The Tale of Two Strategies

In the second-quarter of this year, Energy Transfer Partners LP, based in Dallas, and Sunoco Inc., based in Philadelphia, announced their intention to enter into a definitive merger agreement whereby Energy Transfer will acquire Sunoco.

Energy Transfer Partners LP’s (ETP) acquisition of Sunoco Inc. would accelerate the strategies of the two companies. For ETP, an aggressive buyer, the deal is transformative as it transitions from nearly a pure play natural gas pipeline to a major transporter of liquids, crude oil and products.

The 126-year-old iconic Sunoco, which has been shedding assets and businesses, found a buyer willing to pay a premium for its remaining assets. The combined entities would create one of the largest and most diversified energy partnerships in the country.

The deal calls for ETP, a master limited partnership (MLP), to pay $5.3 billion—about half each in cash and ETP units. The deal represents about a 29% premium paid to Sunoco shareholders. The merger is expected to be completed during the third or fourth quarter of the year.

“The transaction represents the next step in Energy Transfer’s transformation into a more diversified enterprise with an integrated and expanded footprint,” said Kelcy Warren, ETP’s chief executive and chairman, in a joint press statement released April 30.

“Our goal is to derive more of our distributable cash flow from the transportation of heavier hydrocarbons like crude oil, NGLs (natural gas liquids) and refined products. With this transaction, we make a major move in that direction, bringing our cash flow mix related to the combined enterprise’s pipeline businesses to approximately 70% natural gas and 30% heavier hydrocarbons. At the same time, we will enhance the size and scale of the ETP platform by creating new service capabilities and entering new geographic operating areas.”

According to the press release, ETP-­customer demand for a fully integrated midstream service company drove the transaction. Warren is also chairman of Energy Transfer Equity LP, (ETE) the owner of ETP’s general partner.

Sunoco’s assets

Philadelphia-based Sunoco operates pipelines, storage facilities and other assets in the U.S. By acquiring Sunoco, ETP would also own Sunoco’s general partner interest in Sunoco Logistics Partners LP, a publicly traded MLP, formed in 2002 to acquire own and operate a diverse mix of crude oil and refined products pipelines, terminals and storage facilities.

Sunoco Logistics owns and operates 7,900 miles of refined product and crude oil pipelines primarily in the Northeast, Midwest and South Central regions of the U.S., and has some 42 million barrels (bbl.) of refined products and crude oil terminal capacity. In addition to the transportation and terminalling assets, Sunoco Logistics engages in crude oil acquisition and marketing activities. ETP says the Sunoco deal will accelerate its plans to convert some underutilized natural gas pipelines into crude shippers. The profit for shipping crude on pipelines outweighs gas.

Sunoco also operates a retail business that sells transportation fuels and convenience items through a network of about 4,900 gasoline stations in the U.S. Last year, Sunoco announced it was exiting the refining business and had recently exited the chemical and heating oil businesses and spun off its metallurgical coke operations.

Sunoco’s chairman, chief executive, and president, Brian MacDonald, reported in a prepared statement that Sunoco is a stronger and more focused company as a result of shedding some businesses and narrowing its focus to its logistics and retail operations.

MacDonald was named chief executive and president on March 1, 2012. On May 3, he added the title as board chairman. MacDonald served as Sunoco’s chief financial officer and senior vice president since August 2009, when he succeeded Lynn Elsenhans, who headed the company for the four previous years and shed the company’s unprofitable businesses. Sunoco in 2011 posted a loss of $1.7 billion.

“Over the recent years, we have taken a number of actions that have completely transformed Sunoco, and we have returned significant value to shareholders. We now have two strong, high-return businesses in retail and logistics. We continue to focus on ensuring these businesses are positioned to deliver strong results and to execute on their respective growth opportunities. This deal is an appropriate next step for Sunoco,” said McDonald in the joint prepared statement.

“ETP recognizes that the steady, ratable cash flows that our logistics and retail businesses generate are backed by great assets, deep expertise, and the potential for future growth. ETP has an interest in growing its Marcellus shale-related activity, and I am pleased the combined enterprise will retain a strong Pennsylvania presence.”

In the press statement, MacDonald said that Sunoco in the past year has thoroughly reviewed its entire business including a publicly announced comprehensive strategic review.

Warren originally met with MacDonald and other Sunoco officials in February to seek MacDonald’s cooperation to convert ETP’s Texoma gas pipeline to carry oil and connect with Sunoco’s Nederland storage terminal. In a report, Warren said he liked the people and soon the two companies were talking about a much bigger deal.

Few stocks are as volatile as Sunoco’s. Even with the premium paid to shareholders in the ETP deal that price ($50.13 per share) pales in comparison to the $84.92 share price reached in June 2007. But, it is far better than the low of $22.09 reached in July 2009.

Sunoco Logistics’ projects

Sunoco Logistics has announced three separate crude oil pipeline projects at various locations, each intended to move crude oil out of West Texas. The projects are in varying stages.

The first project, dubbed West Texas-Houston Access, is currently operational and capable of delivering some 40,000 bbl. per day to the Houston market. The second project, called West Texas-Longview Access, has completed a successful open season with customer agreements being signed. The project is scheduled to be operational in early 2013 and is expected to deliver approximately 30,000 bbl. per day to the Mid-Valley Pipeline at Longview, Texas.

The third project, named West Texas-Nederland Access, is expected to bring some 40,000 bbl. per day of crude oil to the Sunoco Logistics terminal in Nederland, Texas, about 90 miles east of Houston. The open season for this project has closed, and the company is evaluating the customer interest it received. The project is expected to be operational in first-quarter 2013, and will use pipeline segments owned or operated by Sunoco Pipeline LP, West Texas Gulf Pipe Line Co. and Mobil Pipe Line Co., a unit of ExxonMobil Corp.

all, these projects will provide West Texas producers and Gulf Coast and Midcontinent refiners with a comprehensive crude oil supply solution for both West Texas Intermediate (WTI) and West Texas sour crudes.

“These projects, collectively totaling some 110,000 bbl. per day, demonstrate that our attractively positioned assets can bring Permian Basin crude oil to markets where it makes sense for customers,” Michael Hennigan, Sunoco Logistics’ chief executive told Midstream Business.

Sunoco Logistics has also established a beachhead in Pennsylvania's Marcellus shale natural gas region with its projects to transport ethane, a liquid by-product of gas production, to petrochemical markets through Sunoco's existing pipeline network. Sunoco is working with MarkWest Energy Partners LP, which processes natural gas on behalf of drilling companies.

Sunoco Logistics and MarkWest are moving forward with their Mariner West project to ship ethane to Ontario industries that will use it as a feedstock to produce ethylene, an ingredient used in plastics manufacturing. A second plan, called Mariner East, could deliver ethane and propane from Western Pennsylvania to the Delaware River for shipment by sea to petrochemical producers on the Gulf Coast and internationally. Such a project would require the construction of new, refrigerated aboveground storage tanks near the shipping terminal, Hennigan says.

Refining exit

ETP and Sunoco officials agree that their deal will not affect Sunoco’s plans to exit the refinery business. In fact, ETP reported that the timing of implementing that plan makes for optimal timing of its acquisition of Sunoco.

Sunoco, an owner of oil refineries since 1895, reported in 2011 that it would sell or shut down its last two plants because they were losing money. Its refinery operations have lost almost $1 billion during the past three years, so exiting the business is necessary for the viability of the company.

Sunoco has since closed its 175,000 bbl. per day refinery in Marcus Hook, Pennsylvania, and reported that it will shut down its 330,000 bbl. per day refinery in South Philadelphia in August 2012 if it cannot reach a deal concerning that facility.

In a joint statement, MacDonald said, “We have entered into exclusive discussions with The Carlyle Group regarding the potential joint venture involving the Philadelphia refinery. Such a transaction would entail Sunoco contributing its refinery assets in exchange for a minority non-operating stake. Sunoco would have no ongoing capital obligations with respect to the refinery. If a suitable transaction cannot be completed, we will idle the refinery in August of 2012. We believe that having strong partner like The Carlyle Group is necessary to preserve the future of the facility.” That facility is the largest refinery on the east coast.

Under the plan, Sunoco would contribute the refinery to a joint venture between it and The Carlyle Group, a global asset management firm based in Washington, D.C. In exchange, Sunoco would get a minority stake in the joint venture. Carlyle would contribute cash to the joint venture, own the majority of it and be responsible for the day-to-day operations of the joint venture and the refinery.

Sunoco had shopped its Marcus Hook refinery, but received no takers, and idled that facility in December 2011. The company is looking at alternative uses, probably tied as an industrial site into Pennsylvania’s booming Marcellus shale natural gas production. The site’s deepwater dock, connections to rail and pipeline networks, and extensive fuel storage capacity could allow it to be converted into a terminal or petrochemical plant.

For the past few years, Sunoco’s margins at its refineries were getting crushed by ever-higher oil prices. With no production of its own, Sunoco has been at the mercy of the global market, paying for crude shipped from Europe or Africa and missing out on increasing oil production from new shale fields in the nation’s heartland due to inadequate pipeline infrastructure. East-Coast based refineries are being hammered by the price spread between WTI and Brent oil, which at times reach more than $20 per bbl. Before it began to shed assets, Sunoco had been the second-largest refiner behind Valero Energy.

Meanwhile, numerous analysts have suggested that ETP will likely ultimately sell or spin off Sunoco’s retail gasoline service stations because the business is not a fit with ETP ownership structure, nor is it a core business for ETP.

Warren, in the joint statement, said, “I think everyone knows that we would not have targeted a retail business for a strategic move for the company. However, it is part of the overall package. We believe it is extremely well run. We think the cash flows are very sustainable, and it is a very good business. We are happy to have it and committed to the business. We will continue to grow it and manage it with the people who have been doing that so well for quite a while.”