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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: Midstream Better for Sale

Midstream traded down each day this week and finished down 3-6% across the different indexes, reversing some of the early 2021 gains.  The S&P 500 rebounded and oil prices continued to elevate, but energy struggling in a sudden shift in sentiment that seemed to coincide with the ultimately peaceful transition of power in the White House. 

Midstream is holding onto a wide lead on broad market indexes with 8%+ returns through 3 weeks, but the steady selling this week signaled a clear inflection in recent positive momentum.  In the parlance used by trade desks on Wall Street, midstream (and MLPs specifically) were “better for sale” this week. 

From what I understand, this trade chatter idiom means there were more sellers than buyers.  That was definitely the case this week, as the market came to grips with what should have been well known entering this week: the Biden Administration will engage in policy that supports other forms of energy at the expense of fossil fuels.

Energy Transition, ESG Focus in Midstream

Williams held its first ESG-specific investor event this week, laying out commitments to reduce GHG by 56% by 2030 (vs. 2005) and to strive for net-zero emissions by 2050.  WMB has also identified $3bn in planned green energy investments from 2021 to 2025, including $600mm directly into solar and renewable natural gas projects.  WMB has also embarked on several social and governance measures it is taking to improve in those areas, including formation of a Diversity and Inclusion Council. 

Expect Kinder Morgan to continue to step up its energy transition rhetoric at its analyst day event this week.  Midstream companies across the sector are evaluating ways to improve their disclosure on ESG and to participate in the bridge to a carbon free economy.  Focus on ESG and an acknowledgement of the policy and investor sentiment momentum around the energy transition is a positive step for midstream companies.

Transition to an Empty Nest?

I see some parallels to a similar transition my wife has been pursuing in recent years.  She left her promising professional life years ago to dedicate herself to raising three precocious and energetic (i.e. exhausting) children.  She knows that in 10 years, she won’t be needed as a day-to-day manager of our children’s lives (we hope). 

So, she studied and passed the CPA exams and has been working the last few tax seasons.  She is going to be ready to make the transition to full-time career mode when the children are gone.  In the interim, however, she struggles with not being able to dedicate herself fully to either the kids or the career right now.

Quick aside: Empty Nest was a show that aired for 7 seasons on NBC in the early 1990s as a spin-off from The Golden Girls.  I remember skipping past it on my TV, but never stopping…

If the global commitments to a net-zero carbon emission world continue to permeate, and if technology continues to develop, then there could come a time when the massive infrastructure required to support the current carbon/fossil fuel economy is not as critical. 

Midstream companies face the choice between (1) harvesting cash until that day comes by reducing capital investment, accelerating free cash flow and return of capital to shareholders, and (2) making a hard pivot to spending capital on the energy transition.  Most midstream operators will likely choose option 1 until they get their balance sheets in order, and then they may make that pivot.

The challenge (aside from the competitive dynamics of the renewables sector) becomes threading the needle between harvesting and pivoting while not doing a poor job at both things. 

Speaking of the early 1990s, being all things to all people is not easy, a lesson we all learned in a 1990 episode of Saved by the Bell when Jesse Spano tried to keep up with studies and her duties for the band “Hot Sundae” by getting addicted to “caffeine”, which was a euphemism for speed.  Low interest rates are the caffeine of the energy transition…

Winners & Losers

MLPs

MLPs were the worst corner of the midstream space this week, trading like energy stocks in a risk-off week for energy.  DCP and PAA were the worst performers, with fear around federal land exposure likely driving those stocks lower.  Downstream and non-index names like CAPL, GLP and EVA were big relative winners this week.  NGL announced guidance and launched a debt deal that led to a volatile week, including a 20% gain one day, but ended up 2.8%.

CAPL and EVA went from bottom 5 to top 5 this week.  DCP went from first to worst week over week, ENBL was also a bottom performer after being near the top last week.  GEL repeated in the bottom 5.  On the YTD leaderboard, still mostly positive YTD performance among MLPs, and still a few that held those 20% gains from last week, with NGL out in front.

Midstream Corporations

There were no positive performers in the U.S. corporation group this week, but LNG and KMI were close.  OKE maintained its dividend which probably helped it avoid a worse fate in such a negative energy tape. TRGP also fared better than you’d expect, perhaps helped by the upsized bond deal at 4.0% interest.  ETRN MVP headlines noted below dragged it well below the others in the group.

ETRN’s volatility is wild these days, it was the leader of the group at +12% last week and dropped 17% this week.  OKE repeated in the top 5.  Cheniere rebounded nicely on a relative basis.  YTD returns in this group are more muted than MLPs, but still strong.  KMI’s positive earnings release helped it climb all the way to the top spot 3 weeks into the year.

Canadian Midstream

Canadian midstream didn’t see the same level of carnage that U.S. midstream did this week.  TRP finished flat after some volatility around the Keystone XL permit news filtered through the system this week.  Pembina had a strong week, minimally impacted by U.S. regulatory fears but still exposed to the positive NGL value chain tailwinds.

On the YTD leaderboard in Canada, Pembina extended its early lead after very weak stock performance in 2020.  Other smaller names with businesses closer to the well head like Keyera and Inter Pipeline have also been strong early.

News of the (Midstream) World

More debt capital markets action on the debt side this week.  No M&A or growth project updates from companies, but there were definitely some regulatory items worth noting.  The new administration came into office firing executive orders as noted above.

Capital Markets

  • TRGP priced upsized offering of $1.0bn of 4.0% senior notes due 2032 at par (press release)
    • TRGP will use the proceeds to fund the tender offer of TRGP’s 5.125% senior notes due 2025
    • Upsized from $750mm originally offered
  • NGL Energy (NGL) announced $2.05bn offering of senior secured notes due 2026 (press release)
    • NGL traded up 20% on the announcement
    • NGL intends to use the proceeds combined with $500mm borrowed on a new asset-based revolving credit facility to repay all outstanding credit facility borrowings and to terminate NGL’s $250mm term credit agreement

Growth Projects / M&A

  • Pembina Pipeline (PPL-CA) announced binding open season on Cochin Pipeline (press release)

Other

  • President Joe Biden signed an executive order to rescind the Presidential Permit for the Keystone XL pipeline development (reaction press release from TRP)
    • TRP suspended the project ahead of the expected announcement earlier in the week, and is expected to incur a significant write down of the carrying value of the project ($1.7bn as of Q3)
    • The stock reacted negatively to the headline, but bounced back quickly as this project had a low probability of success anyway
    • TRP reiterated 10% dividend growth guidance in 2021 and 5-7% thereafter, which did not include KXL
  • Department of Interior issued a Suspension of Delegated Authority order to freeze new leases and permits to drill on federal land for 60 days (Department of the Interior)
    • Does not impact current operations, but the temporary restriction was taken as a negative signal on policies impacting fossil fuels under the new administration
  • FERC voted 2-2 on a certificate request from Equitrans Midstream (ETRN) for its Mountain Valley Pipeline (MVP) related to a stream crossing variance
    • Recently appointed commissioner Mark Christie (Trump appointee) did not vote

Distribution Announcements

  • This week, I counted 18 dividend and distribution announcements.  No fireworks, all maintained quarter over quarter.