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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: Midstream Restraint Rewarded

Midstream was higher each of the first 4 days this week, before taking a breather Friday, to finish up 5-6% over last week.  MLPs were particularly strong, especially gathering & processing stocks. Natural gas prices spiked throughout the week, finishing at their highest point all year, supporting midstream stocks along with positive broad equity markets and higher oil prices.

Earnings this week highlighted strong cost control among gathering & processing stocks (DCP and ENLC notable in this respect), the return of shut-in production, and plenty of capacity across midstream infrastructure that should lead to less capital expenditures for midstream for a while.  Also notable was how ET and PAA posted less robust crude marketing results than EPD’s results last week seemed to imply. 

WMB’s strong results and buzzword-heavy earnings call (not quite as many climate buzzwords as BP, but close) won the day on Tuesday when it traded up 8% to its highest price since mid-February.  Spiking natural gas prices helped, although differentials to the Northeast have expanded with the spike in prices at Henry Hub.

Mid-week the news came down that the Dakota Access Pipeline (DAPL) did not need to shut down while waiting for its environmental assessment, which initially was taken as very positive for the most impacted names like PSXP and ET.  But that enthusiasm was quickly sold as this week’s ruling does not resolve the larger issue that may put the pipeline out of service at some point later this year or next year.

Excess Capacity = Operating Leverage

In summary, it was likely the worst quarter of the year for midstream volumes across the board, and companies did their best to cut expenses as much as possible, which can work for a quarter on very temporary low activity levels.  It can also work if those expenses are slow to come back as volumes ramp back up.  Operating leverage was a common refrain from management teams, including TRGP, DCP, ENLC, ET and others. 

That operating leverage comes from excess capacity, which should allow midstream operators to avoid spending capital as volumes come back to fill up existing assets.  That loose capacity situation was referenced by multiple management teams as also raising the return threshold for new capital investments.  The returns needed to justify deploying capital into new assets is higher, because there is generally excess capacity.

Nailed to the Wagon

This forced and reluctant (in the tone of ET) capital discipline is better than no capital discipline at all, even if it came from the total lack of capital discipline for years before now.  The situation reminds me of a common film and TV trope, apparently referred to as being “nailed to the wagon”.  The concept is best explained with an example. 

Early in the pandemic, my family consumed the entirety of the TV series “Parks and Recreation”.  In one of the later episodes, Councilman Jamm starts dating Tammy, Ron Swanson’s ex-wife.  Tammy is a bad person, but Jamm can’t help himself.  So, Ron Swanson and Leslie Knope take Jamm to a cabin to break him of the trance.  Jamm is “nailed to the wagon” for his own good, and they end up repeatedly spraying Tammy’s perfume in his face and slapping him in the face.

In this analogy, companies in the midstream sector are Jamm, while investors and the macro environment are Ron and Leslie. 

Even with cost reduction efforts and operating leverage, expect the market to remain skeptical that recent commentary means the sector has permanently improved its capital allocation skills.  The sector still needs to see more rationalization of excess capacity (and executive compensation) via corporate consolidation, which is slowly happening.

Winners & Losers

MLPs

Some massive moves among MLPs this week, including ENBL leading the way with 26.7% gain on its earnings and renewed hope that the new CNP CEO can figure out how to get it sold.  GLP rallied on last week’s distribution increase and this week’s Q2 earnings release.  DCP crushed expectations with its results, sparking a short covering rally Thursday.  On the other end of the spectrum, GEL was down on weaker Q2 results and 2020 outlook.  The rest of the bottom 5 was smaller MLPs outside of indexes and ETFs that track the sector, including SRLP, ARLP, HMLP and KNOP.

GLP repeated in the top 5 and now has back-to-back double-digit percent gain weeks.  On the YTD leaderboard, EVA reclaimed the top spot and DKL broke into positive return territory.  Not much changed in the bottom 5.

Midstream Corporations

Every midstream corporation was positive this week.  On the back of strong natural gas prices, AM rallied 20%+ to lead the midstream corporation group, just ahead of ENLC, which reported better than expected results for Q2.  Other gas-oriented stocks like ETRN and WMB were strong on good results as well.  HESM rounded out the top 5. 

Week over week, ENLC, ETRN and HESM repeated among the biggest winners.  RTLR, PAGP repeated near the bottom.  On the YTD leaderboard, AM is now well into green territory counting its dividends so far this year.  HESM is also climbing the leaderboard. 

Canadian Midstream

Canadian Midstream stocks were all positive this week, led by smaller stocks with earnings as positive catalysts.  ENB underperformed after leading last week.  There seemed to be some rotation into higher-beta smaller names and away from the most stable, utility-like Canadian names (ENB, TRP) this week.

On the YTD leaderboard, those stable names are still well ahead of the average.  TRP and GEI are now in single digit negative total return territory.

News of the (Midstream) World

Outside of plentiful earnings results, news was light this week.  The DAPL ruling was noteworthy, but the relief for the most impacted stocks was short-lived.  Beyond that, we got a flurry of management changes, but no M&A or capital markets action.

Capital Markets

  • None.

M&A / Growth Projects

  • NGL Energy (NGL) announced new acreage dedication for produced water transportation and disposal in the Northern Delaware Basin (press release)

Other

  • A U.S. appeals court on Wednesday said the Dakota Access Pipeline (DAPL) does not have to be shut down and drained, but the larger issue of the environmental assessment needed for the water permit remains unresolved (Reuters)
  • Cheniere Energy (LNG) announced resignation of CFO Michael Wortley, to be replaced by Zach Davis (filing)
  • Centerpoint (CNP) announced 2 new members for Board of Directors of G.P. of Enable Midstream (ENBL) Al Walker and Robert Gwin (press release)
    • Al Walker was CEO of Anadarko Petroleum (APC) and was Chairman of Western Gas Partners from IPO in 2008 through 2019
    • Robert Gwin was CFO of Anadarko Petroleum (APC) from 2009 to 2018, and was recently appointed to the Board of Directors of Pembina Pipeline Corp. (PPL-CA)
  • Calumet Specialty Products (CLMT) announced resignation of CFO Keith Jennings (press release)
  • Hoegh LNG (HMLP) announced CEO/CFO Steffen Foreid plans to step down from his role by October 31 (press release)