Fitch Comments on Private Letter Ruling on Olefins Manufacturing
CHICAGO -- October 18, 2012
Olefins manufacturers which crack natural gas liquids (NGLs) ethane and
propane into derivative streams (ethylene and propylene) qualify for Master
Limited Partnership (MLP) structures, according to a Private Letter Ruling
issued by the IRS on Oct. 12, 2012. Fitch Ratings anticipates that the ruling
could result in the creation of new MLPs in the chemicals sector, as firms
with assets that generate qualifying income under the new structure may seek
to take advantage of the ruling, given the tax advantaged status of MLPs and
differences in valuations between MLPs and comparable C-corporations.
Westlake Chemical Corp. (Westlake; Fitch IDR of 'BBB-') commented that they
are reviewing the ruling. Westlake's largest business segment produces olefins
and would likely qualify for an MLP structure given the IRS ruling. Other
companies that have significant U.S.-based olefin production assets which
could be placed in such a structure include Chevron Phillips Chemical Co., Dow
Chemical Co. (IDR 'BBB'), Eastman Chemical Co. (IDR 'BBB'), Exxon Mobil Corp.,
LyondellBasell Industries N.V., and Shell Chemical Co., among others.
The credit implications of the MLP structure for any olefin manufacturer would
depend on a number of factors--including the size and asset diversity of a
manufacturer both before and after an MLP is put in place; debt levels and
financial policy at the sponsor and MLP level; the future distribution policy,
coverage ratios, and leverage ratios at the MLP; the expected growth strategy
at the MLP level, including the impact of any additional future dropdowns from
the sponsor; and the impact of any other offsetting features, such as
long-term take-or-pay contracts or hedging agreements. If an olefin
manufacturer with downstream processing were to place its cracking assets into
an MLP structure, Fitch would generally expect to see adjustments made at the
sponsor level to offset the potential loss of operating income associated with
the dropdown of assets. Fitch will continue to monitor developments in the use
of MLPs for olefins manufacturing.
Fitch analyzes MLPs similarly to corporations, since many of the credit issues
are similar despite different legal structures, distribution practices and tax
considerations. Fundamental to Fitch's ratings of MLPs is the type and quality
of assets that generate operating cash flow, and the financing of those
Fitch recognizes the incentive to make constant and growing distributions to
MLP unit holders. Therefore, stability of cash flows is crucial in analyzing
MLP credits. Olefins manufacturing is a cyclically exposed industry with
revenue driven by business cycles and costs determined by feedstock production
and consumption dynamics. Currently, captive shale-driven NGL production in
combination with limited NGL cracking capacity is greatly benefitting North
American olefin manufacturers utilizing NGL crackers.
Fitch views the current operating environment among U.S. olefin producers as a
prolonged upcycle in the intermediate term. Fitch expects North American
olefin manufacturers to generate substantial operating income until
significant new NGL cracking capacity is built. A number of projects have been
announced to date with the bulk of production capacity likely coming online in
2017 and 2018. The NGL crackers are expected to be cost advantaged vis-a-vis
olefin manufacturers reliant on oil-based feedstocks, mainly in Europe and
Asia. Longer term, as that oil-based capacity is displaced and shuttered, NGL
cracker margins will likely become more variable due to greater exposure to
business cycles through the change in the cost curve.
Fitch would expect an olefin manufacturing-based MLP to have greater
distribution coverage and less debt compared to a similarly rated pipeline
MLP, all else equal, given the higher volatility of its underlying business.
Olefins manufacturers have limited options to reduce their operating income
volatility. Cost-plus contracts with downstream olefin consumers would expose
the olefin manufacturer to counter-party credit risk. Hedging of NGLs is
difficult and expensive given the illiquid nature of NGL forward markets.
The addition of olefins production to a midstream MLP's business mix might be
an appropriate fit if that MLP has stable fee-based revenues to offset the
volatility from NGL cracking or if its existing NGL services operations have
functional ties to the facilities. The Williams Companies, Inc. (WMB) recently
announced plans to drop down its Geismar Louisiana olefins production facility
to its MLP, Williams Partners L.P. (WPZ). The Geismar facility uses ethane as
a feedstock. The acquisition would effectively transform WPZ's commodity price
exposure from ethane to ethylene. WPZ management believes ethylene demand will
remain strong and that ethylene prices will be less volatile than ethane
prices. Hence they expect cash flow volatility to be lessened.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Master Limited Partnerships 101' (Nov. 1, 2011);
--'Dark Side of the Boom: Shale-Driven Chemical Expansions May Dent Balance
Sheet Flexibility' (Aug. 1, 2012).
Applicable Criteria and Related Research:
Dark Side of the Boom: Shale-Driven Chemical Expansions May Dent Balance Sheet
Master Limited Partnerships 101
Corporate Rating Methodology
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS.
PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK:
HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING
PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND
METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF
CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL,
COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM
THE 'CODE OF CONDUCT' SECTION OF THIS SITE.
Christopher M. Collins, CFA, +1-312-368-3196
70 W. Madison Street
Chicago, IL 60602
Sean T. Sexton, CFA, +1-312-368-3130
MLP and Pipelines Contact:
Ralph Pellecchia, +1-212-908-0586
Mark C. Sadeghian, CFA, +1-312-368-2090
Brian Bertsch, +1-212-908-0549
Press spacebar to pause and continue. Press esc to stop.