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Edited Transcript of TWM.TO earnings conference call or presentation 13-Nov-19 6:00pm GMT

Q3 2019 Tidewater Midstream and Infrastructure Ltd Earnings Call

CALGARY Dec 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Tidewater Midstream and Infrastructure Ltd earnings conference call or presentation Wednesday, November 13, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Joel A. MacLeod

Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO

* Joel Kyle Vorra

Tidewater Midstream and Infrastructure Ltd. - CFO

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Conference Call Participants

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* Elias A. Foscolos

Industrial Alliance Securities Inc., Research Division - Equity Research Analyst

* Patrick Kenny

National Bank Financial, Inc., Research Division - MD

* Robert Catellier

CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research

* Robert Hope

Scotiabank Global Banking and Markets, Research Division - Analyst

* Robert Michael Kwan

RBC Capital Markets, Research Division - MD & Energy Infrastructure Analyst

* Robert Robinson;R.H.R Capital;Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Tidewater Midstream and Infrastructure Ltd. Third Quarter Results Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded.

I will now like to hand the call over to your speaker today, Joel Vorra, CFO. Thank you. Please go ahead.

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Joel Kyle Vorra, Tidewater Midstream and Infrastructure Ltd. - CFO [2]

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Thanks, Sheryl. On the call with me today, as usual, is Joel MacLeod, Tidewater's President and CEO.

Before I pass it over to Joel, as usual, to review the quarterly highlights, I just want to remind everyone that some comments made today may be forward looking in nature and based on Tidewater's expectations, estimates, judgments and projections, forward-looking statements we express today may differ as a result of risk and uncertainties.

Further, some information refers to non-GAAP measures and to know more about forward-looking statements and non-GAAP measures, please refer to our various financial reports, which are available at tidewatermidstream.com or on SEDAR.

With that, I'll pass it over to Joel MacLeod for a review of the third quarter highlights.

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [3]

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Good morning, everyone, and thanks for joining our Q3 2019 conference call. Our Q3 was an okay result and in-line quarter, where we delivered $25 million of adjusted EBITDA and a significant improvement versus the $17 million of adjusted EBITDA 12 months prior in Q3 2018.

We'll provide a rundown of the main components of our Q3, but also want the market and our valued shareholders to note that we are laser-focused on deleveraging and are also eager to deliver on over 100% EBITDA growth from our Q3 2019 results into 2020. We are confident in our abilities to get back to 3 to 3.5x debt-to-EBITDA into the end of 2020 and also achieve our targeted level of 2.5 to 3x debt-to-EBITDA in the next 18 to 24 months.

Tidewater successfully commissioned our 100 million cubic feet a day Sour Deep-Cut processing complex, our Pipestone Plant on time and on budget, and began processing customer gas in September 2019. The Pipestone gas plant is currently processing over 60 million cubic feet a day of natural gas and throughput continues to increase. Full capacity has been impacted due to construction delays on downstream third-party infrastructure, which are expected to be in place in January. We do not anticipate a material impact to our Q4 -- our Q1 results as a result of downstream third-party infrastructure delays. We continue to see significant activity at Pipestone, and it continues to be one of the most active areas in Western Canada with over 120 wells being drilled since January 1, and results continue to impress.

Throughput on the Pioneer Pipeline continued to increase through the third quarter of 2019, with volumes reaching approximately 130 million cubic feet a day in the first week of November 2019 under the 15-year take-or-pay commitment with TransAlta. Tidewater and TransAlta continue to work together on additional volume commitments on the pipeline. TransAlta has and continues to be an incredible partner, and we wish to thank the entire TransAlta team for their support.

On the ESG front, we believe we are becoming a leader within the oil and gas sector. As we build and operate the Pioneer Pipeline, which will be the largest pipeline in Alberta to distribute clean natural gas to TransAlta's legacy coal-fed Sundance and Keephills generating stations, reducing carbon emissions by over 30%.

Further, the Prince George Refinery is one of the only assets in Western Canada that can utilize renewables. Canola oil, bio-diesel and ethanol are utilized at the facility to help reduce our carbon footprint, along with several other green initiatives. We also want the market to be aware that we are becoming a leader on the health, safety and regulatory front, as we did have over 2.5 million man hours on our 3 capital projects, over 8.4 million kilometers driven, over 20,000 field level hazard assessments, with an industry-leading TRIF score of 0.2.

On October 4, we announced the acquisition of the Prince George Refinery, where support from both customers and midstream peers has been stronger than anticipated. Our team worked some long weekends and evenings to close the acquisition early, where the asset continues to outperform. We are currently focused on harvesting the related cash flow and deleveraging, but are likely to proceed with some small capital projects in the sub-$1 million range with payouts of sub 24 months. Significant upside exists at Prince George, but our current focus is on deleveraging for the next 3 to 9 months and delivering the outperformance in our quarterly results.

Tidewater has transformed our business over the past 24 months with the successful sanctioning, completion and commissioning of the Pipestone Gas Plant, Pipestone Storage Facility and Pioneer Pipeline and the acquisition of PGR. Tidewater continues to build an integrated and connected midstream infrastructure network from wellhead to end customer in order to increase value for its customers and ourselves.

Over the past 2 years, Tidewater has added over 10 new take-or-pay contracts, ranging in term from 5 to 15 years and including over 5 new investment-grade counterparties, which now account for a significant portion of the corporation's cash flows. Tidewater continues to work to offer premium service to its customers through multiple egress options at its facilities, including its Alliance, TC Energy and Storage connections at Pipestone and its Pioneer TC Energy and Storage connections at Brazeau. And exposure to premium markets through access to its rail infrastructure and refined products markets

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continue to make huge strides in improving the strength of our customers and contracts where approximately 75% of our EBITDA is from take-or-pay or long-term agreements and approximately 50% of our EBITDA is from investment-grade counterparties, and is a key factor for being able to finance the entire Prince George acquisition with low-cost debt.

We wish to thank our credit syndicate for all their support in a tough oil and gas environment. The completion of the Pipestone plant, Pipestone storage facility, Pioneer pipeline and the acquisition of PGR, Tidewater is positioned to generate significant free cash flow in multiple commodity price environments. Tidewater's asset mix allows us to generate cash flow in varying commodity price environments to allow our customers to capitalize on high and low commodity prices.

Tidewater's focus over the next 6 to 12 months is to harvest our related cash flow from our large capital projects and the Prince George Refinery acquisition. Tidewater plans to deploy limited growth capital in 2020 and focus on optimization and small capital projects with 2- to 3-year payouts. Tidewater has decided to delay the expansion at Pipestone -- our Pipestone Plant 2 until further notice and focus on deleveraging over the next 6 to 12 months. We are highly unlikely to consider any acquisitions in the next 3 to 6 months as we need to focus on deleveraging.

To reiterate, we remain highly confident in our ability to execute on our plan, where EBITDA is expected to grow over 100% in the coming 3 to 6 months. Also, I want to be crystal clear that our near-term focus is deleveraging and getting back to 3 to 3.5x debt-to-EBITDA by the end of 2020.

With that, I'll pass it back to Mr. Vorra, and he can walk you through some of the details around the financial side of our Q3. Thank you.

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Joel Kyle Vorra, Tidewater Midstream and Infrastructure Ltd. - CFO [4]

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Thanks, Joel. I'll just spend a little bit of time reviewing the key financial highlights for the third quarter. Revenue, we came in at $147 million, representing a 5% decrease from the prior quarter and an 84% increase from the same period in the prior year, mainly as a result of the new capital projects coming online and the crude infrastructure business. Important to note, to include our hedging business in that number when adjusting revenue for hedges, it would represent a 4.5% increase over the prior quarter and a 100% increase over the same period in the prior year.

Gross operating margin was approximately $11.8 million or 8%. And again, when adjusting for hedges, the margin was approximately $27 million or 17%, representing a 2% increase over the prior quarter and a 36% increase from the same period in the prior year.

Adjusted EBITDA, as Joel mentioned, came in, in line with our expectations at $25.5 million, a 17% increase from the prior quarter and a 47% increase from the same period in the prior year. The increase to EBIT is mainly a result of contributions from the Pipestone Gas Plant in the quarter and the Pioneer Pipeline during the quarter as well as increased contributions from gas storage. As Joel mentioned, EBITDA is expected to continue to increase with Pioneer volumes consistent through the fourth quarter and Pipestone volumes continuing to ramp up during the fourth quarter as well as contribution from the Prince George Refinery, which we've closed ahead of schedule.

We continue to maintain a conservative payout ratio in an effort to deleverage, maintain the payout ratio of 28% or $12 million in distributable cash flow, which is also expected to continue to increase as our completed projects ramp up. And we have a contribution from the Prince George Refinery, which will significantly help our goal to 3 to 3.5x leverage by the end of 2020.

With that -- I think those are the key financial metrics. With that, we can open it up to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Rob Hope of Scotiabank.

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Robert Hope, Scotiabank Global Banking and Markets, Research Division - Analyst [2]

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Maybe to start off on the comments you had on delevering and focusing on smaller projects. Can you give us a sense of what you think your aggregate capital spend in 2020 will be both on the growth and maintenance side?

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Joel Kyle Vorra, Tidewater Midstream and Infrastructure Ltd. - CFO [3]

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Good question, Rob. I think on the maintenance side, we'd be in that -- I think we've previously guided $10 million to $15 million with the addition of some of the new projects and the Prince George Refinery, we'd be in that $20-ish million maintenance capital range. And then as far as growth capital, I would say, minimal, and it's going to depend on some of these smaller projects, but we'd be significantly less, obviously, than in the previous 18 to 24 months, but you could ballpark. And we do have some projects, including the Pipestone Battery that's been announced, so you could ballpark in the $20-ish million range. But I think we'll continue to give updates as some of these smaller projects come to fruition.

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Robert Hope, Scotiabank Global Banking and Markets, Research Division - Analyst [4]

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All right. And then as a follow-up, when you're thinking about the Pipestone Gas Plant expansion, so you're deferring it now. But is there a way you can kind of slow play the development such that you can stagger it in your capital plan to kind of hit post your delevering plan, if you will?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [5]

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Yes. I think, Rob, for now, we were clear. It's on hold, but that can change quickly. We've still got a lot of customer support, lots of options to finance, should we want to head down that path. But it's been clear from shareholders in the market for now, let's focus on deleveraging and harvesting the cash flow from the recent acquisition and our 3 large capital projects. So I don't think you're going to see us spend highly unlikely $5 million to $10 million on Pipestone Phase 2 expansion in 2020. I think it will be more of a go, no-go. Right now, it's a no-go decision, but that can come back to life quickly, especially if we get a large investment-grade producer and/or our shareholders give us feedback that -- and I think we demonstrate that deleveraging. I think we'll be in a better position to kick it back off and get it moving again. But I want to be clear, for now, it is on hold, and our focus is on deleveraging.

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Robert Hope, Scotiabank Global Banking and Markets, Research Division - Analyst [6]

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All right. And then just one final question for me. Can you just give us an outline of how you're looking at your gas storage? We've seen AECO have been quite volatile with a nice upward slope in the move recently. Could we see an uptick in kind of gas margins in Q4? Or is it on the contract side, more ratable through the year?

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Joel Kyle Vorra, Tidewater Midstream and Infrastructure Ltd. - CFO [7]

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I think it's a good question, Rob. We -- the summer months with the significant volatility in AECO is usually the biggest contributor to gas storage. But with prices moving up, some of those volumes are contracted. So it would be a little more ratable. I'd say, overall, to answer your question, usually, the summer months are the juicier months. But I think, yes, there is probably the potential for gas storage to exceed what we would have thought in the winter with prices where they are, but it likely wouldn't be as high a margins as we would see in the summer months when you have AECO bouncing between 0 and $1 on any given day.

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Operator [8]

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Your next question comes from Patrick Kenny of National Bank Financials.

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Patrick Kenny, National Bank Financial, Inc., Research Division - MD [9]

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Just on Pipestone Phase 1, maybe just a little bit more color on the third-party infrastructure delay there? And what level of confidence you have that this delay is operational in nature and that you'll have this connection in place by January as opposed to some sort of landowner or regulatory issue that could persist, perhaps into mid-2020 or beyond?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [10]

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Good question, Pat. And I think it's helpful even for us to respond to that. So it's not a landowner issue. It's nothing that is going to persist. The third-party infrastructure provider is a key partner for us and a very large entity that's been on this for 2 years. Our sense is -- main driver has been weather, and with the ground freezing, we may exceed that January date. But for now, we'd want a message. We don't see a material impact to our Q4, Q1. We are trucking out the liquids today. So it's related to our liquids and the related pipe connection. Worst case is a January date. Best case is probably end of December. But again, don't expect a material impact to our Q4 or Q1. And I think that's enough color. Joel, is there anything you want to add there?

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Joel Kyle Vorra, Tidewater Midstream and Infrastructure Ltd. - CFO [11]

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No. I think it's good.

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Patrick Kenny, National Bank Financial, Inc., Research Division - MD [12]

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Okay, that's great. And then over on to PGR. Can you guys confirm what you're seeing on your end for the PG 2-1-1 crack spread over the first 12, 13 days of ownership? And also, what that translates into from a Tidewater, LCFS adjusted crack spread perspective, relative to your $44 a barrel guidance into 2020?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [13]

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Yes. I think we'll provide ranges, given we're 13 days in, offtakes going well and the refinery is running very well. Obviously, there's days when it spikes, even potentially above that $60, but I think I'd rather give you a range of $50 to $60 a barrel crack spreads on our 85% of diesel and gasoline production. So very happy with what we've seen and currently seeing the asset outperform, but don't want to get ahead of ourselves. And even want to ensure that we do have a cushion. We don't expect an unplanned outage. But for us, we want to make sure we also have some cushion there should we see an unplanned outage. And don't expect we've seen near record throughput here over the last couple of months. But I'd say, I know we're not going to be direct with a perfect answer. But if we said, ranging between $50 and $60 crack spread path, that's where it would be today. And yes, there has been days when it's ticked up above that, but we'd like to be conservative at this point in time.

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Patrick Kenny, National Bank Financial, Inc., Research Division - MD [14]

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And sorry, Joel, is that translating it into a Tidewater adjusted crack spread? Or is that the expectation for the benchmark, 2-1-1?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [15]

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I think we can say yes to both, Pat.

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Patrick Kenny, National Bank Financial, Inc., Research Division - MD [16]

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Okay. Okay. Sounds good. And then also, just any thoughts on the B.C. premier looking to implement some form of regulation for gasoline prices in the province. I know some of the recent articles seem to be focused on the Lower Mainland. But do you see any risk to your margins up in northern B.C.?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [17]

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We see minimal risk. Especially in regards to gasoline, you'll see that Prince George trades at a significant discount to Vancouver, in that even $20 to $30 a barrel range. So most of the concern from what we've seen in our staff at Prince George who have had -- we have had to provide and they have prior to us acquiring the refinery significant data to the B.C. government. But to your point, it's more focused on Vancouver. In Vancouver, the prices are very high. Some of that's related to the cost of infrastructure and real estate as well. So today, we don't expect any impact. And today, our offtake want to be clear as related to the Prince George Orbit. So today, we would see less than 1% to 2% of our volume moved to Vancouver. So for us, minimal risk, minimal exposure. At the same time, we do see upside if we can start to feed some of our gasoline and even diesel. Today, I believe, is trading a little bit above at Vancouver versus Prince George. So I want to be clear, that would be some upside that we see in trying to move some of our gasoline and/or diesel into that Vancouver market, which hasn't happened historically.

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Patrick Kenny, National Bank Financial, Inc., Research Division - MD [18]

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Yes. And I was going to say, on the flip side, I guess, given the 8-week turnaround at the Burnaby refinery next quarter. Is there an opportunity to capitalize on potentially lower -- or sorry, higher Lower Mainland prices? Or how does that work with the Husky offtake agreement that you have?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [19]

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Yes. Husky is -- has the offtake for 90% of the supply on the gasoline and diesel side, but we do have the ability to bring in other products and try and sell them into the Vancouver market. We do plan to consider that, and it's low capital. We have the infrastructure, 1 million barrels of storage, rail and truck facilities. At the same time, we're not forecasting any upside but are definitely getting ready. At the same time, Parkland does historically in our dealings with them is they do an incredible job. Our sense is they're building inventory and preparing. So we don't want to forecast any upside, but we definitely want to be ready, and we started to both rail in and rail out product, just so we're ready for any opportunities. And there's no capital cost for us to do so. So I think there's potential for some upside, and we want to be in a position to capitalize it if there is, and we're doing so as we speak, but don't want to bank on it.

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Operator [20]

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Your next question comes from Robert Catellier of CIBC Capital Markets.

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Robert Catellier, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [21]

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I just wanted to follow-up a little bit on Pipestone 2, that decision to delay the FID. So that's the case of the company making a capital allocation decision as opposed to somebody else picking up the project. Is that correct?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [22]

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Correct, Rob. We still and continue to speak to customers and continue to see a lot of activity and interest in the project, both on the financing front and customer support. For now, a message has been received from shareholders in the market. Let's focus on deleveraging here over the next couple of quarters. Or have a material strengthening in our customers at Pipestone and in the Pipestone Phase 2 would be helpful as well. But risk tolerance from our shareholders in the market is saying we need to focus on deleveraging for the time being. At the same time, we can move fairly quickly. We have a lot of engineering. We obviously have a plant that runs there today. So we can move quickly, should there be a need or a desire to move forward, but want to be clear. For now, the next 3 to 6 months, our focus is deleveraging.

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Robert Catellier, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [23]

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Okay. And then I'm curious as to how the NGL pipeline connection or lack thereof, at this point, is impacting operations. Are you seeing higher OpEx because you're trucking the liquids? Or are customers delivering hot gas into the Alliance pipeline? Or how is that impacting your margins there?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [24]

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Yes. So we are trucking all liquids out, so both C3+ and condensate. At the same time, with the differential between light, sweet and condensate, we have been able to help certain producers that have a density closer to oil or above 800 density. So I wouldn't say we're generating incremental EBITDA, but know that that differential between light, sweet and condensate has helped mitigate some of the pain. Producers have been very reasonable. They are even incurring the majority of the costs or a portion of in cases. So overall, we would expect our Q4 and the related Pipestone EBITDA to be, I don't know, within 10% to 15% of our forecast. We're not going to be 30%, 40%, 50% under what we would have anticipated. And then some of our other assets are currently outperforming. So when we look at Q4 and even into Q1, at worst case, our sense is a January 15 date for the pipeline to be in place. We want to plan for that. But with the cold weather here, there's a chance, we'll have all the pipe connections in place by the end of the year. But we want the market to be aware of it, and happy to answer any other questions.

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Robert Catellier, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [25]

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All right. Got it. And you touched on something there just producer relationships. And I'm just curious with the Bellatrix situation, you gave your -- sort of your, I guess, your bad debt exposure there, which was minimal. But what kind of throughput are you exposed to with Bellatrix, in particular, and what sort of pressure are you seeing from producers with respect to fees?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [26]

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With Bellatrix, we made an effort to move away from them at Brazeau and brought in Westbrook, who's been a great customer. So they have not been flowing at Brazeau River for over 18 months here, but they do flow a small amount of volume sub-5 million a day into our Alder Flats facility. So they would be sub even 0.5% of our EBITDA and our exposure from our previous press release, maximum would be in that $100,000 range. It's closer to 0. We don't see material exposure there today.

And then to your second question on other producers are processing fee pricing pressure? Over the past 30 days, we haven't seen any. It's more how do we get $2.50 gas and even $2.80 gas. Today, I think, $2.40 online. So we have not seen any pressure on processing fees. Even at Pipestone, I've not seen any pressure on processing fees. But want to be prepared for that. And in general, gas processing through the Deep Basin, I mean, throughput today is high, but into spring and summer, don't want the market to think we're going to see massive growth on gas processing cash flows through the Deep Basin into 2020 and 2021. Nice to have a few strong months here and then may continue for a couple more months, but want to be clear that we do expect to see a flat-to-declining gas processing environment through the Deep Basin, not at Pipestone. But today, I don't see any pressure on fees and don't necessarily expect any pressure on fees.

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Operator [27]

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Your next question comes from Robert Robinson of R.H.R Capital.

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Robert Robinson;R.H.R Capital;Analyst, [28]

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Can you just give us some -- a little color on the refined product market in your area. You've got some of the highest margins anywhere in North America. And I'm just wondering what keeps it so high? Is there a large transportation cost issue to move it into that market from your competitors?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [29]

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Great question. So today, there's only 2 refineries in British Columbia, the Burnaby refinery, which is a 55,000 barrel a day refinery and then our Prince George refinery at 12,000 barrel a day refinery. So today, the B.C. market is short, roughly 150,000 barrels a day. And we would be one of only 2 refineries in the area. So the market is short, and we control the largest piece of infrastructure, north of Vancouver and outside of Edmonton in the area. So it is a captive market. And we're also seeing some of the largest capital projects in all of Canada, in British Columbia. The Site C dam project is roughly a $10 billion project. It's underway. We're starting to see and we see demand pull from there today. And even LNG Canada and Coastal GasLink, we don't want to guarantee that, that activity is going to continue, but we are starting to see demand pull there. And that's a $40 billion to $50 billion potential project. TransMountain as well, that we're hopeful. As TransMountain moves forward, we're not banking on it. It is another large capital project in our backyard, and we would control one of the largest infrastructure hubs for refined products with our 1 million barrels of storage and rail and truck. So it's a captive market.

Edmonton would be the main source of competing supply. And to your question, there is a transportation cost to move Edmonton refined product into Prince George. At the same time, there isn't competing infrastructure in that Prince George area, north of us or even south of us until you kind of get into that Vancouver area. So nice to have the largest piece of infrastructure and control that Prince George area, where we are seeing demand increasing. And don't -- we're not forecasting with our base $75 million of EBITDA on that asset, but want to be upfront that there is some very large projects that are starting to increase demand in our backyard there at Prince George.

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Robert Robinson;R.H.R Capital;Analyst, [30]

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Okay. And can you give us some update on your trolling (sic) [tolling] arrangements that you were planning on putting in place or trying to put in place?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [31]

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Yes. So our tolling arrangements, I would say, we still need some more time. No guarantees that we're going to be able to toll Prince George on a set processing fee, say, for example, it could be $44 a barrel on a 5- or a 10-year agreement. I would say we need some more time. There, the feedback, though from the producer community and existing customers has been, how do we get more capacity at Prince George even in the past 3 weeks with the Keystone outage, the apportionment, so producers have seen even 40% apportionment, where the spot market move $6 and $7 a barrel. The Prince George refinery, we -- there's no apportionment there. We can take volumes in by truck or volumes run on the western pipeline system. So great to continue to have interest in discussions with producers, but we're not quite at a position where we have real tolling arrangements, and it's probably going to take another 3, 6, 9 months before we have some true feedback on it if we think we can get X or Y percent of our fees and potentially to a fixed tolling agreement on a long term. We need a little more time.

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Operator [32]

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Your next question is from Robert Kwan of RBC Capital Markets.

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Robert Michael Kwan, RBC Capital Markets, Research Division - MD & Energy Infrastructure Analyst [33]

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If I can come back to Pipestone 2. And you made a comment that sort of confirmed that there's a conscious decision on your part to reduce CapEx and focus on the delevering. But then there's also some comments around things can move quickly around contracting, and that could allow you to move forward. So I'm wondering, what do you need to see? Is it really just getting -- our put differently, do you have the contracting level today that you would need to go forward, but you want to see that high-graded before you actually go forward?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [34]

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You've got it, Robert. I'd say we've got a similar report to where the FID pipestone Phase 1, which would be with minimal investment-grade counterparties, but with 60% to 70% of the volumes with risk tolerance in the market and even our leverage profile, the message from our shareholders in the market is unless at this point in time, we prefer you to sit tight. But if you were able to secure a large investment-grade customer, it would be a decision that would likely have support to move forward with. But we want to be clear that for now the next 3 to 6 months, the project is on hold and maybe hold on hold forever. I get a sense we likely do move ahead with the project, but it's definitely not in the next 3 to 6 months and maybe not even into the next 12 or 24 months, and there's a risk we never move forward with Pipestone Phase 2.

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Robert Michael Kwan, RBC Capital Markets, Research Division - MD & Energy Infrastructure Analyst [35]

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Got it. And then if you decide to move forward, how do you think about that decision with respect to the 3 to 3.5x target leverage exit 2020, and with leverage, is the 2.5 to 3x still the long-term target?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [36]

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Yes. I would say we still want -- if we move forward would -- our goal would be to maintain those targets. So still be in the 3 to 3.5x into the end of 2020; and longer term, we would like to be and can -- are even at a point where we're close to committing. Our Board doesn't want us quite yet to commit to 2.5 to 3x, but that's where we want to head, and that's our target.

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Robert Michael Kwan, RBC Capital Markets, Research Division - MD & Energy Infrastructure Analyst [37]

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Okay. So if you load on, so let's say, Pipestone 2 does go forward, does that default you to equity? Or are there asset rationalization opportunities, like how would you be looking at funding that CapEx?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [38]

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Yes, equity is not an option. I want to be crystal clear. Raising equity is not an option. We'd rather pass or delay. So what options would we have. We've talked about continue to see a lot of interest in selling down working interest in Pipestone Phase 1 at a premium and then offer that partner the opportunity to participate in Pipestone Phase 2. So nice to continue to see interest there. Could we monetize other assets or noncore assets? Absolutely. Price is the question as far as what we could receive for various noncore assets. And then we always have other assets that we do not want to be selling our crown jewels, but continue to see expressions of interest in some of our stronger contracted assets.

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Robert Michael Kwan, RBC Capital Markets, Research Division - MD & Energy Infrastructure Analyst [39]

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Okay. And then if I can just finish, you mentioned it's highly unlikely you'll look at M&A in the next 3 to 6 months. What do you need to see to kind of start looking at M&A again?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [40]

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We need to see our leverage. And I think have a quarter or 2, see the market believe in our deleveraging. And if we do see outperformance from our assets to see accelerated deleveraging and see some support in the market, then I think we'd start to look at opportunities again. But for now, acquisitions are essentially shut down or on hold here for the next 3 to 6 months, and I want to be clear on our focus.

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Robert Michael Kwan, RBC Capital Markets, Research Division - MD & Energy Infrastructure Analyst [41]

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So similar to Pipestone 2, if you did M&A, you would still be living within that 3 to 3.5x exit 2020 leverage metric?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [42]

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Yes. We have to stay within that band here into the end of 2020.

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Operator [43]

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Your next question comes from Elias Foscolos of Industrial Alliance.

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Elias A. Foscolos, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [44]

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The -- I wanted to focus on EBITDA for the quarter and some sort of operational understanding. The EBITDA that you reported was definitely boosted by a realized gain on derivative contracts. So a couple of questions related to that. If -- do you see more of that coming? And that's question one. And question two, when I look at operational margin, I see a decrease sequentially quarter-over-quarter in gathering and processing and a widening in the loss in sort of the other category. So I'm interested in some color on, in particularly, the gathering and processing because I wouldn't have expected that to have deteriorated.

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Joel Kyle Vorra, Tidewater Midstream and Infrastructure Ltd. - CFO [45]

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Yes. Good questions, Elias. I think to answer your first question, the realized gain on hedging, I wouldn't consider that necessarily a onetime contributor to the EBITDA, given those are contracts that we locked in even as early as Q4 last year in 2018, and a lot of those would be related to crude oil differentials and the crude oil business. So when you have volatility in that business, we have locked in that margin, and it will impact the revenue and the operating expense line items above the operating income line on the income statement and the related offset shows up in that hedging number, which is the $15.2 million number. So I would say, with less volatility, that hedging number is smaller, but then the revenue is higher. So we've locked in those margins as early as 12 months ago. So not as big of a contributor to EBITDA as you might think. For that number to go down, our revenue number goes up.

To answer your other question, the gathering and processing piece. I wouldn't say there's a significant decline quarter-over-quarter. There's a bit of a decline in margin. That being said with gas storage in Q2. The margins there are significant when we have volatility in AECO. So I'd say, overall, we should be within the 5% to 10% of the gas processing piece. Overall, in the summer, though, gas processing itself usually comes off a little bit, and then we see a bit of a return in the winter months. But I wouldn't say looking at the business as a whole, that we've had a significant decline in the gas processing piece. But yes, the summer, it's tough months for producers when prices are sub $1.

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [46]

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And Elias, Joel MacLeod here. To your question, Q4. So if you look at Q2 and Q3 differentials where I don't have it in front of me, but minus 12%, minus 13%, minus 14%. So you will see those hedging gains. But in the Q4, with differentials moving out, you're likely to see less gains unrealized and realized and you'll see more net operating income into Q4. But it's a function of us locking in those contracts for a period of 12 to 24 months. And when differentials move in, yes, we realized gains on those related hedges. But when differentials move back out, like you'll see into Q4, those gains will reduce, and you'll see the cash flow show up more in operating income. On the gas storage side, Joel can speak to it better than I can, but there was volatility. We saw negative days, 0 days, and a lot of that on natural gas storage. Cash flow shows up below the line in those hedging gains and losses. But again, it's a hedge, and those are contracted with large investment-grade counterparties. Joe, anything else you want...

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Joel Kyle Vorra, Tidewater Midstream and Infrastructure Ltd. - CFO [47]

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Good summary.

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Elias A. Foscolos, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [48]

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So what I really shouldn't think of the margin exclusive of those realized gains. I really should, kind of, think of them together or the investing community should think of them as somewhat interrelated or quite a bit interrelated?

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Joel Kyle Vorra, Tidewater Midstream and Infrastructure Ltd. - CFO [49]

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Right, you've got to include the realized gain in as either a reduction to your operating expense or an increase to the revenue given they offset each other almost 1:1. Those margins are locked in. The reason we don't present it that way is it changes the presentation under IFRS of the statements, and I think would create even more confusion, but that's something we'll evaluate going forward, but we wouldn't expect large -- I mean, over the last 12 months, there's been so much volatility that, that number has been large. But on a run rate basis, it's not a 1:1 contributor to EBITDA. But yes, to answer your question, you have to include those hedging numbers in the operating margin.

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Elias A. Foscolos, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [50]

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Got it. That's kind of it, although it maybe one other follow-up a bit of Robert's question, and it has to do with the acquisitions? And how that's kind of off the table for the next 3 to 6 months. And the question I would ask is how much would a stronger share price, let's ignore the deleveraging, let's just say, share price is substantially stronger, how much would that potentially change your outlook?

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [51]

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It'd be significant to us. If our cost of capital can improve. Today equity is off the table. But if we were back in that $2-plus range, I think we could start looking at other opportunities. And I think as most are aware, there's probably more opportunities than ever. But for today, we just completed what we feel is probably the best acquisition I've been involved in, in my entire career. Now we demonstrate to the market the performance and bring our leverage down and our risk profile down. But good questions, Elias.

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Operator [52]

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There are no further questions at this time. I will turn the call over to Joel MacLeod for closing remarks.

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Joel A. MacLeod, Tidewater Midstream and Infrastructure Ltd. - Chairman, President & CEO [53]

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Thank you, everyone. A big thanks to our employees, customers and our valued shareholders to what has been a very challenging oil and gas environment. Thanks, everyone.

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Operator [54]

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This concludes today's conference call. Thank you for your participation. You may now disconnect.