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Tallgrass Zone 3 Project Boosting Revenues; Company Positioning for PRB Growth

Tallgrass Energy Partners LP has signed three firm contracts totaling 105 MMcf/d for incremental natural gas pipeline capacity in Zone 3 of the Rockies Express Pipeline (REX) system after generating about $15.8 million of revenue in incremental sales during the fourth quarter, CFO Gary Brauchle said Tuesday.

The operator’s natural gas transportation segment produced adjusted earnings of $99.9 million in 4Q2017, up from $45.8 million in 4Q2016, with REX generating $15.8 million of revenue from the sale of incremental Zone 3 capacity, Brauchle said on a call to discuss quarterly earnings.

These incremental sales averaged about 400 MMcf/d of gas volumes during the quarter, and are over and above the fully contracted 800 MMcf/d of capacity on the Zone 3 Capacity Enhancement project.

“We'll continue to optimize the additional capacity when it's available in Zone 3,” Brauchle said. The recently signed contract are for terms of 3.5 to five years.

Tallgrass’ Zone 3 Capacity Enhancement project, which offers east-to-west capacity out of Clarington, OH, went into full service in early 2017 in response to growing interest from end- users looking to tap into REX.

Meanwhile, Tallgrass is also looking to capitalize on “robust opportunities” to expand its midstream service offerings in the Powder River Basin (PRB). The company has announced $340 million in acquisitions and growth projects over the last month, most recently the formation of a joint venture (JV) with Silver Creek Midstream LLC to develop the Iron Horse Crude Oil Pipeline.

The 100,000 b/d Iron Horse Pipeline, which is expected to enter service in 1Q2019, would connect Silver Creek's newly constructed gathering system and Midway terminal in Converse County, WY, to a Tallgrass terminal and other pipelines at Guernsey, WY, in neighboring Platte County. Iron Horse would also connect to the Tallgrass Pony Express crude oil pipeline system at Guernsey. Both terminals are under construction.

Leawood, KS-based Tallgrass expects to spend about $150 million on the JV, a figure that includes construction costs for Iron Horse and its new terminal at Guernsey, but excludes proceeds from the sale of a 50-mile crude oil gathering system in the PRB.

Tallgrass COO Bill Moler said while producers have mostly been working to appraise values in the PRB over the last 18 months, there are some that are entering the development stage in 2018, “meaning they've figured it out and they intend on adding rigs and drilling more.” Moler said he sees the basin in full development mode by 2019.

“We believe we will get our fair share of activity and opportunity for both capital investment and accretive projects, and revenue enhancement projects in Tallgrass midstream in the Powder River Basin,” Moler said, noting that the company currently has about a dozen proposals “out the door.”

Meanwhile, Tallgrass also announced last week the acquisition of water infrastructure assets in the Bakken Shale for $95 million through its subsidiary BNN Water Solutions LLC.

BNN acquired Buckhorn SWD Solutions LLC and Buckhorn Energy Services LLC, which collectively own 10 saltwater disposal wells and a 39-mile produced water gathering system serving about 133,000 acres for multiple Bakken producers, including ExxonMobil Corp. subsidiary XTO Energy Inc.

According to Tallgrass, BNN plans to spend an additional $45 million this year to expand the produced water gathering system in order to accommodate an expected increase in drilling and completions in the Bakken.

Moler on Tuesday touted the water business for its ease of making good returns on capital, as well as the lower cost of investment in the business.

“It's a good business. You get paid back very quickly. You are the first guy that gets paid in the value stream,” he said.

As for expanding its water business even further, Moler said he didn’t want to put a cap on what Tallgrass would invest in the future, but said it would continue to look at expanding and buy-in businesses. “But again, our underwriting requirements are probably going to get more and more stringent,” he said.

In addition to the JV and the Buckhorn acquisitions, Tallgrass in January announced an agreement to buy a majority (51%) interest in the Pawnee crude oil terminal from Zenith Energy for $31 million. The terminal is an injection point for Tallgrass’ Pony Express Northeast Colorado lateral, with 300,000 bbl of storage and backed by minimum volume commitments of around 90,000 b/d.

The company also announced in January the acquisition of a 38% interest in Deeprock North LLC for $19.5 million. Deeprock North owns a crude oil terminal in North Cushing, OK.

The recent announcements and acquisitions further Tallgrass’ strategy of making Pony Express “one of the most diverse oil pipelines in the country both from a supply and delivery standpoint,” CEO David Dehaemers said.

The Tallgrass chief also attempted to calm any concerns regarding the company’s restructuring that was announced earlier this month. Tallgrass Development LP has merged into a subsidiary of Tallgrass Equity LLC, itself a subsidiary of Tallgrass Energy GP LP. As a result, Tallgrass Equity acquired a 25.01% membership interest in REX valued at around $400 million and about 5.62 million Tallgrass common units, which were valued at $256.2 million based on a 30-day volume-weighted average price.

Effective Feb. 1, Tallgrass also acquired a 2% membership interest in Pony Express and administrative assets -- primarily information technology assets -- from Tallgrass Development for $60 million. Tallgrass funded the transaction with borrowings under its revolving credit facility.

“We want a simpler structure with a lower cost of capital that attracts investment in Tallgrass to help deliver responsible growth,” Dehaemers said.

The reorganization, however, was met with mixed reviews as Barclays upgraded Tallgrass Energy Partners, but downgraded Tallgrass Energy GP.

Over the last five years or so, Tallgrass’ history demonstrates “value creation”, and the company is approaching its reorganization process that same way, Dehaemers said.

He said management believes “there are reasonable alternatives available to effectuate a reorganization where there are no distribution cuts, and there is no dilution, and that is how we are setting off and beginning this process today with the board meeting we had. So, I hope this provides a little more insight into, and frankly comfort, around last week's announcement.”

Tallgrass reported net income of $89.1 million in 4Q2017, up from $70.2 million in the year-ago quarter. For the full year, the company reported earnings of $434 million, compared with $270.5 million in 2016. Adjusted earnings were $173.2 million for the fourth quarter 2017, up from $121.5 million a year earlier. For the full year, Tallgrass reported adjusted earnings of $678 million in 2017, versus $423.5 million in 2016.

Distributable cash flow (DCF) for 4Q2017 was $141.5 million (96.5 cents/share), up from $109.7 million in 4Q2016 (81.5 cents). For all of 2017, DCF was reported to be $611.3 million ($3.67/share), compared to $408.5 million ($3.07) in 2016.

Tallgrass expects adjusted earnings for 2018 in the range of $755 million to $835 million. This adjusted earnings metric includes the assets owned by Tallgrass at year-end, the additional 2% acquisition of Pony Express, and the distributions beginning in February attributable to the additional 25% interest in REX acquired by Tallgrass Equity in early February.

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