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REAL ESTATE SERVICES
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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: Macro Noise Offsets MLP News

After 5 straight negative days last week, midstream had three positive days this week, including an intra-day reversal Thursday and a positive Friday.  But the week was still negative across the board, with Canada weakness dragging down the AMNA.  With oil and natural gas prices dropping and the broader equity market flattish, it was hard for the midstream sector to bounce back from the selloff that started last week.  But there were several strategic announcements that made a difference for a select few stocks in the group.

Interest rate on the U.S. 10-year dropped back towards 1.52%, 16 bps under last week.  Utilities didn’t respond as much to the lower rates than we’ve seen, but they were still positive for the week. 

The MLP Index is now down 4.2% in 10 trading days, the AMNA index is down around 3.5%.  But even with negative performance in 3Q and this week, Midstream and MLPs are positive for the year and have far outperformed other, more volatile areas of energy that are more directly tied to the commodity prices.

The news this week included a number of news items that have read throughs to other MLPs and midstream companies, positive and negative. 

  • There were multiple ENB regulatory updates with read throughs across Canadian midstream.
  • There was a Supreme Court announcement that will impact two major gas pipeline projects.
  • There was a new Permian oil pipeline FID that has implications for companies with existing competing oil pipelines and NGL pipeline when Seminole is placed back into NGL service
  • There was a big upgrade to a private equity takeout bid for an MLP, which could offer hope to those seeking a better deal from the TGE bidder
  • There was a NEP pipeline acquisition at premium to publicly-traded pipeline comparables, which is another data point in the argument for undervalued large scale gas pipeline assets footprints (like those owned by WMB and KMI)

Lastly, there was the HESM surprise mega-drop and IDR elimination.  With each IDR removal, including the latest one from HESM, those that still have IDRs stand out even more.  With each transaction that gets done earlier in the IDR lifecycle and for reasonable multiples, the harder time those that still have IDRs will have in justifying the continued existence of their IDRs and the valuations they expect for removing them.

  • Eight MLPs still have IDRs and are in the top (50%) tier, which means 50% of all incremental cash paid out is paid to the general partner: SHLX, DCP, DKL, CNXM, SUN, NBLX, EVA, SRLP.
  • Nine additional MLPs still have IDRs and are in the lower tiers: CQP, BPMP, OMP, ENBL, TCP, NGL, USDP, MMLP, GLP.

With so few MLPs left (both with and without IDRs), and still robust AUM held within MLP ETFs and open end funds, even those MLPs with IDRs have some technical support as they get disproportionately upweighted with each MLP merger or takeout.  That short-term technical support will eventually fade and expect discerning active managers to eschew any MLP with IDRs. 

Like we saw with positive reactions to PSXP and HESM, the current time feels ripe for IDR removal, because managers are likely to look past the short term dilution of IDR removal to pile into the stock that has removed an overhang. 

Winners & Losers

MLPs announcing strategic transactions (TOO and HESM) were the best performers in the group this week.  Others like SHLX and NBLX with lingering IDR and sponsor uncertainty also somehow outperformed on no news.  There was no news among the biggest losers this week.

CINR and SMLP went from top 5 to bottom 5 week over week.  NBLX went from bottom 5 to top 5.  SMLP didn’t bounce and repeated in the bottom 5.  On the YTD leaderboard, NBLX’s bounce back bounced it out of the bottom 5, replaced by CINR.  CEQP returned to the top 5 YTD.

Midstream Corporations

Midstream corporations underperformed MLPs this week.  Only three names were positive, and two of those (SEMG and TGE) have pending mergers.  TRGP led the group.  Lower commodity prices didn’t help ALTM, ENLC and AM this week.  PAGP sold off and was weaker Friday after EPD announced a new Permian oil pipeline.  The market reception to RTLR’s acquisition was lukewarm at best.  ETRN traded well Friday on the news the U.S. Supreme Court is going to review the case that went against the Atlantic Coast Pipeline, which is a positive read through for resolution on ETRN’s Mountain Valley Pipeline project.

TRGP’s strong performance was a rebound from weakness last week.  ETRN, TGE and KMI repeated in the top 5.  ENLC, AM went from top 5 last week to bottom 5 this week.  On the YTD leaderboard, TRGP broke through 20%+ return for the year on the upside, while ENLC broke through -10% return and AM broke back through -30% on the downside.

Canadian Midstream

Canadian midstream corporations underperformed this week, with a wider than normal spread.  ENB had mixed news that left its return in the middle of the group.  TRP and Gibson outperformed, and more commodity price sensitive names IPL and KEY underperformed, all on no news.

IPL and KEY were the bottom two performers for a second straight week.  As a result, Gibson climbed into 2nd place overall, but still 2000 basis points behind TRP’s return.

News of the (Midstream) World

Step-change in deal flow this week, with multiple updates on major projects, large and/or complicated transactions announced. 

Capital Markets

  • None.

Growth Projects / M&A

  • Hess Midstream (HESM) announced acquisition of sponsor Hess Infrastructure Partners (HIP) that will result in elimination of incentive distributions rights and Up-C structure for pro forma entity (presentation)
    • HESM to convert from an MLP to an up-C structure (partnership governance, corporation taxation, will issue 1099)
    • Transaction will eliminate HESM IDRs (HESM was paying less than 5% to its IDRs based on current annualized distribution and was in the 25% tier of the IDRs)
    • Implied all-in multiple for the drop-down and IDR takeout of approximately 10.3x
    • Announced accretion of 6% to DCF/unit in 2020 and greater than 15% in 2021-2022 (helped by the increase in leverage up to 3.0x)
    • HES and Global Infrastructure Partners will own 93.7% of the outstanding HESM units
    • HESM is not expected to pay cash income taxes for next several years
    • Announced EBITDA guidance for pro forma entity of $730mm
    • HESM maintained 15% distribution outlook through 2021 with 1.2x coverage
  • Energy Transfer (ET) filed form S-4 with details of the process of the acquisition of Semgroup (SEMG) (see story at S&P Global)
    • Details include interest from several private equity and strategic partners that ET outbid (by a healthy margin) to win
  • NextEra Energy Partners (NEP) announced the acquisition of Meade Pipeline Co. for $1.37bn, including $90mm in future expansion capex through 2022 (press release)
    • Meade is currently owned by AltaGas (ALA-CA, 55%), Cabot Oil (COG, 20%), and private capital (25%)
    • Meade owns a 39.2% interest in the Central Penn Line, a 185-mile, FERC-regulated natural gas pipeline in Pennsylvania which is backed by a minimum 14-year contract with an IG-equivalent customer
    • Transco, owned by Williams Companies (WMB), owns the remaining 60.8% interest of the Central Penn Line
    • Initial financing includes $820mm in partially amortizing project debt, $170mm in convertible equity with BlackRock, and the balance with NEP’s holding company debt
    • Transaction price is an estimated 12.5x EBITDA including the expansion capex
  • Plains All American (PAA) and Holly Energy Partners (HEP) announced a 50/50 JV, the Cushing Connect Pipeline & Terminal (press release)
    • The JV will construct a new 160,000 bpd common carrier crude oil pipeline connecting Cushing to Tulsa, and it will own and operate 1.5mm barrels of crude oil storage in Cushing, OK
    • The JV Terminal is expected to be in service during 2Q20 and the Pipeline is expected to be in service during 1Q21
    • The total JV capex is estimated to be $130mm, including the existing JV Terminal contributed by PAA valued at $40mm
  • Enterprise Products (EPD) announced expansion of Midland to ECHO oil pipeline system by building a 450,000 bbl/d pipeline (press release)
    • EPD expects the pipeline to begin service in 1H 2021
    • The new pipeline will enable EPD to convert its Seminole Red pipeline back into NGL service in 2021
    • EPD expects to achieve $60mm in annualized cost savings with the addition of the new pipeline by reducing the use of drag reducing agents on its current pipeline system
  • Teekay Offshore (TOO) announced agreement on revised price for previously discussed merger with sponsor Brookfield (press release)
    • Price is $1.55/unit, which represents a 33.6% premium to the prior closing price and a 47% premium to the original offer Brookfield made in May
  • Rattler Midstream (RTLR) and Oryx Midstream announced a JV to acquire Reliance Gathering for $355mm in cash (press release)
    • JV is a 60/40 split between RTLR/Oryx with Oryx as the operator
    • The system includes over 230 miles of gathering and regional transportation pipelines and 200,000 barrels of oil storage in Midland, Martin, Andrews, and Ector counties
    • JV also includes over 160,000 gross acres in Northern Midland Basin dedicated under long-term, fixed-fee agreements
  • Tallgrass Energy (TGE) announced a binding open season for Pony Express pipeline expansion (press release)
  • Sempra Energy (SRE) announced MoU with China Three Gorges Corporation regarding potential cooperation in supplying LNG to support demand growth in China (press release)
  • Kinder Morgan (KMI) announced commercial in-service of the first unit at its Elba Island LNG facility (press release)
    • First of 10 liquefaction units of the $2bn Elba Liquefaction project

Other

  • U.S. Supreme Court agrees to review the lower court ruling that halted construction on the Atlantic Coast Pipeline being developed by Dominion Energy (Reuters)
    • MLP EQM Midstream (EQM) is developing a pipeline facing similar issues, both Dominion and EQM outperformed Friday after the news broke
  • The Canada Energy Regulator halted Enbridge’s (ENB-CA) open season for its Mainline pipeline system due to the “perception of abuse of ENB’s market power” (press release)
    • ENB will not be able to offer contracted space on the pipeline until the commission approves the terms
    • ENB reaffirmed its plan to proceed with contracting the Mainline system through an expected filing
  • The Minnesota Public Utilities Commission voted for the MN Commerce Department to submit a revised environmental impact statement for Enbridge’s (ENB-CA) Line 3 and its potential effects of oil spills in the Lake Superior watershed (Reuters)
    • The department has 60 days to report back