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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: Big Score for Midstream

Midstream broke a 4-week losing streak and rang in the new year with a bang, rallying 7-8% across the midstream indexes.  The big week was just the 3rd best week for MLPs since the vaccine news turned things around in early November. 

Oil prices were helped by a surprise unilateral production reduction from Saudi Arabia Tuesday after a long negotiation that seemed to be leading to no action from the other OPEC members and Russia.  Stocks were strong, presumably on enthusiasm over potential large fiscal stimulus actions following Democrat senate wins in Georgia, and not on the bizarre events at the capitol building. 

Energy stocks generally were positive all week, but midstream indexes faltered Friday after 4 positive days to open the year.  With little company-specific news, it was all about the macro energy picture and rotation into smaller, value stocks across the market, and energy stocks largely fall into both of those categories (small and value) these days, with midstream existing as a subset of that energy group.

January Effect Happens in January for a Change…

After this week, midstream indexes are back near where they peaked in early December.  Weakness the last 4 weeks may have been due to positioning and hesitation to buy MLPs so late in the year and incur K-1s for 2020 so close to the new year. 

This well-known January effect for MLPs wasn’t gamed this year like we’ve seen in some other recent years when expected January strength was pulled forward into the final weeks of the year.  It may have been fatigue after a rough year or lack of interest from hedge funds that otherwise would have been actively positioning for the bounce.

Looking back at recent years, we see a surge in MLP performance around the beginning of the year, but the rally started well in advance of January each year.

Does the January effect happening in January as opposed to December mean that this January effect will sustain through the year? Unclear.  But it may indicate a return to a more retail-oriented investor base for midstream stocks after many energy-focused hedge funds have grossed down or shut down.

Free Cash Flow / Lufthansa Heist Corollary

2021 should be a year of higher free cash flow for midstream.  Free cash flow has been impeded in recent years by high distribution payout ratios, high capital expenditures and declining cash flow from existing assets.  Distribution cuts have reduced payout ratios.  Capital expenditures have been wrung out of the system by sustained low commodity prices. 

This leaves high near-term free cash flow for midstream generally that can be used to reduce leverage that remains stubbornly elevated in many cases.  Stubbornly elevated because of that third issue above (existing cash flow), which is still being impacted by producer restraint and competition.

While there are some midstream companies that may be able to direct capital towards other uses besides leverage reduction, many do not have that luxury.  So, 2021 should be another year of transition for midstream.  Expect fewer press releases and company-specific news as midstream companies focus on quietly reducing expenses, laying low until the day when they step back into the spotlight with splashy capital deployment into buybacks, acquisitions or capital investments.

In a way, this is similar to the scene in Goodfellas where Jimmy Conway (Robert DeNiro) tells his crew after the Lufthansa heist to avoid making big purchases that will draw attention of investigators.  Midstream players, especially those with high leverage and legacy cash flow challenges, need to lay low this year and give the market a chance to gain confidence in the sector again.

Winners & Losers

MLPs

PAA was a standout performer among large MLPs this week, which is interesting because PAA has been cited as the stock with the most exposure to potential frack ban on federal lands that would appear to be more likely after the Georgia outcomes this week.  Higher oil prices seemed to outweigh the frack ban concerns, which may have been mostly priced in already. 

Notable underperformers included downstream captive subsidiary MLP Westlake Chemical (WLKP) and wholesale distribution MLPs SPH, SUN and CAPL.  CEQP was a head scratcher as an underperformer in a risk-on week, but CEQP was a debt issuer this week, which may have pressured the equity from bond buyers hedging with shorts on CEQP.

PAA and NGL went from bottom 5 last week to top 5 this week, the clear oil and energy sentiment plays in MLP land.  WLKP went from first last week to worst this week.   CEQP repeated in the bottom 5. For this week only, the leaderboard for the year matches the week’s performance.  We’ve wiped the slate clean.

Midstream Corporations

Plains was tops in the corporation group this week, followed by other high-beta producer facing stocks like TRGP and ENLC that tend to trade well in a rising oil price environment.  LNG continued its recent outperformance with a strong opening week as global LNG prices hit fresh highs above $20.70/mmbtu in Asia, with spot prices reaching above $30/mmbtu according to Bloomberg.

ETRN was the only negative stock, and (like CEQP above) it was a big issuer of debt this week.  HESM extended its MVC contracts with sponsor Hess for another 10 years, but it underperformed in the high-beta rally.  OKE underperformed other big cap names even with the strong commodity prices and generally positive tone, making it one of the few big 2020 losers to lag this week.

LNG repeated near the top, RTLR and HESM repeated near the bottom week over week.  PAGP went from close to the bottom to the front of the pack.

Canadian Midstream

In Canada, last year’s big losers were big winners this week, led by Pembina and Inter Pipeline.  TRP and ENB were up, but lagged, while GEI was left behind likely due to some rotation among smaller Canadian midstream stocks this week.

Pembina and Inter Pipeline went from bottom to top week over week, while GEI did the opposite.

News of the (Midstream) World

Capital Markets

  • Equitrans Midstream (ETRN) priced $1.9bn worth of senior notes in upsized offering (press release), including:
    • $800mm of 4.50% senior notes due 2029
    • $1.1bn of 4.75% senior notes due 2031
  • Crestwood Equity (CEQP) priced offering $700mm of 6.00% senior notes due 2029 (press release)

Growth Projects / M&A

  • Kinder Morgan (KMI) announced Permian Highway placed into service (press release)
  • Hess Midstream (HESM) exercised option to extend agreements with Hess Corp. (filing)
  • Noble Midstream (NBLX) announced additional acreage dedication from Chevron in the DJ Basin (press release)

Distribution Announcements

  • EPD announced distribution of $0.45/unit, up 1.1% quarter over quarter and year over year
  • PAA/PAGP announced quarterly distributions of $0.18 per unit/share, unchanged from prior quarter, 50% below prior year