MLP pick: An investor's guide to TC PipeLines' earnings (Part 5 of 6)
TCP and the Great Lakes pipeline
TCP has different contracts set up for its different pipeline systems. While most of its revenues are based on long-term contracts, in the Great Lakes pipeline system, the company derives its revenue from shorter-term contracts for short-haul transportation on multiple paths across its system. The Great Lakes’ performance depends on a number of factors, including weather, levels of natural gas in storage, the price of natural gas liquids, and the associated impact to North American natural gas production and competition. Demand for the Great Lakes pipeline’s services peaks during the summer, when the vast storage complexes in Ontario and Michigan are typically filled in advance of the upcoming winter. During winter, Great Lakes serves the heating requirements of customers mostly in Minnesota, Wisconsin, and Michigan.
For the past three years, the Great Lakes pipeline has performed poorly for TCP. The decrease in net income was primarily due to lower revenue resulting from capacity contracted at lower rates and volumes. The Great Lakes pipeline provides access to the storage fields in Michigan and Southwestern Ontario. As the revenues from this pipeline system are tied to short-term contracts, the tariff or average price of gas to residential customers is subject to fluctuations in the market. From 2009 until the end of 2013, the averages price of natural gas experienced a decline, as the graph below shows. Volume and gas throughput at the Great Lakes pipeline also dropped in the past two years.
The effect of the long-term underperformance of the Great Lakes pipeline may significantly impact TCP. In its 10-K of 2013, TCP wrote the following, “Due to the challenging market conditions that continued to impact Great Lakes in 2013, we conducted a review of the carrying value of our equity investment in Great Lakes. We determined that the fair value exceeded the carrying value. Our assumptions related to the estimated fair value of our equity investment in Great Lakes could be negatively impacted by near and long-term conditions including weather and other demand drivers, North American natural gas production in the major producing basins, natural gas prices and natural gas storage market conditions. There is a risk that adverse changes in these key assumptions could result in a future impairment of the carrying value of our equity investment in Great Lakes which was $672 million as of December 31, 2013 (2012 – $677 million).”
However, in November 2013, FERC approved increasing tariffs for the transportation of gas to customers. This would increase the maximum recourse rate by 21% for the Great Lakes pipeline. In 1Q14, revenues for the Great Lakes increased due to a record drop in temperature and higher demand for natural gas resulting from the drop. The new rate will be in effect until 2018. Looking ahead into the next quarter of 2014, the performance of the Great Lakes pipeline will be TCP’s focus.
As Stuart Kampel, the VP of TCP, commented in the conference call, “I think a lot of it’s going to really depend on the winter – the summer weather that we’re going to see the power generation load that we see across the system, how natural gas competes with coal on the margin here over the next few months and what the prospects are for gas production here at the end of the year. So I think there is a number of variables that are in play here, so it’s really hard to actually draw a line of sight to what’s going to happen on capacity on various pipelines including our own.”
TC PipeLines LP (TCP) is a master limited partnership operating in the midstream energy space. TC PipeLine’s general partner is wholly owned by TransCanada Corporation (TRP). TC Pipelines is also part of the Global X MLP & Infrastructure ETF (MLPX), Alerian MLP ETF (AMLP), and MLP ETF (MLPA).
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