Kelcy Warren’s 19-year-old Energy Transfer, once a small natural gas pipeline operation, now includes one of the nation’s most significant portfolios of energy assets. At its heart, Warren’s master limited partnerships (or MLPs) own more than 71,000 miles of pipeline transporting crude oil, natural gas, and rich natural gas liquids. The industry’s recent shift in focus to drilling for crude oil rather than gas has created even more opportunity for the enterprise. Then again, Gladewater, Texas-born Warren, the company’s 58-year-old chairman and CEO, seems to have a knack for being on the right side of a trend. Energy Transfer, which includes the $18.6 billion (market cap) Energy Transfer Partners LP and the $31.5 billion Energy Transfer Equity LP, now holds positions in or around most of the country’s major oil and gas plays. These include “oily” plays like Texas’ Eagle Ford shale and Permian Basin and the Bakken shale in North Dakota, as well as the Marcellus and Utica shales in the Northeast, where natural gas production still dominates. Now, Energy Transfer is aggressively redrawing its map of pipelines and services, with recent acquisitions in the shale-oil sector and new plans to export liquefied natural gas. We began our conversation with Warren by asking about the evolution from natural gas to oil production. Specifically, we wondered how far the industry’s “midstream” (i.e., the oil and gas processing, storing, transporting, and marketing) sector had lagged behind changes in the “upstream” (the exploration and production) component.
Kelcy Warren: Two things occurred, including one that’s not talked about anymore but remains important. When natural gas is produced, natural gas liquids are involved. For as long as memory serves, the price of natural gas liquids had trended slightly above [dry] natural gas, and that’s called the “frac spread.” But then, about 10 to 12 years ago, there was a shift as natural gas liquids began to track crude oil prices. A decoupling occurred that the industry thought was temporary. But a 10-year decoupling is not temporary; that’s a trend. It took some of us a while to recognize that this was not just a typical energy business cycle, but that this was the new normal. We had been a natural gas-focused company. That changed just a few years ago as we became confident in the movement of heavier hydrocarbons. This business is truly going to be a good margin business for a long time.
D CEO: Do you see the current trend holding steady for a while?
KW: I do. None of us knows what the price of crude is going to be in the long term, and that’s very, very important. If crude falls to $60 a barrel, God help us. The party has changed. What could make that occur? I don’t know. I don’t see any fundamentals that concern me at present.
D CEO: Energy Transfer is now one of the largest distributors of hydrocarbons in the country. Did you ever expect to achieve so much so quickly?
KW: No. It’s funny. When you wake up every day and do one thing the best you can during your whole career, then that equation kind of solves itself, right? I am proud of the success we have had over the last 12 to 14 years, and of what we have become: the finest hydrocarbon transportation [company] in the United States!
D CEO: Your revenue from transporting crude and refined products—as opposed to natural gas—increased from zero in 2010 to 22 percent in 2013. In the coming years, what proportion of revenue do you expect these segments to contribute to your overall revenue?
KW: Within two years, I would like to see it be 50/50. We will still be growing the natural gas business dramatically. So it’s not from a lack of focus on the gas side, but rather that crude opportunities are greater for us than gas opportunities. We will be adding to the gas business incrementally as well as adding more crude opportunities.
D CEO: Your crude conversion project, also known as the Eastern Gulf Crude Access pipeline, is the first direct crude oil pipeline to the East Coast refinery market from the Midwest. What need does it solve for Midwest production?
KW: The Keystone XL project that gained national attention, bringing Canadian crude oil via a Canadian company through the U.S., no matter the politics was dead on arrival. [Editor’s note: At press time, U.S. government review of the Keystone XL oil pipeline had been extended indefinitely, at least until after the November election.] Our crude-conversion project is unique, and it accomplishes the same thing. It utilizes an existing, good quality pipeline that has been in natural gas service, and converts it for crude oil [transportation]. It has minimal impact on the environment and landowners. This repurposing of an existing asset, versus building a new one, is a much better utilization.
D CEO: Your 2013 acquisition of Trunkline LNG Co., a liquefied natural gas import and regasification facility in Lake Charles, Louisiana, gives you the ability to export liquefied natural gas by around 2019. What kind of role do you expect LNG to play at Energy Transfer?
KW: Big. It’s a game changer for our whole industry. Up to now, we have only been allowed to export natural gas to Canada and Mexico. LNG export was otherwise not allowed. So import facilities like Lake Charles were built. For exporting to make sense, new LNG facilities must be built. There will be at least three facilities built on the Gulf Coast, and probably more like five to seven eventually. This adds tremendous growth to the natural gas business. However, if gas rises above $6/mmBtu, LNG will not be exported from the United States. It will be exported from Argentina, Africa, Trinidad, or Qatar. Billions of dollars of installed infrastructure could become idle. I do not believe that will occur, though. We are so blessed with a ridiculously abundant amount of hydrocarbons in the U.S., I believe this will become a big part of our business—transporting gas from all over the country, liquefying it, and then putting it on ships primarily bound for Asia.
D CEO: Your plans at Lake Charles call for an $11 billion expansion of the existing facility. So it seems that you’ll really be invested in LNG.
KW: Often overlooked in LNG export is that the gas has to be transported to the LNG facility itself. We will provide that service and upgrade pipelines in order to do so. These pipelines were built orginally to take gas from the South to the Northeast consumption area. But the Northeast is now being supplied by the Marcellus and Utica [shale plays]. So we are going to reverse the flow of gas in the U.S., particularly in our pipeline systems, and transport it to this funnel point of Lake Charles. That’s a big deal for us. It will create more volume at Energy Transfer, which translates into more profit.
D CEO: Along the same lines, your Mariner South Pipeline project will help create a “world-class” LPG [or liquefied petroleum gas] export/import operation on the Texas Gulf Coast. Why is this project important for your company?
KW: In our business, we transport a product that tends to become glutted from time to time. In the pipeline business, when supply and demand are balanced, then you do not do really well; but when they are out of balance, that creates basis or a spread [related to prices]. With exporting product from the U.S., we have increased the market and demand, a wonderful thing for the industry and for Energy Transfer. This is just our first step in … the export of product, which we intend to expand.
D CEO: Besides oil and natural gas, the Eagle Ford play in South Texas produces a considerable amount of condensates or “rich liquids.” How is Energy Transfer leveraging this growth?
KW: We remind ourselves every day at Energy Transfer, like a mantra, that we are service providers. You’d better supply the services your customers are asking for. If you don’t, then you will lose their business. Energy Transfer was not [previously] in the condensate transportation and stabilization business or in natural gas liquids, which are necessities in the Eagle Ford. We now provide all those services: gathering the rich gas, separating the condensate, and transporting it. We take the rich natural gas to the cryogenic processing facility, which fractionates the hydrocarbon streams and sells them to Gulf Coast markets. We did not offer those services until the latter part of 2011.
D CEO: How is Energy Transfer positioning itself to accommodate growth in shale oil production in the Permian Basin in West Texas and other similar plays?
KW: Once again, we realized we were not providing the services that our customers required. We could transport their natural gas to as many places as it needed to go—and we did it extremely well. They told us, however: ‘We also have liquids and crude oil.’ And we did not have a solution. So, as a partnership, we scrambled to get into those businesses. We have been building facilities, moving into new business segments, and acquiring companies in those businesses. Our acquisition of Sunoco Inc. [in 2012] is one of the greatest examples of these efforts. Our competitors may say that they can provide better services than us, but I’ll challenge them. We cover the entire spectrum of services for the E&P firms active in the Permian. We can do it better, be more responsive, and less costly than anybody. Today, about 70 percent of all Barnett Shale production runs through our pipelines. That’s big. We are not quite there on the Permian, but we plan to be.
D CEO: How big an opportunity does the Permian play in your future?
KW: In my view, there isn’t a bigger opportunity than exists in the Permian for us. The Permian is unique compared to the Marcellus and Utica shales, which are close to their consumption markets. The Permian is driven by oil; with oil comes associated natural gas, and with associated natural gas comes natural gas liquids. All of those products require transportation. The dog [as opposed to the tail] is crude oil and the services required from that category, unlike with the Utica, which is natural gas-oriented driven by economics.
D CEO: The Permian is a big dog, to extend your metaphor. Is the Bakken shale that same kind of opportunity for you?
KW: It is crude-driven. It’s not as large, but the Bakken is the real deal. We are building a pipeline to the Bakken. It is an enormous and ambitious project. But the Permian is massive and includes other [hydrocarbon] reservoirs.
D CEO: From 2009 to 2011, your midstream revenue was less than $2 billion. With your various acquisitions, by the second half of 2013, midstream revenue was approaching $4 billion, showing stellar growth. What’s your strategy to expand revenue capabilities in existing segments or through more acquisitions?
KW: Excellent question. Yes, we are going to grow that business aggressively. Regarding acquisitions, when you become the size we are, an organic strategy is not a good strategy. You need to have a shot of immediate cash flow from time to time. Your unit holders expect to see consistent distribution increases. Say you and I make a deal to build a pipeline. It could take 18 months before your gas, liquids, or oil begin to flow. But if I acquire a firm in that 18-month window, then I have immediate cash flow. Acquisitions are more expensive. Organic growth is more accretive. But the correct mix of that is necessary if you are going to run a master limited partnership correctly.
D CEO: What’s the rationale for having so many MLP structures within Energy Transfer?
KW: A wildly misunderstood concept about an MLP is that it [does indeed have] a taxation advantage. When you purchase units—not shares—you are a unit holder or a partner. When we make a profit, we distribute it to you, and then you owe your taxes. If we do our jobs correctly, making the right investments, your taxes will be minimal—until you ultimately sell your units. C corporations are inefficient because of the double taxation at both the corporate and individual’s dividend level. With an MLP, you have to push all of your earnings out the door. That is a tough way to live. Be careful what you wish for in being an MLP. There are only a few types of firms providing infrastructure where this organizational form makes sense mathematically. We happen to be in that sweet spot. We were criticized for having an overly overcomplicated structure. But complexity is okay if your unit holders are receiving greater distribution growth. While we recognized that simplification and consolidation were what the markets wanted, the tradeoff is less distribution growth. We are a family of MLPs of varying levels of growth and maturities, and this is a much better way to serve the unit holders than a consolidated monster that has minimal growth potential.
D CEO: In a May earnings call, Energy Transfer talked about moving natural gas from the North to the southern states, with the Gulf Coast being the “fastest-growing market in the world.” Can you elaborate on that?
KW: Given the LNG facilities already approved by the energy department, which includes our facility and more coming, together with the petrochemical business expansions on the Gulf Coast, additional natural gas demand could easily be 10-12 billion cubic feet per day on the Gulf. That, coupled with oversupply from the Northeast, is a pipeliner’s dream. You have to repurpose assets from South to North—in ways they were previously not built for—to North to South. That sounds like a problem, but it really is an opportunity.
D CEO: Are you one of the main players repurposing infrastructure to reverse the flow?
KW: We are. There is also Kinder Morgan, a very good [company], and others. There are only a few big players that can play in that space, though.
D CEO: Energy Transfer recently announced plans to acquire the retail unit Susser Holdings for $1.8 billion. This adds to the previously mentioned ($5.3 billion) acquisition of Sunoco, which gave you 5,000 retail gas stations on the East Coast. Why are the “downstream” business and the retail operations so attractive to Energy Transfer?
KW: With Sunoco, we wanted the pipeline assets to move crude, which is no secret. Other businesses came with the acquisition, including the retail assets and the Sunoco brand. Likewise, the Susser brand, in the form of a publicly traded partnership, was a creative way to move the retail business into a separately traded entity which funds its own growth without burdening other unit holders.
D CEO: Is Mexico another area of opportunity for your company?
KW: It looks really good. We have wonderful infrastructure and pipeline systems along the Mexico border—by far the largest in existence in comparison to other competitors. When Mexico recently changed its constitution, it effectively opened the border for natural gas importation. This was a better solution than how it was being imported previously. There will now be more efficient movement of gas, especially from the Eagle Ford. You will see us capitalize on that and build more infrastructure to Mexico.
D CEO: Turning from oil and gas to your “non-energy” pursuits for a moment, I understand that you have an interest in golf—and that the musician Jackson Browne inspired your private music label in Austin and related activities. What’s so important to you about music?
KW: Music is enormously important to me. It is not a business that takes up my time per se, but one in which I have been involved for a long time. It has not been financially rewarding like the energy business, but we are very proud of what we do. Think of the things in life that make everything better, like a child’s laughter. Has anyone ever gotten mad about that? Well, maybe if you were in a conversation at the time, or something! But music, especially music like Jackson Browne’s, has a way in just a few verses to tell a large story. In music, everyone can have different tastes. If it resonates with you and means something to you, then it is good.
D CEO: Besides your various music activities and the community-service endowments you’ve given Dallas—the contribution funding Klyde Warren Park, for example—are there any other endeavors that you’ve yet to pursue?
KW: We are involved in many activities. With Klyde Warren Park, we chose to be overt for certain reasons. Normally we prefer covert giving. Most of our focus is on children’s charities, but we have been doing some landmark preservation projects. We are proud of what we do and we will continue to do it.
D CEO: As a CEO, what has changed over the last decade in how you view managing and growing Energy Transfer?
KW: We were a small group of guys that had a dream—doing something we thought we did well. We grew from 30 people [in 2002] to about 26,000. I reminisce about the old days. Today we are very successful financially, but we are the same guys who were struggling to lay five miles of eight-inch pipe. We have learned many lessons. In 2008, the market turned on us and we did not have a friend. Everyone loves you when the party is at your house, but you can get turned on. We are going to do things our way, and continue to show growth to our unit holders. And we are going to be the very best pipeline company in the world. We will be. We are close to that now, but we will be. A primary way to make money throughout most of my career was to build something and sell it to a big player for a payday. With MLPs, you build these businesses for the long haul—for generations.