MLP investment pioneer David Schulte is fresh from his first trade show appearance as chief of a real estate investment trust (REIT)—and he couldn’t be more optimistic about the future of domestic energy. While it may sound incongruous at first, REITs are steadily marching into the midstream sector as the keepers of those assets that move and store energy industry fluids around North America.

CorEnergy Infrastructure Trust Inc. spent the last two years transitioning from a business development corporation (BDC), essentially a New York Stock Exchange-listed private equity fund, into a publicly traded REIT. The firm claimed the status officially for the first time in March, when it filed its 2013 tax return.

“We expect that in every year, from then on, we will be a REIT,” Schulte told Midstream Business. “So we made it.”

The transition, which Schulte is careful to note was not a “conversion,” was challenging to manage.

“We did so by prudently selling securities that did not qualify as real property and redeploying that capital into assets that did qualify as real property,” he explained. In a conversion situation, the firm would have simply taken its existing business and asked the Internal Revenue Service for a REIT status.

IRA income

Schulte said he is confident there is adequate investor appetite to grow CorEnergy. First, income needs of individual retirement accounts (IRAs) and other tax-exempt monies represent a huge pool of capital that can own REITs. By contrast, IRAs tend not to hold MLPs to avoid the unrelated business taxable income issue. In addition, both REITs and utilities have wide institutional ownership that CorEnergy can tap into as its market capitalization grows.

Schulte explained that growth in the MLP sector tends to be driven by expansion opportunities or by opportunities to integrate assets into an existing MLP network.

“But not all energy and midstream opportunities are that type,” and where divestitures are motivated mainly on monetization grounds, “a REIT provides a better fit for that type of asset,” he said.

Key to the transition to REIT status was the major midstream acquisition of pipelines and central gathering facilities built by Ultra Petroleum Corp. to serve the strategic assets of Ultra’s Pinedale anticline natural gas field in Wyoming. The $228.5 million purchase, which was structured as a sale-leaseback, was announced by CorEnergy in 2012 and gave the firm the real property assets needed inside a 12-month time frame to meet its expected goal of qualifying for REIT status by the end of 2013.

As such, the first half of 2014 has been punctuated by milestones for CorEnergy.

“We’ve come a long ways toward the goals that we set out for ourselves a couple of years ago,” Schulte said. “We have increased our dividend because of those acquisitions to 52 cents per share annualized. We’ve elected REIT status. And, we’ve demonstrated multiple ways that we can provide financing for energy companies.”

The primary way that CorEnergy finances midstream energy companies is with the purchase or construction of an asset that is then leased back to the operating company for sole use in its business.

“By doing so, we put our balance sheet to work, and our tenant has an operating expense, which is rent or a lease payment,” he explained.


Wells in Wyoming’s Pinedale Anticline produce little in the way of gas liquids but do produce a lot of water. That creates handling and disposal challenges for operators in the region. CorEnergy’s primary midstream energy infrastructure assets are subject to long-term triple net participating leases. Source: CorEnergy

Gaining collateral

CorEnergy can also assist with a secured financing in which the firm provides capital to an energy company and takes a collateral position in its real property. This type of transaction does take the form of debt on the operator’s balance sheet, but it lets them use assets as collateral that a more traditional lending institution might not favor.

In January, CorEnergy became eligible for “participating rents” on its Pinedale leaseback agreement, a source of revenue growth for the trust.

“We provide 100% of value of the real property asset that we’re financing—that’s a lot more than a bank might if they’re advancing 50% of the value of an asset. For that, we would like some additional compensation for the risk we’re taking, and the form that takes is in participating rents,” he explained. “In our lease transactions, we will get visibility into the business prospects of our tenant by sharing revenue on the project with them, over and above a certain threshold. Those participating rents give us potential for modest upside, and therefore our dividends can increase over time for our stockholders.”

CorEnergy expects a 1% to 3% growth rate in its dividend during the next 12 months, he said. Contracts provide for cash flow increases based on inflation and on activity level on the projects it finances.

CorEnergy’s largest concentration of assets is in water disposal, and the largest is the pipeline system in Wyoming, which takes water that is produced with the gas from Ultra Petroleum’s Pinedale field to an environmentally safe area through a pipeline network.

Pioneering the midstream

Schulte knows his way around midstream assets. He is one of the cofounders of Tortoise Capital Advisors LLC, which was established in 2002 as one of the first investment firms to cultivate the MLP asset class. CorEnergy is a Tortoise affiliate.

“I have a long history of managing conservatively profiled investment vehicles,” he said. “Our goal is to mitigate risk, and we try to do our homework in investments. We say we measure three times and then cut once. We are attempting to acquire and provide longterm leases on low-risk energy infrastructure assets that have good cash flows for our investors.”

In addition to Schulte’s time in midstream financing, CorEnergy has a deep management bench in energy. Executive Chairman Rick Green has more than 30 years of experience in the energy industry, serving as CEO at Aquila Inc. and its predecessor company, Utilicorp United, for more than 20 years. Rebecca Sandring, CorEnergy’s treasurer and chief accounting officer, has spent more than 20 years in the sector. Three senior directors—each an engineer with more than 25 years in the field—identify potential assets for the firm’s portfolio.

As Schulte explained, some investors that want an infrastructure asset class investment are “looking at other ways to gain access to the asset class, and by organizing as a REIT, we can provide those benefits without the pass-through tax treatment they would obtain if they were direct owners of an MLP or a private equity fund that invested in infrastructure,” he said. “We think we give investors differentiated access to the same high-cash flow, inflation-resistant distribution yields with very long duration that they’re seeking from the asset class in an attractive tax structure.”

1099 simplicity

Tax issues on the REIT level may be considered more straightforward than those of an MLP. As Morningstar explains in its white paper on unconventional equities, under the REIT model, shareholders receive annual Form 1099-DIVs from the REIT, giving taxpayers a simple breakdown of the dividend distributions. REITs don’t pay taxes at the corporate level, and investors incur taxes at their individual tax rate for the ordinary income part of the dividend.

During the first half of the year, CorEnergy made two transactions—acquisition of a petroleum products facility in Portland, Ore., and a secured financing of the Black Bison saltwater disposal properties in Wyoming—that Schulte expects will serve as prototypes for the rest of 2014.

The initial investment in those deals ranges between $10 million and $50 million, but has the potential to grow in excess of $50 million.

“Those transactions, we think, are a great fit for the size of our company and for the flexibility we offer operators to retain control, while obtaining funding from a public capital markets vehicle,” he said.

Keeping with the flow

With the proliferation of shale and hydraulic fracturing, the amount of water used in energy is also increasing. Water disposal is the largest concentration of CorEnergy’s assets, and there could be additional opportunity for businesses such as CorEnergy to help E&P enterprises, Schulte said.

“Shale drilling demands a lot of water on the front end, and then it produces a lot of water over the life of the well,” he explained. “There is a significant waterhandling challenge related to the development of onshore resources through fracking and the harvesting of those resources of produced water that comes out. It’s essential to the activity conducted by the upstream, and they are increasingly outsourcing those capital needs, rather than handling their own.”

Plus, he said in early 2013, “As upstream companies focus on their highest-return opportunities, we expect them to continue to divest, monetize or partner on the ownership of infrastructure assets, so they can preserve capital to fund drilling and exploration opportunities.”

CorEnergy has three sources of potential growth, Schulte said: contractual rent increases, through escalators or participations; existing assets that can grow their revenue streams; and acquisitions, which can be funded by utilizing balance sheet resources, or the company’s $20 million revolving credit facility that will allow the firm to put more capital to work without issuing new equity.

“It’s a large market opportunity, but we will only grow if it’s good for our current shareholders—not just to get big,” Schulte said. “And that means we maintain a discipline around what we buy that is similar to that of MLPs, which would be issuing equity for an acquisition if it’s good for your current shareholders, not just to dilute them.”

Craig Mailman, equity research analyst with KeyBanc Capital Markets, said in a May investors’ note that CorEnergy could well announce another deal or two this year. However, with just $23 million in cash on hand, the firm would likely need to fund such opportunities with an equity raise.

“The ability to deploy capital remains the largest earnings and dividend growth driver for the company,” he said. “Momentum on this front could take several quarters, as (CorEnergy) is essentially pioneering this asset class in a REIT structure, and the acceptance of this financing option could take some time to materialize. The positive tone surrounding the pipeline suggests that perhaps utility and energy companies are starting to take a closer look.”

Deon Daugherty can be reached at ddaugherty@hartenergy.com or 713-260-1065.

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