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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: Sweltering Energy Discontent Hits Midstream

Midstream stocks, and MLPs in particular, held up ok this week, all things considered.  This week saw a combination of negative macro forces converge to crush energy stocks more broadly.  Oil & Gas E&P ETF XOP dropped 7.6% this week, inline with the drop in oil prices.  The S&P 500 declined 1.2%, hurt by earnings misses that were sold hard from industrials like CSX and tech giants like NFLX.  In the face of that carnage, midstream was down less than 2%.

Kinder Cliff Notes

In spite of energy stock angst (more on that below), midstream stocks appear to be on firmer footing at the moment, having inflected and then held onto gains this year.  This earnings season will be critical to the continued differentiated performance from midstream stocks. 

Kinder Morgan kicked off earnings season with an underwhelming report that didn’t offer any real surprises.  In summary, KMI has a stable outlook and its earnings were not a red flag for the rest of the midstream sector’s pending 2Q results:

  • NGL prices being in the tank dragged down parts of KMI’s business relative to 2019 guidance, but the impact is modest
  • Other reasons for below guidance outlook are more company-specific, but also well-telegraphed: 501-G settlements and delay of in-service for Elba Island LNG
  • The need for additional natural gas pipeline capacity from the Permian Basin to the Gulf Coast drove discussion of a new potential pipeline following Gulf Coast Express and Permian Highway (and Whistler, which KMI is not involved with)

Midstream Cliff Notes

I wrote a summer review post this weekend that pulls together our house view on trending midstream topics and on questions I frequently hear from advisors taking a fresh look at MLPs and Midstream after a few years off.

link to other post

Summer of Energy Discontent – To Sleep, To Dream…No More?

“Now is the winter of our discontent / Made glorious summer by this sun of York” are the opening words of Shakespeare’s Richard III.  The lines basically mean the end, or “winter”, of the discontent.  Summer in this case, represents the beginning of a new, better phase.  In that context, if winter is the end of something, then summer would far away from the end. 

If that’s the case, we may still be in the summer of discontent for energy stocks broadly.  Even though its been 5 years since oil cracked, it doesn’t feel like the general mood towards fossil fuels or energy stocks is improving.  It may be a while yet before our summer of discontent reaches the twilight or winter that would signal an end of energy under-performance is near. 

It seemed like signs of discontent were everywhere this week:

  • A SMID cap M&A transaction (CPE buying CRZO) was announced at a big premium, but that premium was priced in equity that quickly sold off such that the premium was basically eliminated
    • The reaction was not a bullish sign, and doesn’t encourage more interest from investors to look at energy stocks
  • Natural gas prices are set to post their lowest average prices for the summer in more than 20 years (not adjusted for inflation)
  • Tuesday saw oil selloff 3% on potential softer dealings with Iran based on Secretary of State Pompeo’s comments
    • Doesn’t feel great when oil prices are so sensitive to any whiff of an increase in global supply
  • Berkeley, California banned natural gas hookups for new construction
    • Natural gas is clearly not green enough for a certain sect of the population now that coal use is in remission
    • Even here in Pennsylvania, there was discussion in the local paper as to whether Philadelphia should do the same (Philadelphia Inquirer)

But we’re interested in hearing your thoughts. Where do you think we are in this cycle, if it is a cycle?

What stage of energy discontent are we in?

  • Middle innings (33%)
  • Late innings (29%)
  • No end in sight (29%)
  • Early innings (10%)

Total Voters: 135

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Winners & Losers

ET was notable among the best performing MLPs this week.  It was the best performing of all midstream companies with more than $10bn in market capitalization this week, likely benefitting from a well-timed Bloomberg report/leak of a large potential asset sale likely at an attractive valuation.  Outside of ET, other more defensive MLPs HEP and TCP made the top 5. 

On the other side of the ledger, NRP was the worst in the group, hurt by low natural gas prices that impact relevance of coal as a substitute, but also low prices for other commodities, which impact the minerals businesses NRP has diversified into in recent years.  3 of the bottom 5 this week were gathering & processing MLPs.

NRP and TOO repeated in the bottom 5 this week.  SMLP went from top 5 to bottom 5.  On the YTD leaderboard, OMP joined the top 5 while the bottom 5 got uglier across the board.

Midstream Corporations

Not a single midstream corporation was positive in the U.S. this week and the median was down 3.9%, far below any of the indexes.  The least bad performer in the group was PAGP at -1.3% in a reversal from last week when PAGP underperformed.  KMI’s earnings were not well-received (KMI -3.7% this week, inline with peers), but the stock wasn’t crushed like some of the other S&P 500 non-energy companies that announced this week, a sign that weaker results for midstream is potentially already baked in.

ETRN and AM, two sponsor-backed Northeast natural gas players, were hit the hardest hit this week.  The market has taken a draconian view of the viability of any producer in the Northeast, and that negative sentiment is trickling down.  Talk of yet another Permian gas pipeline from KMI probably didn’t help.  The rest of the bottom 5 was as you would expect: more volatile and/or commodity-sensitive names like TRGP, ALTM and SEMG. 

ETRN and AM repeated near the bottom of the group, while TGE was among the best performers again this week.  On the YTD leaderboard, AM is flirting with negative YTD return.  TGE climbed up a few spots on relative strength.

Canadian Midstream

While KMI’s results weren’t received very well, Kinder Morgan Canada’s stock price reacted positively to commentary of potential share repurchases.  KML was the outlier, but the rest of Canada held up well relative to midstream stocks in the U.S., and the group traded in a pretty tight bunch as usual.

Keyera remains atop the YTD leaderboard after overtaking TRP last week.  ENB’s YTD return slipped back below 20%.

News of the (Midstream) World

Capital Markets

  • None.

Growth Projects / M&A

  • Energy Transfer (ET) reported to be considering selling its 33% stake in Rover Pipeline (Bloomberg)
    • “People familiar with the matter” say the stake could be sold for $2.5bn
  • ET announced a binding supplemental open season for the Bakken Pipeline System (press release)
  • Kinder Morgan’s (KMI) Gulf LNG export project in Mississippi was approved by FERC (Houston Chronicle)
  • TC Energy filed application for Louisiana Xpress project (FERC Filing)
    • $500mm project would add 0.5bcf/d of additional southbound capacity on Columbia Gulf through three new compressor stations and modification to an existing one
    • Underpinned by 20-year contract to provide transportation service to Cheniere’s 6th train at Sabine Pass
    • In-service targeted for Q1 2022, inline with target in-service of KMI’s plan to add 0.9bcf/d of additional southbound capacity to the Louisiana Pipeline

Other

  • Equitrans Midstream (ETRN) and EQM Midstream Partners (EQM) appointed Diana Charletta as President and ETRN named CEO Thomas Karam as chairman (press release)
    • Charletta will retain her current COO position for both ETRN and EQM GP
    • Karam will retain his CEO role for both ETRN and EQM GP
  • Affiliates of Blackstone (filing) and KKR (filing) reported 9.4% common unit stakes each in Genesis Energy (GEL) after converting preferred units acquired in August 2017

Distribution Announcements

  • 13 distribution announcements this week
    • HEP: 59th consecutive distribution increase
    • WES: 26th consecutive distribution increase, every quarter since IPO
    • USAC: 16th straight flat distribution
    • TRGP: 15th straight flat distribution
    • CEQP: 13th straight flat distribution after the cut