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We have downgraded our recommendation on Plains All American Pipeline L.P. (PAA - Analyst Report) to Neutral from Outperform. This revision was primarily due to decline in hydrocarbon volumes, uncertainty in global capital and credit markets, stringent regulations and higher expenses associated with offshore drilling, and commodity price volatility.

We know that Plains All’s cash inflow primarily depends on transportation of hydrocarbon through its infrastructure. A decline in hydrocarbon volumes due to lesser demand, stringent environmental and other regulations related to hydrocarbon transportation, and natural calamity may cause the partnership’s cash flow to decline in the future.  

Secondly, Plains All generates a major part of its revenue from low-risk fee-based activities. However, the partnership may be exposed to commodity risk within its Supply and Logistics segment, which is involved in the purchase of crude oil through third-party tankers. Though the partnership re-sells the oil and locks in profit margins, this act involves payment of collateral for hedges based on the market price of crude. Therefore, volatility in crude oil pricing and market structures may negatively impact Plains All’s volumes and margins in its logistics and marketing businesses.

On a positive note, Plains All American Pipeline’s portfolio of crude oil pipeline and storage assets are strategically located in well-established oil producing regions that serve major U.S. refinery and distribution markets. We know that the partnership’s crude oil gathering and transportation activities are expected to predominantly generate fee-based revenue, resulting in stable and low-risk earnings and cash flows.

In addition, Plains All continues to increase its internal operational efficiencies along with steady investments in infrastructural development activities. In the first half of 2012, the partnership’s capital expenditure was $2.2 billion. Under the organic growth program, Plains All is expanding its crude oil rail facilities, increasing its gathering system; constructing a new condensate stabilization facility; and building a new pipeline beside the Gulf Coast.

On the flip side, Plains All has adequate operating gas storage facilities, which will enable it to meet its contractual obligations with respect to wheeling, injection, withdrawal and gas specifications. If the partnership is unsuccessful in performing its plans or fails to wheel, inject or withdraw natural gas at contracted rates, or unable to meet contractual quality requirements, it may incur high costs to satisfy its contractual commitments.

Houston, Texas-based Plains All American Pipeline, L.P. owns assets strategically located in well-established oil producing regions, catering to major U.S. refinery and distribution markets. The partnership competes with Enterprise Products Partners L.P. (EPD - Analyst Report). Plains All American Pipeline, L.P currently has a short-term Zacks #3 Rank (Hold rating).

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