It isn’t every midstream company that could declare a price tag of $1 billion for just one planned project, followed by the statement, “We do not anticipate any need to issue equity in the foreseeable future” to fund all of its announced projects. Then again, Magellan Midstream Partners LP isn’t just any company.

Magellan boasts a market cap of more than $18 billion and a disciplined approach to growth projects that has allowed the company to aim for distribution increases of 15% in 2015 and at least 10% in 2016.

In an interview with Midstream Business, Magellan CEO Mike Mears said the company’s management team has been able to maintain a unified, conservative approach in its business dealings because so many members of management have been a part of that attitude since its beginning.

Building careers

In the commercial and operations sides, “In most cases, [senior managers have] made almost their entire career here with these assets,” he said. “So they’ve kind of built this culture and been part of this culture from the beginning.

“It’s easy to maintain that culture and continuity on business philosophy when you have long-term employees moving up through the organization to take senior management roles, and thankfully, that’s the position we’re in right now with regards to our commercial and operations management,” Mears said.

That approach has allowed Magellan to operate the longest refined products pipeline system in the U.S., with 9,500 miles of pipeline, 53 terminals and 42 million barrels (bbl) of storage with access to almost 50% of U.S. refining capacity. The company also owns and operates 27 terminals connected to third-party pipelines, and six marine facilities.

The refined products sector has provided Magellan with earnings stability superior to many other companies—notable even in the midstream sector, where most companies are insulated from commodity price changes by long-term, fee-based contracts.

“The downside is its relatively low growth, compared to some of the other areas you could be in. So we set out, probably four or five years ago, to diversify into the crude oil space.”

Growth in the crude space

As of December 2014, Magellan operated 1,600 miles of crude oil pipelines, most backed by long-term throughput contracts, and the company expects to expand exponentially from there. While 68% of Magellan’s operating margin was in its refined product sector during 2014, the company expects to make major investments to grow its crude oil asset profile during the next several years.

Excluding its planned Saddlehorn Pipeline joint venture (JV) with Plains All American Pipeline LP, which has a total cost between $800 million and $850 million, 60% of its $750 million current expansion spending is in the crude oil sector. In addition, Magellan is evaluating well in excess of $500 million of other potential organic growth projects.

“There are a lot of opportunities in the crude oil space, and we felt that our methods of customer service and just the way we manage our business and focus on achieving, working in partnership with our customers to achieve their goals, would play well in the crude oil space, and we found out that that’s true,” Mears said. “It doesn’t diminish the fact that our refined products business is still the majority of our business. But with regard to new capital deployment and growth of the company, the opportunities are weighted in a different direction.”

Going organic

Most of the opportunities Magellan expects to pursue will be in organic growth.

During Magellan’s fourth-quarter 2014 earnings call, Mears told analysts that while equity values are dropping and making acquisitions seems especially tantalizing, there is also an increased risk with those acquisitions while commodity prices are depressed.

“Even though there may be opportunities out there, and there may be acquisitions that are attractive because of the low equity value, it also has an associated increase in risk,” Mears said during the call. “The equity values drop for a reason.”

Mears said that organic growth, combined with opportunistic acquisitions, is a better strategy for Magellan, and is one the company has followed since going public.

“Organic growth projects are obviously easier to manage, because you’re developing those from the ground up,” he said. “They’re easier to craft specifically to specific customer needs, since you’re working with customers to design the service, and they typically have higher returns than M&A.”

The preference for projects Magellan controls from the beginning doesn’t mean the company is taking the prospect of M&A completely off the table, though. The company’s acquisition strategy is to wait for the perfect assets to come along, he said, “and what I mean by that is primarily feebased business models that minimize direct commodity sensitivity.

“M&A is more opportunistic for us,” Mears explained. “We do not have a plan to execute, for instance, a certain amount of dollars per year on M&A. We view it really as an opportunistic process, where when assets come on the market or assets that are attractive to us might be owned by willing sellers, then we’ll engage in the process. But we’re very disciplined in regard to that.”

Houston service

During Magellan’s earnings call, Mears explained one such opportunistic acquisition to analysts. In November, the company announced its acquisition of a 40-mile crude oil pipeline system in the Houston Gulf Coast area from BridgeTex Pipeline Co. LLC. He then explained the strategy behind the $75 million acquisition: “It provides not only a new secure revenue stream, but also increases our operational flexibility with other pipes we own in the Houston area.”

The message is that Magellan doesn’t build its business through M&A, but rather complements its carefully planned organic growth with strategic acquisitions.

“I think if you talked to most folks in the industry they would concur that Magellan, with regard to merger and acquisition work, is probably one of the most conservative companies in the space. We hold firm to return threshold; we hold firm to the kind of business models that we’re willing to acquire.”

This strategy tends to put Magellan on the low end of the completed acquisitions spectrum in comparison to its peers, Mears said. “But on the other hand, every transaction that we’ve done has been a significant success for us. When we are successful on an acquisition, it turns out to be a very strong performer for us. That’s been our record to-date.”

You can take it with you

Mears said that once Magellan entered the space, the management team discovered that it could take lessons learned in the refined products sector and apply them to the crude sector.

“I’d say that at a high level, we are a very customer-focused business, given that we are in predominantly refined products, and given that that business is very mature and it’s not typically contract-driven, since the business has been around for quite some time,” Mears explained. “You have to be customer-focused with regard to maintaining the health of the business. We pride ourselves on the level of attention and care we give to our customers and our customer service.”

The attention to customer needs is reflected in the high level of retention Magellan has with its customers, Mears said. It was very important to Magellan leadership that the company retain what Mears called an “independent business model.”

“What I mean by that is that we focus on being a service provider only—the service provider being a transporter of fuel or providing storage for fuel. What we don’t do is make a market in those products,” Mears said. “We don’t take trading positions with regard to refined products; we don’t post or sell fuel across the truck rack with regard to refined product.

“We’ve found in the refined product space that our customers value that. They prefer to do business with somebody that isn’t also competing with them in the marketplace,” he said.

“We’ve transferred that business model over to the crude oil space also, where in most cases the people that have been long-term players in the crude oil space do make markets in crude oil,” Mears said. “We’ve translated this independent model over to the crude oil space, and we’ve found that many crude oil customers appreciate that and support that business model.”

‘Direct route’ to success

One of Magellan’s major crude oil projects to benefit from this business model, what Mears called a “cornerstone asset” in terms of the company’s growth and strategy in the crude oil transport sector, is the Longhorn Pipeline. The pipeline has a current capacity of 275,000 bbl/d, transported an average of 230,000 bbl/d during 2014 and is fully subscribed under longterm, take-or-pay agreements. Originating from the southern Permian Basin, Longhorn is “the most direct route from the Permian Basin to the Houston refining market,” Mears said.

The Longhorn Pipeline was “the first project to step up and provide an outlet” for the oversupplied basin, he said. “It was a converted existing piece of pipe, so we have the ability to charge much lower tariffs on it than some of the other projects out of the basin,” making the pipeline extremely attractive to shippers, he said. The pipeline generated 3X EBITDA.

Magellan also constructed the BridgeTex Pipeline in the Permian as part of a 50:50 JV with Occidental Petroleum Corp. Plains All American acquired Occidental’s share in the JV in November. BridgeTex was the largest organic growth project in Magellan’s history at $775 million, including the recent acquisition of the system from East Houston to Texas City, for Magellan’s share of capital spending. The pipeline has 300,000 bbl/d of takeaway capacity and entered operations in September 2014.

BridgeTex originates in the northern Permian Basin. In combination with Longhorn, the takeaway capability from both ends of the Permian “really positions us well to continue to participate in moving the incremental supply out of the Basin,” Mears said. “We think both of those projects have strong long-term viability.”

Unlike Longhorn, which has reached its full throughput capacity, BridgeTex also offers opportunities for further expansion, though not necessarily out of the Permian itself.

“The pipe, just on its route from the Permian to Houston, also travels through the Eaglebine production area, so we’re looking at some opportunities to put some barrels on there,” Mears said. However, “With the current energy environment and current crude oil prices, there’s some question as to when those incremental capacity additions might be necessary.”

‘Low-risk, reasonable return’

There are still opportunities to expand in this environment, however. In identifying those opportunities, Magellan has turned its sights north from the Permian, up to the Niobrara Shale.

The recently announced Saddlehorn Pipeline is designed to run from the Niobrara just north of Denver to Magellan’s storage facilities at the Cushing, Okla., crude trading hub. The 550-mile, 20-inch diameter pipeline has a design capacity of up to 400,000 bbl/d and has already received binding commitments from Anadarko Petroleum Corp. and Noble Energy Inc.

The pipeline has a targeted in-service date in mid-2016.

During the company’s recent earnings call, Mears said the project is expected to cost about $1 billion, which Magellan will construct and operate. Magellan recently announced that it has formed a JV with Plains All American and Anadarko to move forward with the Saddlehorn Pipeline project. The equity ownership in Saddlehorn will be 40% Magellan, 40% Plains and 20% Anadarko.

Pursuing large projects as JVs with partner companies gives Magellan additional protection against potential risks with large projects. Mears said that the company’s conservative approach makes for JVs that are “low-risk and reasonable return.”

“Low-risk, reasonable-return projects I think are the kind of projects that every MLP strives for,” he said. “Not every project meets those criteria, though.

“Many of our peers are investing in projects that generally might have more risk or more commodity-sensitive aspects to it, in hopes of achieving higher returns. But everyone’s willing to do a relatively low-risk, reasonable return project, so when we’re working with JV partners on those kinds of projects, those JVs usually work very well, because everyone’s aligned on what the goal is in regards to that focus on investment objectives.”

Condensate calling

Magellan also sees condensate as an important component of its business plan during the coming years.

“Condensate is a rapidly growing component of the energy production mix,” Mears said. Especially in the Eagle Ford and increasingly in the Permian, Texas crude oil is much lighter than it has been in the past. It’s also plentiful, making projects focused on aggregating, processing and even preparing condensate for export especially tempting for Magellan.

“The U.S. refining infrastructure is not designed to process ultralight crude, and there’s only a certain amount of that that can be blended into medium crude or heavy crude,” Mears said. “That saturation point was probably reached quite some time ago, so this incremental production of condensate needs to find a market if it’s going to be produced.”

Magellan’s condensate splitter is one project aimed to take advantage of the prevalence of light crude oil from the Eagle Ford and Permian. The 50,000 bbl/d splitter is planned for construction at Magellan’s terminal in Corpus Christi, Texas. The splitter’s capacity is fully committed with a long-term, take-or-pay agreement with Dutch company Trafigura Beheer BV. It’s expected to enter operation during the second half of 2016.

Magellan also intends to cash in on condensate through the Double Eagle Pipeline, a JV with Kinder Morgan Inc. The pipeline spans 200 miles from the Eagle Ford to Corpus Christi and has a capacity to transport 100,000 bbl/d of condensate. The JV is also building a 10-mile pipeline to connect the system to the Houston Ship Channel.

Mears was confident that there is room for both splitters and exports in the condensate market, which he expects will increase over time.

“The recent clarity that the [U.S.] Department of Commerce has provided on exporting processed condensate is very helpful, and I think that’s going to continue to grow,” he said.

“We don’t think it impacts the viability of splitters, because the thought process behind a splitter is to process or split the condensate as close to the supply source as possible, and then optimize where you take the finished product,” Mears added. “So it may not make sense in every case to put condensate on a ship and ship it to Asia if you can split it in the U.S. and then take the naphthas to Asia and the diesel and jet fuels to Latin America or keep them domestically where the market’s better. So we think there’s a place for both—there’s a place for splitters, and there’s a place for export facilities.”

Caryn Livingston can be reached at clivingston@hartenergy.com or 713-260-6433.