Keystone Pipeline Comeback?

TC Energy's oil pipeline spinoff has breathed new life into the troubled project.

No North American midstream project has stirred as much controversy the past decade plus as TC Energy’s (TSX: TRP, NYSE: TRP) Keystone Pipeline.

The southern leg of the oil pipeline system has been operating since the previous decade, connecting the Cushing hub in Oklahoma to the US Gulf Coast. And with 8 years plus of contracted volumes, it’s set to produce robust, reliable cash flow for years to come.

The northern leg was supposed to enter service at roughly the same time, connecting Cushing to the oil sands region of Alberta. But in stark contrast to the southern leg, it was controversial almost from day one.

The proposed crossing of the Canada/US border added the regulatory burden of US State Department approval. And so far at least, that’s proven to be a bridge too far for the project.

“Keep it in the grounders” made rejection their line in the sand with the Obama Administration, which otherwise approved literally every other oil and gas pipeline project industry proposed. The Trump Administration vowed speedy approval. But both ironically and predictably, its “drill baby drill” mantra further decreased the project’s odds of ultimate approval, as it triggered a fund raising bonanza for opponents of fossil fuels. The groups have used their bounty to oppose not only Keystone, but to also bring virtually every other major pipeline project to a standstill with unprecedented court challenges.

It’s clear the Biden Administration won’t allow work to resume on Keystone’s northern leg expansion. But at least equally important, TC had long before to focus investment efforts in less controversial areas, especially natural gas pipeline and related infrastructure. And the company eventually decided to formally suspend the project, even after convincing the Alberta provincial government to back it and despite the at least outward support of the Canadian government.

Last week, however, something changed that may revive the northern leg project, which after all these years remains in high demand from industry: TC Energy announced it will spin off its Liquids Pipelines division into a separate company—with an anticipated closing date anticipated sometime in the second half of 2024.

Liquids pipelines have been a profitable business for the company for many years. And Q2 segment earnings grew 4.6 percent as volumes and contract rates remain robust, particularly on the flagship Keystone system.

For TC, however, the unit is now a relatively minor part of overall operations, accounting for just 14.2 percent of overall earnings in the first half of 2023. And it’s been a relatively minor focus for CAPEX, especially compared to natural gas infrastructure.

TC’s two biggest oil pipeline projects of the past decade have wound up being blocked by regulators and the courts and eventually shelved: The northern leg of Keystone and the Energy East pipeline that would have transported Albertan oil to Canada’s Atlantic Coast. In both cases, management decided it wasn’t worth trying to surmount regulatory and court hurdles to bring projects to completion, especially when there was an easier and therefore more profitable opportunity in natural gas.

The company now owns nearly 60,000 miles of operating gas pipelines. That includes a 30 percent market share of transportation for LNG exports in the US, second only to Kinder Morgan Inc (NYSE: KMI). And that figure will expand meaningfully again, as TC’s Coastal GasLink project transports Canada’s first LNG for export in British Columbia by early next year.

The result of the natural gas focus is liquids pipelines are no longer a core business for TC. And that’s all but negated any hopes Keystone’s ever-controversial northern leg would be revived.

All that changes when the spinoff is completed in second half 2024 all

from Canada. TC Energy has become a relatively small player in the oil pipeline space with just 3,045 miles of operating pipeline in a business that strongly favors scale. That plus the possibility of reviving Keystone will make the spun off oil pipelines company an immediate takeover target.

Potential suitors include other North American midstream with a focus on oil pipelines, such as Energy Transfer LP (NYSE: ET) and Plains All America Pipeline (NYSE: PAA). But the buying-in of midstream MLPs by major oil companies like Chevron (NYSE: CVX) and Shell (NYSE: SHEL) means they’re potential suitors as well.

Private capital remains a major investor in pipelines, though recent deals have included sales such as Lotus Midstream to Energy Transfer. And the Canadian government also can’t be ruled out as a potential buyer, as its Trans Mountain project nears service.

There’s the challenge of winning US State Department approval, a non-starter under the Biden Administration. But the project’s regulatory prospects would change dramatically with a change in party control at the White House. And the US Supreme Court’s upholding last week of Congress’ Mountain Valley Pipeline approvals signals similar legislation allowing Keystone to circumvent court challenges would also be upheld.

That’s ultimately not a bet TC Energy management felt worth waiting around for, particularly with its CAD6 to CAD7 billion annual opportunity to invest in natural gas, renewable energy, carbon capture and hydrogen. But a larger energy company with deeper pockets is likely to find the possibility of owning a revived Keystone compelling, especially given the reliable cash flow from the new company’s already operating pipelines.

TC Energy shareholders can afford to be patient as well. Shares currently trade in the low-to-mid 30s with a dividend yield of 8 percent plus, which is backed up with reliable cash flow. That means few are assigning much upside for either piece of the post-spinoff company.

I think that will change meaningfully by the time the spin takes place next year, if for no other reason than we’ll be 12 to 18 months further along into the energy upcycle. Oil prices should be at higher levels. And spare oil pipeline capacity is certain to be in even shorter supply, as nothing else gets built and ever-tightening regulation forces existing infrastructure to shut down.

My expectation is by the time this energy cycle peaks, the two halves of TC Energy will be worth at least $60 a share, with or without a takeover of the oil pipeline piece. That’s a compelling value proposition for income and growth oriented investors alike.