Even with the shutdown order stayed, I’ve spent quite a bit of time in the weeds of the Dakota Access Pipeline case. While it might seem a bit of a waste, it is a necessary effort as the outcome will have profound implications for its owners: Energy Transfer (ET), MPLX (MPLX), Enbridge (ENB), and Phillips 66 Partners (PSXP). We are now days away from a decision that will likely swing valuations at these companies by billions of dollars cumulatively.

It is unfortunate we are at this point, and I personally do not like having exposure to companies where there are material legislative/regulatory risks that could impact run rate EBITDA. It has been a lesson learned with time: most of my worst investments can be traced back to being on the wrong side of a legal decision or regulatory change. That makes me cautious, and even though I still have a constructive view on the likelihood of a favorable outcome, contextually it’s important to understand all the parties involved, the timeline, and the legal arguments laid out.

Further Background

Judge James Boasberg ordered the Dakota Access Pipeline emptied because the United States Army Corps of Engineers (“Corps”) “violated the National Environmental Policy Act (“NEPA”) when it granted an easement to construct and operate a segment of the crude oil running beneath the lake.” This traces back to early 2017 when, as one of his first orders of business, President Trump helped push through a thirty-year easement under Lake Oahe by instructing the Corps to conduct an expedited review. Because the owners of Dakota Access were complicit and knew of the push to get the review done, the court deemed that any economic harm that they might face is meaningless because of that knowledge. Risk from the pipeline leaking and subsequently damaging a fragile ecosystem, however small, outweighed the impact to owners and those indirectly harmed. While a stay has since been granted by the DC Circuit Court of Appeals, that is no guarantee of success and the pipeline could be ordered emptied yet again pending its ruling.

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Much ink has been spilled over the shutdown of Dakota Access, most of it pro pipeline. To be clear, there is case precedent for ordering pipeline shutdowns for NEPA violations. In Montana Wilderness Association v. Fry, a federal court in Montana shut down an already operating oil pipeline because of NEPA violations. This stance was re-emphasized in Sierra Club v. U.S. Army Corps of Engineers, in which the DC Circuit Court observed that “if the Corps violates NEPA when permitting an oil pipeline, shutting it down pending compliance was an available remedy.”

There is some sound logic behind this. Dakota Access owners take the position that even though the Court has vacated the easement, the decision to close instead rests with the US Army Corps of Engineers (as the landowners). But, if you think about it, given the US Army Corps of Engineers and the Dakota Access owners have no intention of a shut-down, that means that a NEPA violation – a rule of law – cannot be enforced by the court to stop operations. At the minimum, I think that violates the spirit of NEPA in the first place. Without a reason – the pipeline taken offline – there is little to spur the Army Corps or the pipeline owners to complete the new environmental impact statement (“EIS”) in a timely manner.

It is up for debate, however, and that is where the DC Circuit Court of Appeals will come in via a randomly assigned three-judge panel. The judges there will decide whether or not Boasberg did have the power he used to both vacate the easement and order the pipeline to empty. Further, the argument of harm will also be raised again, with a debate over whether Boasberg properly considered the harm to parties across North Dakota. In its argument, Dakota Access owners argue that the closure of the pipeline would impact communities across North Dakota via a number of ways: lost jobs, lower state tax revenue, stranded assets.

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The three judges in place here are two liberal appointees, one conservative. That is not a surprising outcome as the DC Circuit, at least among its full-time judges, skews overwhelmingly towards liberal appointees. These three have not worked together in tandem much, but interestingly enough, recently overturned a ruling by Judge Boasberg. In that case, (AHA v. Burwell) Boasberg ordered the U.S. Department of Health and Human Services (“HHS”) to clear its backlog of appeals within its Office of Medicare Hearings and Appeals over the next four years, going as far as mandating a complete elimination of the backlog by December 2020. The HHS argued it would be impossible to reduce the appeals backlog on that schedule – much like Dakota Access owners argued that it would be impossible to empty the pipeline in thirty days – without improperly paying claims. Boasberg disagreed.

In its ruling on the AHA v. Burwell case, the appellate court found that it was an “error of law” and an “abuse of discretion” for Boasberg to order that schedule. I think that ruling is incredibly relevant here, and one can make a great case yet again that Boasberg did not weigh all the facts and displayed a clear abuse of power.

No matter what the end game is, Dakota Access and the US Army Corps of Engineers want this issue resolved quickly because of the current political environment. The election is just a few months away, and a change of the guard to a Biden administration risks throwing a wrench into the entire process. If elected, Biden could very well extend the timeline of an EIS review and, particularly if the pipeline is ordered shut until those findings are released, that could jeopardize its future. While a new EIS was guided to 2021, Trump recently relaxed recent NEPA rules, so it might not take a year given current data. However, a rushed process runs the risk of just causing issues again within the courts.

Takeaways

In my view, odds are strong of a positive outcome here for Dakota Access. I view the odds of 80% that the Boasberg decision is overturned, either at the DC Circuit Court of Appeals or the US Supreme Court. As far as the Appeals court on its own, it is basically a coin flip. That’s a troubling perspective to have as a shareholder.

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Unlike others, I do not find this to necessarily be a killer for the midstream industry either. The entire argument on Dakota Access is all about an easement and not an issue with the permitting process. Even in past years which were decidedly more “pro pipeline” than today, these kinds of easement issues are not altogether uncommon as easements expired, especially on tribal lands. Because of that, I don’t think that a victory or defeat here in any way sends a message that shutting down operating pipelines is “fair game” or that new development is now impossible despite how it might be portrayed in the media. However, it can and should shift how developers choose to route lines in the future. In another universe with different routing that avoided Lake Oahe, Dakota Access is running without contention.

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Disclosure: I am/we are long ET, MPLX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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