Symbiotic Relationships in the Lone Star State Will Reward Investors

Symbiotic Relationships in the Lone Star State Will Reward Investors

Down in Texas, two companies are working together to provide increasing cash flow to investors: Diamondback Energy and Magellan Midstream Partners LP .

The more the merrier
Currently Diamondback Energy is running four rigs in the area with plans to add in another by the end of 2013. In 2014, Diamondback Energy is contemplating whether or not to add one or two rigs, and I hope it chooses the latter. The more rigs Diamondback Energy has up and running, the more production it can wring out of its assets.

Diamondback Energy has plans to utilize those rigs to complete its 2,707 drilling locations on its acreage. Diamondback Energy is drilling down to every part of the Permian Basin, from the Clearfork up at the top to the Cline at the bottom. Diamondback Energy sees 3,500 feet of stacked resource potential in the Permian, with plans to use new drills to tap into each part.

What makes the Permian Basin even better is that the break-even cost for the Wolfcamp play, which makes up a large chunk of the Permian Basin, is very low at $55 per barrel of liquids to produce a 10% pre-tax return. Compare that to the Eagle Ford's $65 or $68 for the Bakken.

Lots of liquids, but how is it going to be moved?
Diamondback has ~85% of its reserves in liquids, with 65% oil and 20% NGL. This has caused the average well to produce between 80% and 90% liquids, which results in high margins. High margins can't materialize if there is no way to get the product, in this case crude oil and NGL, to a buyer.

This is where Magellan Midstream Partners comes in. Magellan signed a five-year contract with Diamondback to move crude to refining facilities on the East Coast through Magellan Midstream's Longhorn pipeline. Diamondback and Magellan Midstream are working together in the Lone Star State to produce and move oil to a refinery, so it can end up in a consumer's gas tank.

Magellan Midstream purchased the Longhorn pipeline back in 2009 for $250 million, and has heavily invested in the project to maximize cash flow potential. Magellan Midstream converted the Longhorn pipeline from a petroleum products pipeline flowing westward to a crude oil pipeline flowing eastward. The Longhorn pipeline used to flow from Houston to El Paso, but Magellan wanted to switch directions so it would be able to carry crude out of the Permian.

Magellan Midstream is doing more than just converting the Longhorn; it also plans on expanding capacity. Magellan Midstream is spending $25 million to change the starting point of the pipeline to Barnhart, Texas. Barnhart is a small town that has boomed since the beginning of the fracking revolution. Magellan wants to capitalize on the shale boom by allowing as many players as possible access to its pipeline.

On top of that Magellan Midstream wants to spend an additional $55 million to expand capacity by 50,000 bpd to 275,000 bpd by 2015. Magellan is a midstream MLP that is heavily weighted toward refined petroleum products. The Longhorn pipeline acquisition was done to diversify its portfolio away from refined products to raw resources.

Another relationship
Magellan Midstream has another relationship going on as well, this one being a join venture between Magellan and Occidental Petroleum . Occidental is betting on the Permian Basin for growth and over Occidental's past few quarters has seen the vast majority of output growth coming from California and the Permian Basin.

Occidental's joint venture with Magellan will transport 300,000 bpd of crude from Colorado City, Texas, to refineries out on the East Coast. Occidental and Magellan plan on bringing the pipeline online by mid-2014, "subject to necessary permitting."

The BridgeTex pipeline venture will allow Occidental to keep bringing new wells online in Texas without having to worry about producing more than transportation capacity will allow and gives Magellan a new crude oil asset.

Occidental is focusing on North America for growth as it sells off some foreign assets and needs the infrastructure in place to move raw resources around. Occidental is using joint ventures to move output around to reduce the amount it needs to spend on pipelines, which allows for more money to be spent on drilling.

Final thoughts
Smaller E&P players struggle to expand their drilling operations while building out pipelines that cost hundreds of millions of dollars. So naturally midstream companies are willing to build pipelines for E&P players in return for multi-year contracts, so all players can profit off of the oil boom.

For larger E&P players like Occidental, midstream companies reduce the need to spend billions on infrastructure and allow for more to be spent on growing production. As Occidental spends more on drilling, it rewards investors with cash flow growth, which can be put right back into the Permian.

Another play on energy infrastructure
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Callum Turcan has no position in any stocks mentioned. The Motley Fool recommends Magellan Midstream Partners, L.P.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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