VettaFi recently sat down with Jonathan Stein, CFO of Hess Midstream LP (HESM). He discussed the company’s asset base, growth opportunities, and capital allocation priorities, as well as other valuable insights for investors.
Hess Midstream owns and operates energy infrastructure in North Dakota’s Bakken shale, primarily under long-term contracts. HESM issues a 1099 tax form, eliminating the complexity of a K-1 form. The company’s dividend yield is approximately 7.5%.
VettaFi: Would you provide an overview of Hess Midstream’s asset base for our readers? Where and what type of midstream businesses does HESM operate?
Stein: Hess Midstream has gas, oil, and water infrastructure assets, which are located in the Bakken in North Dakota, and provides midstream services to Hess (HES) and to third parties.
Our asset base is uniquely located in one of the main producing parts of the Bakken and is interconnected north to south. It includes different types of assets, starting with gas processing and gathering, which represents 75% of our EBITDA. It includes two gas plants with 500 million cubic feet per day (MMcf/d) of combined gas processing capacity.
Continuing through our assets, we also have our crude oil terminaling and gathering system, which represents 20% of our EBITDA. Our oil terminaling system includes terminaling north and south of the Missouri River with interconnects to interstate pipelines like the Dakota Access Pipeline (DAPL).
We also have a 140,000 barrel a day rail facility fully interconnected into our system that allows for additional flexibility in terms of takeaway from the Bakken.
We have a single fee structure for crude terminaling, whether it goes out by rail or it goes out by pipe.
Hess is our main customer. They pay a single fee and then they get to optimize relative to those market differentials. But for Hess Midstream, it’s a bit more like a toll road fee. One of the elements of Hess Midstream is having the right risk profile and downside protection through our contract structure.
The last thing to highlight is our water assets, which includes water gathering as well as our saltwater disposal wells. It’s a small part of our business, approximately 5% of EBITDA. It allows us to take produced water from a well pad and provide the full suite of services for gathering and disposing of the water in saltwater disposal wells.
I would also highlight our contract structure, which underpins all these assets. Our contract structure with Hess is a long-term contract through 2033. It is agnostic to commodity prices and has two sets of fee structures.
First, 85% of our revenues are on a fixed-fee basis with an inflation escalator up to 3% per year. Second, 15% of our revenues are on a so-called cost of service, which provides additional protection. Each year, Hess will provide us with their nomination, and then we’ll set a fee that gets a targeted return on our investment. The following year, Hess will give us an updated plan, and then the fee will adjust to maintain a targeted return of capital based on changes in volumes and capital. That includes our water gathering, our terminaling, and one of our gas subsystems. The other 85%, which is the rest of our systems, are on that fixed fee.
The other element that both fixed fee or cost of service have is our minimum volume commitments (MVCs). Our minimum commitments are set three years in advance. They’re set at 80% of an expected throughput. So Hess will give us a nomination, looking three years in advance, see what those inputs will be, and then we set that at 80%.
They provide two things. One is that they provide revenue in the case of a downturn. If you look back over our history, since 2015 through two downturns, these MVCs have provided a downside protection so that we’ve had growing EBITDA across all those years, even through commodity price downturns.
The other thing that MVCs do is provide visibility. For example, our MVC for gas processing for 2026, which was set at the end of last year, is 396 MMcf/d, and based on that, our expected throughput is 495 MMcf/d. This year’s guidance for gas processing is 405 to 415 MMcf/d, so we really have 10% annualized growth visible from this year through 2026. That’s a very unique level of visibility that is really differentiated from other midstream companies.
VettaFi: Hess Midstream’s assets are primarily in the Bakken. What are the benefits of being focused on the Bakken?
Stein: Hess has been in the Bakken since the 1950s and is one of the oldest producers in the Bakken. Hess initially had built out this infrastructure, and then it was sold to Hess Midstream starting in 2015 through a joint venture with Global Infrastructure Partners, and then in 2017, when we IPO-ed into Hess Midstream. It’s a place where we have a long history together with Hess. We’ve also had the opportunity to really support Hess’s growth in the Bakken as they have continued to grow their production level.
I talked about 10% annualized growth in gas. Really the driver of that is Hess continuing to run four rigs in the Bakken, but also a focus on working with Hess to get to Zero Routine Flaring, a sustainability goal, by the end of 2025. To achieve that sustainability, you need to have the capacity that we built. Together with Hess, we’re well on our way to doing that. That’s really us building out that infrastructure side by side with Hess.
What’s unique about Hess Midstream is the integration that we have between Hess and Hess Midstream. So when we look at how we’re going to develop the Bakken, it’s really saying, Hess and Hess Midstream together, how do we optimize the opportunities for growth?
The other thing that we have the advantage of in the Bakken is 10% of our volumes are actually third parties beyond Hess. Hess Midstream’s infrastructure is located right in some of the most strategic locations in the Bakken, both north and south of the river. That allows us to have the ability to service not only Hess, but also third parties that are also seeking to maximize oil production while responsibly handling the gas that comes with it. This includes other producers who have, let’s say, well pads along or near our infrastructure that we can connect into, as well as other midstream providers who are looking to utilize the flexibility and optionality that we have in our system to be able to offload volumes and provide additional flexibility as part of their own infrastructure.
VettaFi: Where do you see growth opportunities?
Stein: We’re very fortunate in the sense that we have very visible growth. All of our asset bases are growing visibly because of the minimum volume commitments, or MVCs. You can see that through 2026 at 10% annualized growth. We have an inflation escalator, so more than 10% growth in EBITDA through 2026. Capital, meanwhile, is relatively stable.
This year’s guidance is for capital of $250 million to $275 million. We expect to be relatively stable at those levels as we head through 2026. That means that with growing EBITDA and stable capital, our free cash flow is obviously going to continue to grow more than 10% per year as well. That really supports the flexibility that we have to deliver ongoing distribution growth to our shareholders on a very consistent basis.
I would also highlight that’s just our growth through 2026. As we look beyond that, as I mentioned, if you look at our gas volumes at 495 MMcf/d expected throughput in 2026 with a capacity of 500, that means we’re going to be basically full as you get to the end of 2026.
We’ve already started engineering this year on a potential gas plant that could add another 125 MMcf/d of gas processing and could come online as early as 2027.
That really gives us the potential for continued growth, particularly on the gas side, through the rest of the decade. So we really are in a unique position where you can visibly see our growth through 2026, and then, with the new gas plant potentially coming online in 2027, that sets the stage for additional growth. The capital for that potential gas plant is already included in that stable capital of $250 million to $275 million.
We’re able to maintain stable capital and continue to drive EBITDA growth over the next two years. Then actually continue to drive volume and EBITDA growth beyond that with the capital really being invested just over the next two years, setting us up for continued free cash flow growth, not only through ‘26 but really through the rest of the decade. So we’re really in a unique position there with great, very visible opportunities ahead.
VettaFi: What are your capital allocation priorities and distribution growth outlook?
Stein: We’re growing EBITDA, maintaining stable capital. We’re growing free cash flow more than 10% per year, exceeding our target distribution growth of 5% per year. What that means is that we’re fully funding our distribution from free cash flow. Not only fully funding, but we actually have growing excess free cash flow beyond our 5% growth in distributions.
The second thing that we do as part of our financial strategy is keeping a very conservative leverage target of 3.0x EBITDA, one of the lowest leverage targets in the sector. As we have growth in EBITDA — since everything is fully funded, capital obviously included in free cash flow as well as distributions — that means our leverage is actually declining. So we expect it to be less than 2.5x by the end of next year.
So what that means is, in terms of financial flexibility, if you take the leverage capacity that we have with that free cash flow beyond our distributions, we have more than $1.25 billion of financial flexibility.
One of the priorities for capital allocation is incremental returns to shareholders. So we have really two parts to our return of capital framework. First is the 5% distribution growth that I talked about that is fully funded from our free cash flow. And then we have share repurchases.
What we’ve done over the past two, three years, and what we expect to continue to do — we just announced one this week — is repurchase shares. Since 2021, we’ve repurchased $1.75 billion of shares, and that has really driven just incredible accretion to our shareholders.
Absent anything else, repurchases lower the number of shares. If absent any other action, our total distributable cash would actually go down because we have less shares. So we take that opportunity to increase our distribution per share with each of the repurchases to bring us back to the same distributed cash that we had before the repurchase. So it’s kind of self-funding itself, if you will.
The result of that is not only that $1.75 billion of repurchases. Simultaneously, we’ve not only grown our distributions by that 5% targeted amount, we’ve also added another 5% or 6% per year to these step-ups following each repurchase. So we really had more than 10% growth per year over the past few years.
In total, we’ve grown our distributions on a per share basis about 50% since 2021 as a result of growing 5% plus these step-ups each year, and then on top of that, with the accretion from the lower share count.
Returning capital continues to be something where we feel very differentiated from our peers if you look at our metrics. As I mentioned, our leverage is one of the lowest, if not the lowest, in the sector. But simultaneously, our cash returns to shareholders is one of the highest, close to 50%.
We have been able to really maintain low leverage and balance sheet strength on one side, while at the same time being able to deliver really leading shareholder returns both through distribution increases, but also through repurchases. That’s really our focus and continues to be a priority for us.
VettaFi: How is Hess Midstream differentiated from peers in the midstream space?
Stein: As we talked about, the combination of balance sheet strength and leading shareholder returns is No. 1.
Right next to that is our operations, and really the growth underpinning all of our business, visible through our MVCs. Underpinning that is continued growth from Hess running four rigs in the Bakken, driving continued growth across all of our commodities: oil, gas and water. A continued focus on gas capture and a focus on sustainability jointly with Hess to reach Zero Routine Flaring also drives our gas volume growth.
The integration between Hess and Hess Midstream is really unique. We’re serving Hess, but also, again, 10% of our volume is coming from third parties. So being able to take that same infrastructure that we are able to service Hess with, and provide that to both other producers and other midstream companies.
From an operational side and also a financial strategy side, we really feel like it’s a very unique and differentiated model to be able to continue to drive visible growth through this partnership and tight integration with Hess, while simultaneously really leading shareholder returns all built on balance sheet strength.
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