Kinder Morgan Splitter Runs at 71% Throughput on Weak Margins BP reduces processing to limit downside.

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1 ? Kinder Morgan Splitter Runs at 71% Throughput on Weak Margins BP reduces processing to limit downside. Morningstar Commodities Research Sept. 6, 2016 Sandy Fielden Director, Oil and Products Research Expected Profits Evaporate Two new 50,000-barrel-per-day, or 50 mb/d, Kinder Morgan condensate splitter units came on line during the first half of Located in Houston s Ship Channel refinery row, they were expected to provide a profitable outlet to process growing volumes of the ultralight crude known as condensate. Instead, average plant throughput has been 71% of capacity in the first 16 months of operation, well below the 90% average operating level of neighboring refineries, in response to sagging condensate processing margins. Operator Kinder Morgan is protected from the lackluster returns because the plant capacity is largely leased to oil major BP under a 10-year commitment. BP in turn relies on access to its own low-cost condensate production from the South Texas Eagle Ford Basin to limit downside on the deal. Other Splitters Face Similar Challenges The weak condensate splitter economics for Kinder Morgan s plant do not bode well for similar facilities in operation today or under construction on the Gulf Coast. A 50 mb/d splitter is being operated in Corpus Christi by Buckeye Energy Partners with a 100% throughput commitment from partner Trafigura. A smaller 28 mb/d splitter owned by Petromax Refining is operating in Houston. A second 50 mb/d plant operated by Magellan Midstream Partners is due on line in Corpus Christi at the end of 2016, also fully committed to Trafigura. Another plant is planned for 2017 at Brownsville, Texas, operated by Centurion Terminals, and Targa Resources plans to build a splitter at Channelview, Texas, with Noble having committed to its 35 mb/d capacity. We do not expect these plants to generate strong margins until condensate production recovers in the Eagle Ford. Other splitters operated elsewhere in the US as part of larger refinery operations by Marathon and Total/BASF are not as impacted by the poor economics. Galena Park Splitter The Kinder Morgan splitter is located at the company s Galena Park terminal, close to the Houston Ship Channel. The project was first announced in July 2012 and later expanded from one 50 mb/d unit to two, both backed by a 10-year 84 mb/d minimum volume throughput commitment from BP. As of July 2016, Kinder estimated the cost of the splitters, as well as 2 million barrels of associated condensate and refined product storage, to be $485 million. The first 50 mb/d unit came on line about a year later than planned, in March 2015, and the second unit followed in July The splitter feedstock supply is delivered to the plant via a lateral to Kinder Morgan s Crude and Condensate pipeline, known as KMCC. The KMCC came on line in June 2012, delivering up to 300 mb/d from DeWitt County in the South Texas Eagle Ford Basin into the Houston area. The initial 250-mile pipeline has been extended since 2012 to connect with the Kinder Morgan/Magellan Midstream joint venture Double Eagle pipeline that originates in La Salle County, Texas, at Gardendale.

2 barrels/day Page 2 of 5 Data reported by Kinder Morgan to the Texas Railroad Commission, or TRRC, which regulates the Lone Star State s oil and gas industry, provides detailed insight into the plant s first 16 months of operation. Feedstock Supply The TRRC data shows that the feedstock delivered to the Galena Park splitters between April 2015 and July 2016 (the most recent data) came from three KMCC pipeline shippers (Exhibit 1). BP was the largest supplier (represented by the blue shaded area), delivering an average 57% of feedstock over the period, followed by 30% from Conoco Phillips and 13% from Eagle Hawk Field Services (a producer owned 75% by BHP Billiton Petroleum and 25% by Kinder Morgan). Pipeline inventory data reported to the TRRC reveals the origin of these condensate supplies. Eagle Hawk delivers into the KMCC from the Blackhawk gathering system in DeWitt County, Texas. Conoco Phillips and BP deliver from gathering systems in Karnes County to a terminal at Helena, Texas. Conoco affiliate Phillips 66 also delivers condensate into the KMCC at Blackhawk and Helena. In May 2015, BP began deliveries into the KMCC via the Double Eagle pipeline system at Gardendale. The TRRC records indicate that BP s combined receipts into KMCC topped out at 54 mb/d during October 2015, meaning that that it has to purchase condensate from other producers such as Conoco and Eagle Hawk to supply its committed 84 mb/d throughput to the Galena Park splitters. In the heyday of the Eagle Ford between 2012 and 2014, that was never expected to be a problem, but basin production has fallen over 30% in the past year in response to lower crude prices. The records show that condensate receipts into KMCC from Eagle Hawk fell by 50% between January and May 2016 and Conoco/Phillips 66 joint receipts fell by 27% over the same period. These production declines, caused by reduced drilling in the Eagle Ford, mean that BP will likely have to pay more for future condensate supplies. Exhibit 1 Galena Park Splitter Feedstock Supply BP Conoco EagleHawk Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Source: Texas Railroad Commission, Morningstar

3 margin $/barrel percent utilization Page 3 of 5 Processing Economics A condensate splitter is a simple refinery that uses atmospheric distillation to break down the feedstock into its component fractions. The resulting outputs are best described as blend stocks because they need to be blended with additives or further processed to produce end-use products such as gasoline. TRRC reports show that the Galena Park splitters produced a pretty consistent mix of refined blend stocks amounting to an average yield from each condensate barrel of 58% naphtha, 25% jet kerosene, 13% diesel, and a 4% mix of propane and normal butane. Using these yields and market prices for the refined components, we calculated a splitter margin, adding together the respective product prices and subtracting a posted field price for Eagle Ford condensate. This analysis showed that monthly average splitter margins peaked at $17.35/barrel in May 2015 but then declined steadily by 60% to just $6.86/barrel in June 2016 (blue shaded area in Exhibit 2 left axis). Subsequently, the margin recovered to just over $9/barrel in August The declining margins reflect falling crude and product prices since the plant began operations, as well as relatively higher prices for condensate. These declining margins appear to have affected how much condensate BP processed through the splitters. The black dashed line in Exhibit 2 (right axis) shows the percentage of the full splitter capacity utilized between April 2015 and July Throughput ramped up rapidly to 96% of the initial 50 mb/d capacity in May 2015, with margins over $17/barrel. With both units operating and margins over $13.50/barrel, throughput jumped to 89% of capacity in November Since then, utilization has dropped off, falling to 59% of capacity in March 2016, recovering to 70% in June and falling back to 64% in July. As such, utilization rates were far lower than those reported by the Energy Information Administration for all Texas Gulf Coast refineries (red line, right axis in Exhibit 2), which averaged 90% over the same period. Splitter utilization may have increased during August 2016 as margins ticked up again. Exhibit 2 Galena Park Splitter Margin and Throughput Splitter Margin Splitter % Utilization Texas Gulf Coast Refinery % Utilization Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug Source: CME Group, TRRC, EIA, Morningstar

4 Page 4 of 5 Good Idea at the Time The rationale behind the Kinder Morgan splitter was that rapidly rising Eagle Ford condensate production would remain relatively cheap because traditional Gulf Coast refineries were not configured to process such light material, yet Federal regulations banned the export of crude and condensate, thereby leaving it stranded in Texas. Those market dynamics would keep condensate prices discounted, while finished product prices for the splitter output, set by international markets, would be high enough to deliver lucrative margins. Kinder Morgan took little risk in building the splitter after BP committed to nearly all the capacity for 10 years, leaving Kinder Morgan to pocket the processing fees (perhaps $3/barrel) whether or not BP actually used the plant, as well as pipeline tariffs to ship in the condensate. BP was an early investor in Eagle Ford production, taking a 50% interest in 400 wells with partner Lewis Energy that gave it significant condensate production to feed the splitters. Provided the splitter margins were good, BP could easily afford to pay Kinder Morgan s processing fee and would in turn receive valuable blend stock products at a terminal in easy reach of four large Houston refineries, as well as marine docks for export. Bad Year for the Roses This rosy picture has not materialized because splitter margins have fallen by over 60% in the first year and do not look likely to recover anytime soon. As we discussed in a July note (see Gulf Coast Refiners Penalized For Running the Lights), rising demand for light crude at Gulf Coast refineries and condensate splitters, combined with the end to the Federal ban on crude and condensate exports, have pushed up condensate prices, bringing them level with regular light sweet crudes. At the same time, available supplies of condensate are reduced by lower Eagle Ford production, meaning that BP may have to pay higher prices for feedstock until Eagle Ford shale production takes off again. An oversupply of refined products into the Gulf Coast market in 2016 has placed downward pressure on splitter blend stock output prices, further pressuring splitter margins. The low margins likely explain why BP cut back splitter throughput to below 60% of capacity in March 2016, and averaged only 71% throughput during the first 16 months of operation, far lower than the average 90% throughput level that area refineries ran at during the same period. At the 71% throughput level, BP still has to pay Kinder Morgan processing fees for their committed 84 mb/d, meaning that it is paying for 13 mb/d it did not use. Our estimate of splitter margins is based on posted field prices (at the wellhead) for Eagle Ford condensate. As a producer, BP has the advantage of only paying its share of development costs for its own production, (presumably less than market prices) so it could expect higher splitter margins as a result. However, our analysis shows that BP has only supplied an average of 37 mb/d to the plant since August 2015 (when the second unit was up and running), meaning that it had to pay market prices for the balance of feedstock supplied to the splitters. This could be one reason why it reduced splitter throughput to not much more than its equity production this year to keep feedstock costs down. If splitter margins improve, BP can buy more condensate from other suppliers to increase throughput. In the meantime, it has to swallow committed processing fees and hope that splitter economics improve before its 10-year commitment expires in K

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