The Biggest Risk Facing Holly Energy Partners

As with many other oil and gas logistics companies, you might not notice Holly Energy Partners '(NYSE: HEP) growth on a quarterly basis. If you back out and look over the past several years, though, you'll see a business that has grown at a rather steady rate for more than 10 years. A large part of that success has been its relationship with parent company HollyFrontier (NYSE: HFC) and its ability to drop down midstream assets to Holly Energy Partners.

Herein lies the rub. HollyFrontier is running out of logistics and transportation assets to drop down to Holly Energy Partners, and it's forcing the company to come up with creative ways to generate growth. This, the lack of apparent growth opportunities, could be Holly Energy Partners' greatest business risk going forward.

Picture of oil pipelines

Image source: Getty Images.

2016 was a big year for both Holly Energy Partners and HollyFrontier. In late October, the parent company announced that it would be purchasing a 15,000 barrel per day lubricant business in Ontario from Suncor Energy . The $845 million deal includes the lubricant production facility, all of the brand names associated with the Petro-Canada lubricant business, as well as several product warehouse and distribution assets.

In order to finance part of the deal, HollyFrontier dropped down about $275 million in assets to Holly Energy Partners. What made this drop-down unique, though, was that it wasn't pipeline, or storage terminal, or any other kind of asset that Holly Energy Partners typically owned. Rather, it was the newly constructed crude, catalytic cracking, and polymerization units at its Woods Cross refinery.

From a straightforward numbers perspective, this isn't necessarily a bad thing. The drop-down of these assets came with a 15-year tolling agreement contract where Holly Energy Partners will only receive a volume-based fee, and at no point will it actually take ownership of the commodity. So, the cash flows from this transaction should be very similar to its other assets in the sense that they are relatively stable and carry no commodity risk.

From a strategic perspective, though, it does raise one question: If HollyFrontier has dropped all of its logistics assets to its subsidiary and is now pushing refining units down to Holly Energy Partners, are the growth opportunities for Holly Energy Partners shrinking that much?

What are the options from here?

One thing for certain is that HollyFrontier can't continue to drop down refining assets to its subsidiary without cannibalizing its own revenue stream. So, some new revenue opportunities are going to have to pop up soon. After all, Holly Energy Partners has a streak of 48 straight quarterly distribution raises to maintain.

Chart of Holly Energy Partners distribution growth

Image source: Holly Energy Partners investor presentation.

A couple of things Holly Energy Partners is working on is increasing its crude oil gathering system in the Permian Basin to serve its Navajo refining assets in New Mexico. The Permian Basin is proving once again to be an incredibly prolific oil-producing region for the U.S., and running Permian crude has a lot of advantages for HollyFrontier. For every dollar change in the difference between a barrel of Permian crude and refined product, it translates roughly to $55 million in annual EBITDA for the parent company.

Aside from that, though, any other growth is going to come from future capital projects from HollyFrontier or from making acquisitions. However, the big Petro-Canada lubricants integration is likely going to occupy management for some time.

What a Fool believes

Thanks to some drop-downs last year -- the Woods Cross refining assets, the Cheyenne product pipeline, and some oil storage terminals -- there should be enough cash flow growth in 2017 to keep the company's distribution streak alive. Beyond that is where things get a little tricky, because the project pipeline is looking a little thin. For investors in this stock, the biggest thing to watch in the coming year is any acquisitions or project announcements that will add assets to the Holly Energy Partners portfolio. Without them, the company's payout could stall out.

That being said, a company doesn't just stumble into 48 consecutive quarters of distribution growth on accident. A track record like that shows a management team that has shown the discipline to balance growth and financial stability. So, if there was a management team up to the challenge of finding new growth, it's this one.

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Tyler Crowe has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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