Tallgrass Buys Out Partner’s Stake In Rockies Express Pipeline

Tallgrass Development LP is buying out its partner's stake in the Rockies Express Pipeline (REX), gaining additional interest in a pipeline with a bumpy past and millions of dollars of debt.

The Leawood, Kan.-based company said March 29 it entered into an agreement to acquire Sempra U.S. Gas & Power's 25% membership interest in REX for $440 million in cash. Sempra U.S. Gas & Power is a unit of Sempra Energy (NYSE: SRE).

Tallgrass’ transaction brings with it about $640 million in debt, the portion of REX’s roughly $2.6 billion debt that Sempra holds.

Ethan H. Bellamy, senior research analyst with Baird Equity Research, said he views the deal as a net positive to Tallgrass as its dropdown inventory to its MLP, Tallgrass Energy Partners LP (NYSE: TEP), expands with no immediate impact.

"Dropdowns are likely contingent on a cost of capital recovery for TEP and the MLP sector, which we believe will take at least all of 2016 while the oil market rebalances," Bellamy said in a March 31 report.

REX is one of the largest pipelines ever constructed in the U.S., according to Tallgrass' website. The more than 1,700-mile pipeline stretches from northwestern Colorado and Wyoming to eastern Ohio. The long-haul design can support a capacity of 1.8 billion cubic feet per day.

Tallgrass entered the deal owning a 50% interest in REX, which it operates through subsidiary Rockies Express Holdings LLC. Sempra and Phillips 66 (NYSE: PSX) own the remaining interest in REX, 25% each. Phillips 66 has an option to purchase part of the interest being sold by Sempra.

Tallgrass originally acquired its stake in REX from a Kinder Morgan Inc. (NYSE: KMI) subsidiary in 2012. The deal included $1.5 billion in non-recourse debt, a loan usually secured by property as collateral, in REX.

Rocky Past

REX originally moved Rockies gas to Northeast markets when it became fully operational in 2009. However, a couple of years later, REX's partners found themselves in a quandary, still owing money for the construction of the pipe following the massive gas discovery of the Marcellus Shale.

The initial cost of the pipeline was about $5 billion.

Since then, the pipe's partners worked to reverse part of REX's flow and start sending gas from the Marcellus and Utica shales to the Midwest. First westbound gas flows began in 2014.

In 2015, REX filed an application with the Federal Energy Regulatory Commission (FERC) to begin its Zone 3 Capacity Enhancement expansion project to add three additional compressor stations and more horsepower at two existing compressor stations.

The expected bidirectional REX system in Zone 3 would operate flexibly to meet:

• Existing west-to-east firm transportation commitments from the Rockies supply basins; and
• New and existing demand for east-to-west firm transportation in Zone 3 from Appalachian supply basins.

On Feb. 27, the Zone 3 project received FERC approval to begin construction. Zone 3 is expected to be in service by the fourth quarter of 2016, according to Tallgrass’ website.

Sempra intends to permanently release the remaining uncontracted capacity that it holds on REX, although no such action has yet been completed as part of the Tallgrass transaction, Bellamy said.

"SRE could continue to pay REX through 2019, or negotiate with TEP for the elimination of its liability," he said.

Bellamy models REX's 2017 gross EBITDA to be about $800 million.

"Investors should recall, however, that REX EBITDA likely declines as legacy contracts expire," he said.

If no new contracts are entered, he estimates REX's gross EBITDA will decline by nearly 50% in 2020, down to $465 million.

Phillips 66 has a right to purchase its proportionate share of the 25% stake being sold to Tallgrass, the release said. If Phillips 66 executes its option, Tallgrass's purchase from Sempra could be lowered to about 16.75% interest.

Tallgrass expects the transaction to close in the second quarter of 2016. The deal has been approved by the applicable boards of both Tallgrass and Sempra and is subject to closing conditions.

Tallgrass Development and Tallgrass Energy Partners are holding companies owned by Tallgrass Energy, which owns, operates, acquires and develops midstream energy assets in North America.

Emily Moser can be reached at emoser@hartenergy.com.