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Why fee-based income and hedging provide stability

Avik Chowdhury

Must-know: Atlas Pipeline's 1Q14 earnings analysis (Part 6 of 7)

(Continued from Part 5)

A significant portion of APL’s contracts with the customers are percentage of proceeds (or POP) and keep-whole contracts. In a POP contract, APL may retain a negotiated percentage of the sale proceeds from residue gas and natural gas liquids (or NGLs) it gathers and processes, while the producer is given the remainder. Under keep-whole contracts, the processor retains the NGLs extracted and returns the processed natural gas or value of the natural gas to the producer. Under this contract, the processor benefits when the price of NGLs increases and the price of natural gas decreases. Approximately 83% of gross margin of APL is under fee-based arrangements, which minimizes commodity price exposure. The company is positioned for shifts in the nature of contracts, as most keep-whole contracts will transfer to POP from June 2014.

A company with a larger percentage of fee-based contracts should have more stable margins because its revenue is not subject to as much fluctuation from commodity price swings. All else equal, the stocks of companies with more commodity exposed margins are riskier, which is often reflected in the yields of Master Limited Partnerships (or MLP) stocks.

Much of the APL’s gross margin depends on the prices of natural gas and NGLs. As of December 12, 2013, the average estimated unhedged 2014 market prices for NGLs, natural gas, and crude oil, were $0.99 per gallon, $4.27 per million British thermal units (or MMBTU), and $95.57 per barrel, respectively, based upon New York Mercantile Exchange (or NYMEX) forward price curves. According to APL, a 10% movement in the prices would affect 2014 net income by approximately $15.5 million. A downward movement in prices would negatively affect earnings.

Also, a fall in natural gas price negatively affects drilling activity and well operations. This could cause operators of wells currently connected to APL’s pipeline system to reduce their production until prices improve, thereby negatively affecting the volume of gas the company gathers and processes. Historically, natural gas, NGLs, and crude oil prices have been volatile, due mainly to supply and demand factors, market uncertainty, and a variety of unanticipated factors.

In 2013, West Texas Intermediate crude oil prices traded in a range of $86.68 per barrel to $110.53 per barrel in 2013. During the same period, Henry Hub natural gas prices traded in a range of $3.11 per MMBTU to $4.46 per MMBTU.

Currently, ~40% of gross margin is fee-based and 71% of commodity exposed gross margin is hedged for 2014, 41% for 2015, and 10% for 2016. Trey Karlovich, the chief financial officer of APL, said in the conference call of 1Q14, “Our fee-based revenues totaled $43 million this quarter which made up approximately 36% of our hedge margin. However this excludes approximately $3 million of minimum volume adjustments that will be invoiced and included in revenues if they are not made up physically in future quarters this year. We continue to expect fee revenues to be approximately 40% of our overall margin in 2014.”

Atlas Pipeline Partners (APL) is a master limited partnership operating in the midstream energy space. APL’s general partner is owned by Atlas Energy, L.P. (ATLS). APL is a component of Alerian MLP ETF (AMLP), MLP ETF (MLPA), and Global X MLP & Energy Infrastructure ETF (MLPX).

Continue to Part 7

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