that are rolling off, the $15 million to $25 million impact in Q1 is the best guidance that I can give you. We continue to see Zydeco as a strategic asset. It is well positioned in the marketplace. It is the only asset that's connecting the 2 refining centers, both Houston and Louisiana, and also connected to LOOP and Clovelly for possible exports. With what I said in these earnings call, we will be a little bit less predictable on the volumes as we will rely on customers and what they bring to us on a monthly basis while we run on spot. That said, we're always looking to optimize the value for the system in the market. And we could be looking at and consider an open season again at some point in the future.

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Derek Bryant Walker, BofA Merrill Lynch, Research Division - VP [20]

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Got it. Appreciate that. And maybe just one last one for me. I think you previously alluded to volumes on Amberjack around 400,000, I believe, by the end of 2019. Has that outlook changed at all?

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Kevin M. Nichols, Shell Midstream Partners, L.P. - President, CEO & Director of Shell Midstream Partners GP LLC [21]

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Yes. So -- I mean, you heard me say that we've grown the system. The system has grown 40,000 barrels in 2 quarters. It's progressing nicely. We had a few operational issues with some of our customers on the line. But I see nothing that takes us off our previous bullishness on this as a growth asset in the portfolio. And with that, and you saw the growth in the Gulf of Mexico, it's an exciting time for Amberjack.

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Operator [22]

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Our next question is from Spiro Dounis from Crédit Suisse.

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Spiro Michael Dounis, Crédit Suisse AG, Research Division - Director [23]

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Maybe just want to start with Zydeco again here. Trying to get a sense of the contracting sort of negotiations and most you can offer there. Has there been any been sort of price discovery around Zydeco? And is it a case where you'd rather not commit at those levels? Or is it just so much uncertainty from the customers here that they sort of prefer to wait?

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Kevin M. Nichols, Shell Midstream Partners, L.P. - President, CEO & Director of Shell Midstream Partners GP LLC [24]

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Yes. I appreciate the comments. I know it's on all of your minds, but it really is best for me not to get into the specific discussions as they're ongoing right now with the existing shippers, new shippers and the market continues to evolve. I think everybody in the marketplace has been used to the system running one way. And now it's running differently. And I think it's taking time for the market to understand all of that. So we're going to get through those discussions, and I'll provide some more guidance at the appropriate time.

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Operator [25]

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We have no further questions. I will now turn the call back over to Jamie Parker.

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Jamie Parker, Shell Midstream Partners, L.P. - IR Officer [26]

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Thank you very much for your interest in Shell Midstream Partners. If you have any additional follow-up questions, following today's presentation, please feel free to call me directly. My contact information can be found on the presentation materials as well as on our website, shellmidstreampartners.com.

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Operator [27]

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Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.