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REAL ESTATE SERVICES
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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: Blue Flame Special for Midstream

Midstream followed up last week’s big week with another strong week of price action.  Midstream’s gains were mostly isolated to Monday and Wednesday, but those two days were good enough for a 3% week for the group overall, better than the S&P 500, utilities and infrastructure. 

Natural Gas Midstream Sentiment Roaring Back

In the last few years, in the face of overwhelming supply outlook from associated natural gas out of the Permian Basin, sentiment towards natural gas gathering & processing and pipeline operators was quite negative.  It felt like management of those midstream companies could do nothing to change that sentiment, and it overwhelmed any positive news related to northeast gas focused stocks. 

That situation has changed, the sentiment tide has turned hard back the other way.  AM and WMB (and more recently ETRN) are having their revenge this year, trading well ahead of the rest of the sector.

In the 1991 film Point Break, Keanu Reeves plays Johnny Utah, an F-B-I agent who tries to take down a gang of bank robbers by blending in with them as a surfer.  When Utah arrives at the field office in Los Angeles, he encounters his boss, who is struck by how dumb Utah appears.  He says, “You’re a regular blue flame special.”  I looked it up and apparently it is supposed to mean Utah is dumb, like so dumb that he lights his farts on fire, according to an online slang dictionary. 

I personally think whoever wrote the script made that insult up, or maybe it was an ad-lib, because I have never heard it used in daily life or anywhere in any other movies.  Anyway, I thought of that line today, because natural gas burns blue, and there is still some fight left in the stocks that own and operate natural gas infrastructure.

Blue Wave Not Special for Oil Pipelines

On the other end of the trade, PAA was among the worst performing midstream companies this week.  PAA seemed to be the preferred short to play the potential impact of the Kamala Harris choice as the V.P. candidate alongside Joe Biden and the potential for a Blue wave in the election.

 

According to PAA management, 20% or less of Permian acreage dedicated to PAA is on Federal land that might be subject to a fracking ban under a new administration.  That is not nothing, but it also is not overwhelming to PAA’s business. 

Incremental midstream investors clearly today prefer midstream operators whose fates are tied to natural gas rather than oil, and the Northeast rather than the Permian. 

Sideshow: IDRs Still a Thing in Dark Corner of MLP World

IDRs have been largely eradicated from the MLP market at this point, but there are a few MLPs that still have them and a few others with IDRs that are way out of the money.  This week, DKL announced a transaction to remove its IDRs.  DKL has a free float market capitalization of less than $300mm. 

Among the remaining MLPs with IDRs, there are a few larger than DKL, and several smaller.  Here is the list of remaining MLPs with IDRs, starting first with those who are paying out IDR cash above the minimum quarterly distribution with the total cash flow percentage paid to the IDRs in parenthesis (gross, not including any waivers).

  • SUN (20.5%)
  • EVA (13.1%)
  • SRLP (13.0%)
  • CQP (8.5%)
  • OMP (5.3%)
  • BPMP (3.1%)

Next is the list of MLPs with distributions too low to qualify for IDR payments after distribution cuts, but the structure remains in place.

  • ENBL
  • GLP
  • NGL
  • TCP
  • USDP
  • MMLP

That’s 12 more IDR elimination transactions to go on the long path towards complete elimination, but with each transaction, the remaining IDR structures become less relevant.  The largest MLPs have all removed them, some a decade ago.  A few years ago, building a midstream portfolio without IDRs was a challenge.  It is becoming increasingly challenging to build a portfolio that includes them.  That’s progress.

Winners & Losers

MLPs

Among MLPs, the big winners were those outside the major MLP indexes, including shipping MLPs HMLP and TGP, coal and royalty MLP ARLP and contracted petchem MLP WLKP.  ARLP and CNXM were beneficiaries of the natural gas trade that’s been working as the Northeast region has become investable again.  Liquids heavy MLPs NGL, PAA and PSXP were big losers this week.  NGL reported results that were way off of expectations, which wasn’t too much of a surprise.

ARLP and HMLP swung from bottom 5 to top 5 week over week.  On the YTD leaderboard, DKL had a strong week and is now neck and neck with EVA for the top spot YTD.  CQP flipped to positive YTD to join 3 others in positive territory within the MLP group.  Each of the bottom 5 is down 50%+, including distributions.

Midstream Corporations

This week can be summed up as follows: natural gas-focused names were up, PAGP was down.  Median returns for this group were lower than index returns, and some of the bigger names like KMI and OKE underperformed, so for the AMNA to return 3.0% this week, strength elsewhere was needed.

RTLR went from worst last week to first this week.  KMI and OKE repeated among the underperformers. ETRN, AM, ENLC and WMB all repeated near the top, benefitting from positive sentiment towards natural gas.  On the YTD leaderboard, AM continues to lead, but ETRN jumped a few spots to third place.  All 3 of the top spots are northeast natural gas focused names.

Canadian Midstream

In Canada, smaller more upstream-oriented stocks like Keyera outperformed this week, while the stability plays TRP, GEI and ENB positive, but lagging others.

Keyera was the best performer for a second straight week.  ENB was the worst performer again this week.  On the YTD leaderboard, TRP and GEI have separated from the pack on the upside, and despite recent strength, IPL remains separated on the downside.

News of the (Midstream) World

The August, post-earnings lull in news has begun, but there were some transactions, including another IDR takeout, as noted above. 

Capital Markets

  • MPLX priced $3bn of senior notes (press release), including:
    • $1.5bn of 1.75% notes due 2026 at 99.785% of par
    • $1.5bn of 2.65% notes due 2030 at 99.913% of par
  • Targa Resources (TRGP) priced upsized offering of $1.0bn of 4.875% senior notes due 2031 (press release)

M&A / Growth Projects

  • Delek Logistics (DKL) announced elimination of incentive distribution rights (IDRs) in exchange for newly-issued units worth $484mm and $45mm of stock (press release)
    • There are waivers on a portion of DKL’s units, but full IDR payments with no waivers on all 29.4mm units would annualize to $45.2mm, which implies a 11.7x multiple, and the multiple is even higher when considering the waivers
    • The playbook for winding down a sponsored MLP generally has been to (1) remove the IDRs with new units that push ownership levels to very high levels for sponsor, (2) cut the distribution, then (3) buy-in the MLP on the cheap
    • It remains unclear if that is DK’s plan with DKL

Other

  • Bloomberg is reporting that Brookfield’s “infrastructure arm” is in talks to acquire Blackstone’s minority stake in Cheniere Energy (CQP) (Bloomberg)
    • Blackstone’s owns a 41% stake in CQP worth roughly $8bn today
  • Williams Companies (WMB) named former sellside research analyst Danilo Juvane as Vice President of Investor Relations (press release)
  • Blueknight Energy (BKEP) named Andrew Woodward as new CFO (press release)
  • Calumet Specialty Products (CLMT) announced new CFO and CAO, internal promotes both (press release)
    • Todd Borgmann will serve as interim CFO
    • Vincent Donargo was named Chief Accounting Officer on permanent basis