With ONEOK, Inc.'s (NYSE:OKE) consolidation complete, OKE is better positioned on cost of capital, distribution, and tax carry forwards. When contemplating the future, however, Morgan Stanley is concerned about Bakken exposure in a lower oil price environment well as limits to NGL uplift potential should Permian production continue to grow rapidly. The equity has been resilient and the firm believes it reflects relatively fair value in the current environment.
Pro forma for the transaction, ONEOK plans to step up its dividend by 21% with subsequent annual dividend growth of 9-11% through 2021. With few tangible near-term projects (though a backlog of $1.5-2.5 Bln), Morgan Stanley sees the outlook beyond 2018 increasingly dependent upon a material rebound in producer activity.
The Bakken remains one of the primary contributors to Lower 48 production and OKE's higher margin upside potential, but many producers who underwrote the basin's growth have moved onto new regions. The firm sees the basin as less competitive for capital in a lower price world. Drilled but uncompleted (DUCs) wells can help provide a backstop for some time, but continued rig additions will be needed over the next 12-24 months. While the company maintains a sizeable footprint within the Mid-Con, Morgan Stanley has yet to see an inflection in project opportunities and volumes related to production within the SCOOP/STACK.
The firm is cautious on the volume/margin trajectory of ethane recovery on ONEOK's NGL system. Morgan Stanley believes higher Permian gas volumes, lower gas prices there, and commitments to new pipelines may incentivize producers to recover ethane, delaying higher margin uplift further north.
The firm sees OKE shares as fairly valued, with a balanced risk reward. Though upside to a return in commodity prices and corresponding producer activity could drive volumes higher than Morgan Stanley forecasts, in the current subdued price environment it is cautious on Bakken exposure and the robust dividend guide. Lastly, an advantaged cost of capital improves ONEOK's competitive positioning over the long-term, but with a mixed outlook in the Bakken and Mid-Con, the impetus for M&A may grow.
With OKE's consolidation complete, OKE is better positioned on cost of capital, distribution, and tax carryforwards. The equity has been resilient and the firm believes it reflects relatively fair value in the current environment. When contemplating the future, Morgan Stanley is concerned about Bakken exposure in a lower oil price environment as well as limits to NGL uplift potential should Permian production continue to grow rapidly and delay the uplift for OKE from the higher margined Bakken barrels.
With WTI expected to remain in a $50- 55/Bbl range through 2018 and only modest recovery by 2020 to $60, the firm sees the Bakken as disadvantaged relative to other plays. From a fundamental perspective, Bakken netbacks must clear higher transportation costs and the play lacks multiple zones of development (compared to the Permian). Morgan Stanley sees a sizeable DUC backlog in the basin (currently estimated at 907 per NDIC) helping smooth underlying declines from existing production but see a material increase in activity facing challenges over the next 12 months.
With rapid increases in productivity within the Permian, the firm has seen several operators pursue transactions to establish large leasehold positions within the basin. A common component to many of these transactions is drilling commitments to meet leasehold obligations (HBP drilling). With a general unwillingness to materially outspend cash flow, Morgan Stanley could see E&Ps diverting capital away from the Bakken to not only higher returning plays (such as the Permian and SCOOP/STACK) but also to fill drilling commitments on recently acquired acreage. Additionally, there could be key development milestones (delineation, infill tests, etc.) which may divert capital away from the basin in a lower commodity price environment. With the majority of key producers within the Bakken having relatively diversified operations both domestically and abroad, the firm sees industry risks for the Bakken to compete for capital absent a material improvement in well productivity while balancing other potential commitments.