Description

CorEnergy (“CORR”) is a short because it is a REIT with lease revenues going to zero.  CORR’s lease revenues come from two challenged tenants that recently announced materially negative news:  (i) Cox Oil stopped paying rent in April and simultaneously shut-in production; and (ii) Ultra Petroleum filed for bankruptcy and will stop paying rent in July as it rejected its lease.  Despite its lease revenues going to zero, CORR still has an enterprise value of $313 million (market cap of $156 million + net debt of $157 million).  CORR management appears to agree that lease revenues are going away as they recently cut the annual dividend from $3.00/sh to $0.20/sh – a 93% decline!  Without the lease revenues from these two leases, CORR’s equity is worthless. 

The two tenants lease aged energy pipelines in largely uneconomic and abandoned fields.  There is no alternative use or alternative customer for CORR’s assets.  In other words, they are worthless if the two current tenants cannot use them.  All our industry calls have confirmed this – in fact, our industry calls on the largest pipeline leased to Cox suggest the assets are of negative value given significant associated environmental liabilities. 

We believe this opportunity exists because CORR has only two sell side analysts and is an externally managed REIT, leaving it ignored by energy specialists even though its three assets are energy pipelines.  We have also found CORR management to be promotional and not forthright about the current situation with its tenants.  Short interest is 3.5%, borrow is GC, and the cost of carry is cheap as the current dividend yield is 1.7%.

CORR is simple to understand as it has only three assets:  two triple-net pipeline leases and one FERC regulated gas pipeline.  As noted above, the two triple-net pipeline leases are a material headwind for CORR, representing 78% of CORR’s total revenues, and an even higher percentage of EBITDA as there are minimal direct costs associated with them.  Without the lease revenue from these two assets, CORR will burn cash and likely default on its debt.  The leases are the Grand Isle Gathering System (“GIGS”) and the Pinedale Liquids Gathering System (“LGS”).

Grand Isle Gathering System (47% of sales): 

CORR earns $41 million per year of rent under a triple-net lease on the GIGS with only one tenant – Cox Oil, a privately held E&P company.  Cox shut in production around the GIGS system and stopped paying rent in April, while simultaneously challenging the lease in court.

GIGS is a system comprised of 153 miles of offshore pipeline and saltwater disposal tanks located in the shelf of the Gulf of Mexico.  The GIGS was built as far back as the 70s by Exxon to support Exxon’s production platforms in the area.  Exxon sold the production and the pipeline system to Energy XXI, who later sold the GIGS pipeline to CORR in June 2015 as part of a sale-leaseback transaction for $245 million and an 11-year lease in order to raise capital before eventually going bankrupt.  Cox Oil acquired Energy XXI in June 2018 and took over the GIGS triple-net lease as a result, even though Cox had no desire to lease the system of corroding pipelines from CORR.  CORR has been suing Cox since they acquired the Energy XXI production assets to live up to the terms of the lease.  It has been clear in recent court filings that Cox has little desire to do anything with CORR – CORR management could not even get someone at Cox to return their phone calls^[1].  We believe the GIGS system transports 20-30% of Energy XXI’s oil from some of its oldest assets and needs at least $50 oil to be profitable, so it is no surprise Cox recently shut in production around the GIGS system and stopped paying rent in April.

CORR will truthfully tell you that GIGS is a unique system, but that is not a good thing.  GIGS is the only pipeline of its kind because Exxon built production platforms cheaply with small platforms that could not separate salt water from the oil at the platform level – the GIGS was needed to transport both the salt water and the oil onshore, where it would then be separated.  Practically all other platforms in the Gulf of Mexico have no need for a system like GIGS which is why the GIGS has always run at very low utilization.  We spoke with several former Energy XXI managers of the GIGS system and they all said GIGS was a nightmare and they could never get material third-party revenues because there was no demand.  Before Cox shut in its production, they had ~10k barrels of oil per day or less running through the system, while there was ~18k barrels of oil per day running through the system when CORR acquired GIGS.  With volumes declining ~42% since CORR acquired the asset, before recently going to zero in April, GIGS is a structurally challenged pipeline system.

Every industry expert we spoke with noted that CORR massively overpaid for GIGS when it bought the asset from Energy XXI – an overleveraged company with a fraudulent CEO^[2].  Our diligence has uncovered that the Energy XXI CEO inflated the expected third-party volumes, the Energy XXI volumes and reserves, as well as the rates at which third-party users would pay to use the GIGS before selling the system to CORR.  It was described to us that CORR was the “patsy at the table” having never been involved in offshore production.  No one with offshore experience wanted to acquire the system and other Gulf of Mexico operators we have spoken with said the GIGS system is a disaster.

We believe that Cox will fight hard to never pay a penny of rent and CORR has no leverage, outside of a long court battle, as Cox has simply shut in production in the area.  Cox has recently challenged in court whether the GIGS guaranty transferred over as part of its Energy XXI acquisition^[3].  CORR tried to be sneaky in its April 13th press release noting rent would not be paid because Cox had shut in all of its Gulf of Mexico production, to which Cox filed a press release on April 17th specifying that it was not shutting in all of its production.  Cox is still operating other assets outside of those within the GIGS system confirming our thesis that Cox is directly targeting the GIGS lease.  The GIGS system is worthless as one Energy XXI executive recently told us, “GIGS is an ancient system that is corroding with several known leaks and is probably failing mechanically right now.”  We might be conservative in placing zero value on GIGS as every expert told us there are very real and material environmental liabilities associated with the system.  They all noted you could not pay them to take the GIGS system. 

There is 6 years remaining until lease expiration, so in a best-case scenario GIGS is worth an NPV of $141 million at a 20% discount rate, but our base case is that it is worth nothing.  CORR’s lenders seem to agree as they just put a borrowing base value of zero^[4] on the GIGS per an 8k filed on May 8th.

Pinedale Liquids Gathering System (31% of sales):

CORR earns $26 million in fixed and variable rent under a triple-net lease on the LGS with only one tenant – Ultra Petroleum, a now bankrupt E&P company.  Ultra filed Ch. 11 bankruptcy on May 14th and rejected its lease with CORR.  In the filings, Ultra notes it will stop paying rent to CORR after the June 1st payment as Ultra will no longer use the LGS given Ultra owns an alternative system that runs parallel to the LGS it will use instead^[5].

LGS is a system of 150 miles of underground liquid gathering pipelines, mostly for water, and four related storage facilities located in the Pinedale Anticline in Wyoming.  The LGS was completed in 2010 and sold to CORR as part of a sale-leaseback transaction in December 2012 for $228 million and a 15-year lease.  The Pinedale Anticline is a declining natural gas rich play that was a dominant onshore gas field in the mid-2000s.  This ended once horizontal fracking and shale took off in more lucrative plays and all the majors have since abandoned Pinedale, leaving Ultra the sole remaining operator.  This has not been a good thing as Ultra consolidated the play and was left highly leveraged causing it to file Ch. 11 in 2016 and again this month!  The fact that Ultra could not find an interested buyer during a strategic alternatives process prior to filing last week helps prove the unattractiveness of the play.  While CORR’s lease was not rejected during the 2016 bankruptcy as Ultra accepted the lease, this time around Ultra rejected the lease and noted they are simply replacing the LGS with an Ultra owned system called “SWEPI LGS” that runs parallel to the LGS in so many instances that they practically overlap on a map.

CORR likes to brag the LGS is another unique system due to Bureau of Land Management (“BLM”) regulations that require liquids be moved via pipelines to preserve the Pinedale terrain as it is viewed as a pristine wildlife area.  The BLM owns most of the land in the area and has implemented stringent requirements making the play less economic, which is another reason all other operators have left.  Ordinarily the costs of building a new system and the BLM requirements would make the LGS lease solid, but in 2014 Ultra acquired the SWEPI LGS from Shell, as Shell was exiting the play, making the LGS lease duplicative and unnecessary.  This former Shell system is completely owned and operated by Ultra and will be used by Ultra beginning July 1st after Ultra finishes connecting wells to the SWEPI LGS^[6].  With Ultra, the only potential customer, now using its own system, the “uniqueness” of the LGS makes it a certainty that no one will ever lease it again!

We believe that the lease will be rejected and with no other alternatives available the LGS, like GIGS, is worthless.  Calls with former engineers and managers of the Pinedale LGS have confirmed there is no need for the LGS.  There is 7.5 years remaining until lease expiration, so in a best-case scenario the LGS is worth an NPV of $79 million at a 20% discount rate, but again our base case is that it is worthless.

Mogas & Omega Pipeline (22% of sales):

CORR’s remaining asset is the Mogas and Omega Pipeline system which is a 263-mile pipeline that supplies natural gas in and around the St. Louis region as well as to small municipalities throughout central Missouri.  Mogas is the main pipeline and Omega is a smaller connected pipeline that serves Ft. Leonard Wood in central Missouri.  CORR acquired this pipeline in November 2014 for $131 million.  This is a FERC regulated pipeline with one large customer, Spire, which represents 32% of sales.  There is nothing remarkable about this pipeline, but we believe it is structurally challenged given: (i) Spire cut the rate it pays CORR by 48.4% in 2018; and (ii) to try to offset the revenue loss CORR marketed heavily in the surrounding areas and could not generate any new business for the pipeline^[7].  None of this is surprising given CORR’s questionable record of making acquisitions.  The contract with Spire ends in October 2030 so there could be another significant rate cut in the future, but we consider the current revenues from this pipeline to be stable.  Of course, if suburban St. Louis or central Missouri industrial companies use less energy there could be a revenue decline as less gas is transported through the pipeline.  In our base case, we simply assume the pipeline is worth the $131 million CORR paid in 2014, but obviously that is conservative given the significant decline in rates from its largest customer.  As this is not a triple-net lease, the majority of CORR’s non-management fee operating expenses are tied to the operation of this pipeline, making it difficult for CORR to cut costs despite 78% of CORR’s revenues going away with GIGS and LGS.

What is CORR worth?

Putting it all together, we believe that CORR is a zero.  The company will go from generating cash to burning cash.  CORR has $121 million in cash from a well-timed convertible offering done at the highs in August 2019 they can use to potentially acquire another small asset.  We simply give them the value of the cash in our SOTP below, but if CORR acquires in line with their historical record, then that cash is probably worth less than face value!  However, the cash balance does buy them some time.  Despite the cash, CORR is a great risk-reward as the stock today prices in the NPV of the triple-net leases continuing through expiration, but as we explained throughout the writeup this is very unlikely.  The greater likelihood is that these leases go to zero.  Our bridge to a base case valuation of zero below:

 [1] “shortly after the acquisition, CorEnergy and Grand Isle began reaching out to Cox to introduce themselves and discuss the ins-and-outs of the business relationship…After weeks of ignored calls, it became clear to Plaintiffs that Cox was neither interested in meeting the owners of the Leased Property, nor aware of its obligation…” Cause No. 2019-20787 in the 11th District Court of Harris County, Texas

[2] “The Securities and Exchange Commission today charged the former CEO of Energy XXI Ltd. with hiding more than $10 million in personal loans that he obtained from company vendors…” https://www.sec.gov/news/press-release/2018-133

[3] “In the Texas state court litigation, EGC has asserted, among other arguments, in its verified answer and affirmative defenses that the guaranty and its assignment are unenforceable because they were executed without the proper authority.” Case No. 16-31928-DRJ for Southern District of Texas Houston Division

[4] “…includes the Company’s agreement with the Lenders that the Borrowing Base value of the GIGS asset for purposes of the CorEnergy Revolver shall be zero, effective as of the Company’s March 31, 2020 balance sheet date.”

[5] “the Debtors analyzed their…unexpired leases, and in particular analyzed alternatives to the Gathering System. As a result of this analysis, Ultra Resources has determined that, in its business judgment, it will be significantly more cost efficient and value maximizing to gather its hydrocarbons through these Gathering System alternatives, for two primary reasons... First, Ultra Resources does not need or use the full capacity of the Gathering System...Second, Ultra Resources has readily available and cheaper gathering alternatives.” Case No. 20-32631 for Southern District of Texas Houston Division

[6] “As previously mentioned, there is nothing prohibiting Ultra Resources from immediately starting to transition its gathering process away from the Gathering System, initiating the construction and permitting process, using trucking resources in the interim, and fully utilizing the SWEPI LGS as much as possible during the transition period. Given the desire by Ultra Resources to no longer utilize the Gathering System, Ultra Resources is in no position to continue to fund UWLGS’s rent obligations under the Pinedale LGS Lease. Under the Pinedale LGS Lease, rent is due, in advance, on the first day of each calendar month. May rent was timely paid, and June rent will be paid. Ultra Resources intends to shortly begin the process to connect the SWEPI LGS to the wells currently serviced by the Gathering System and will truck its liquids beginning on July 1, 2020. Thus, the Gathering System will not be used beginning on July 1, 2020.” Case No. 20-32631 for Southern District of Texas Houston Division

[7] “You may recall, we disclosed about a year ago that we had a very active process to try to mitigate the adverse impacts of the Spire Pipeline renegotiation…we were pretty aggressive about trying to find incremental customers. We are not able to find any. Again, most of those are tied into their local distribution company as their primary source of gas. And we -- so we aren't often out prospecting affirmatively, but we just came through a process where we did and made potential customers aware that we were -- we had extra availability, and we had no take-up on that.” CORR CEO on Q4 2018 Conf Call

Catalyst

CORR’s lease revenues come from two challenged tenants that will no longer pay rent. As the street becomes aware of this fact, CORR's equity will decline. Without the lease revenues from these two leases, we believe CORR’s equity is worthless.