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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure, CBRE Clarion

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Week Thoughts: Midstream Survives The Purge

Midstream and MLPs finished the week negative overall, but rallied Friday on a negative day for oil prices to nearly salvage the week, which was encouraging in light of largely negative news across the sector this week.  Oil prices finished the week down 2.6% overall, despite a strong inventory report that supported prices mid-week.  The AMNA index outperformed the MLP Index and finished inline with utilities for the week, helped by strength in Canada (again).

Midstream stocks held up well this week, despite negative news flow and strong recent performance. This is bullish. It’s almost as if the market is ready to give midstream stocks a pass.  Or maybe there aren’t any more midstream sellers left, beyond the hardcore base.

This final week of this earnings season reminded me of the premise of a horror movie that I’ve never actually seen: The Purge. The film’s premise: for one full day each year, there are no laws, and people murder each other en masse with no fear of retribution or consequences, while the protagonists barricade themselves in houses hoping to avoid death.

Recapping the onslaught of news this week (read more in the news section below):

  • OKE results underwhelmed, plus large capex guidance with wide range.
  • SMLP series of negative announcements, including unnecessary/dilutive IDR elimination, distribution cut, and CEO departure.
    • IDRs not worth anything post cut, but I’ll pay you anyway
    • Could have saved $10mm in IDR payments just by cutting the distribution, rather than increasing unit count, but I digress…
  • SEMG lower guidance, weak outlook, unclear plan to reduce leverage further.
  • ALTM dumpster fire on lower guidance.
    • More on this below, but key takeaway: structure isn’t everything
  • Pipeline delays
    • Atlantic Coast Pipeline had a negative court ruling, which has negative read across to the Mountain Valley Pipeline project
    • Also, after the market closed Friday, ENB’s Line 3 Replacement project announced delay, which is negative for Canada energy generally
  • Weaker macro environment: Lower commodity prices, rising interest rates.

Tree of Trust & Understanding?

A lighter way to look at it, this earnings season was like the scene from Old School when Frank the Tank goes to marriage counseling, and is told: “This is a safe place, a place where we can feel free to share our feelings.  Think of my office as a nest in a tree of trust and understanding.  We can say anything here.”

SMLP and ALTM investors were caught off guard by some of the things said in that trust tree, but overall the market is more focused on the improvements and reforms underway among the larger players.

The market took in all the above negatives and traded poorly, but by Friday with no more earnings announcements this quarter, midstream rallied. So, where do we go from here? Probably higher, if midstream traded this well through the Purge, what negative catalysts are left at the company level?

Status Update: February

MLPs finished February not down, which is much better than last years nearly 10% decline in February.  MLPs finished February +12.9% YTD, still on a very strong pace. The MLP Index is tracking 2013 returns closely:  January 2013 was +12.6% and February was +0.9%.  MLPs finished 2013 with a 27.6% total return, which feels plausible for 2019.

Looking ahead, the MLP Index has been negative in 3 of the last 4 years in March, including the last two in a row.  If MLPs can finish March positive, they would post the best quarter since 2Q 2016 (+19.7%).  In case you were wondering, the best quarter in the history of the MLP sector: 2013 at 19.74%.

The AMNA Index, which includes Canada and is the most inclusive midstream index, has far outpaced the MLP Index this year so far.  In February, AMNA added 100 bps to its YTD lead, and has now outperformed the MLP Index for 5 consecutive months.  As of month-end, AMNA had produced just under 18% total return for the quarter, and its even more after Friday.

Winners & Losers

CQP traded well after strong 4Q results and reiterated guidance, way outperforming its parent LNG. MMP caught a defensive bid after recent underperformance.

But the real action was in the bottom 5 where egregiously poor MLP governance was on display when SMLP announced plans to dilute LP investor to get rid of IDRs, even though they have virtually no value after the simultaneous distribution cut.  In addition, EQM dropped like a rock most of the week as the market digested the news on Atlantic Coast Pipeline and translated its impact on EQM’s Mountain Valley Pipeline.

There was serious shuffling on the YTD leaderboard week over week, with SMLP tumbling out of the top 5 from the number two spot. HESM was a winner in the SMLP collapse, acquiring assets from them and climbing into the second spot behind NGL. Small cap names MMLP, CAPL and USAC also joined the top 5, replacing the shipping names that fell off.  EQM took over the bottom overall spot, more than 2000 basis points off the AMZ return.

Midstream Corporations & General Partners

KMI’s impressive start to 2019 continued, as it led the midstream corporation group for a second straight week. Chairman Rich Kinder continues to buy shares in the open market, which appears to be helping. WMB was a close second this week.  Both KMI and WMB seem to be gaining traction as relatively stable stories with leverage trending in the right direction.

It’s easy to look stable relative to some of the others in this group of late.  This week, ALTM dropped 31.7% after a bigly negative change to guidance.  ALTM was sold in 2018 as a midstream corporation with locked-in growth tied to a strong sponsor. It was also sold as a vehicle that midstream investors would “need” to own. We agree that midstream investors need more corporations to invest in to fill out the non-MLP bucket of midstream strategies. But corporate structure alone clearly isn’t a panacea. Midstream corporations can have poor alignment and broken promises just like MLPs.

Lost in some of the carnage late was weaker results and uncertain capex outlook from OKE, which underperformed slightly on the week. As a result, OKE relinquished the YTD lead, leapfrogged by KMI and WMB.  ENLC is hanging around as well, getting some support post-simplification. TGE was the only YTD negative name in this group last week, but has since been joined by ALTM and ETRN.

Canadian Midstream Corporations

Canada beat the U.S. again this week with every single name positive.  Within the group, we saw further into Keyera, Inter Pipeline and Pembina.  Late Friday’s news of delayed permitting for Line 3 may take some of the air out of Canada midstream overall next week.

Keyera won the week by a wide margin again. TRP was the worst performer but still positive. YTD, Keyera is well ahead of the group now. TRP and Pembina are both up 25%+ too.

News of the (MIdstream) World

Plenty of news this week, but not much of it positive. The week started with fresh Atlantic Coast Pipeline uncertainty. There was an equity offering for a former MLP, and a midstream SPAC that priced on the week that the last one (ALTM) dropped 30%. SMLP announced a brutal trifecta of CEO resignation, expensive IDR elimination, and a distribution cut. ENB capped off the rough week with a 6-12 month delay for the only live oil pipeline egress project out of Canada. EPD’s early in-service for the Shin Oak pipeline was positive.

Capital Markets

  • Tortoise Acquisition Corporation (SHLL) priced initial public offering of 22.5mm units at $10.00/share, raising $225mm in gross proceeds (press release)
    • SHLL is a special purpose acquisition vehicle that will be looking for a midstream business to acquire
  • Viper Energy (VNOM) priced upsized public offering of 9.5mm units at $32.00/unit, raising $304mm (press release)
    • Offering was upsized from 8mm units
    • Overnight offering, priced at 5.4% discount, and traded up 1.88% in the following session

Growth Projects / M&A

  • Summit Midstream (SMLP) made several strategic announcements (press release)
    • CEO Steve Newby resigned, and COO Leonard Mallet was named CEO on an interim basis
    • Elimination of SMLP’s economic GP interest and IDRs in exchange for 8.75mm SMLP units issued to a subsidiary of Summit Investments
    • Sale of Tioga Midstream to Hess for $90mm
    • Prepayment of $100mm of the deferred purchase price obligation and an agreement to fix the remaining obligation due in 2020 at $303.5mm
    • 50% Distribution cut to $0.2875/quarter from $0.575/quarter
    • SMLP investment thesis now reverts back to 2016, where there potentially could be some value to SMLP for a private equity firm seeking a publicly-traded vehicle, as opposed to asset value
  • Hess Midstream (HESM) announced the acquisition of Tioga Gathering System from Summit Midstream (SMLP) for $60mm in cash, plus contingent payments (press release)
    • Tioga is a crude oil and gas gathering system in western North Dakota and is currently delivering volumes into HESM’s gathering system
    • In addition, Hess Infrastructure Partners, separately agreed to acquire the water assets of Tioga from SMLP in which HESM will have the right of first offer to acquire in the event of a sale
  • Enterprise Products (EPD) announced Shin Oak pipeline is now in-service (press release)
  • Western Gas Equity Partners (WGP) and Western Gas Partners (WES) completed their merger (press release)
    • WGP changed its name to Western Midstream Partners, LP and will now begin trading under the ticker “WES”
    • Western Gas Partners changed its name to Western Midstream Operating, LP and will no longer trade
  • TransMontaigne Partners (TLP) announced unitholder approval of previously announced deal with ArcLight and stopped trading as of 2/27 (press release)
  • Cheniere Energy (LNG) and EIG Global Energy Partners completed financing and issued notice to proceed on Midship pipeline project (press release)
  • Targa Resources (TRGP) announced open season for Grand Prix Pipeline (press release)

Other

  • U.S. Court of Appeals for the Fourth Circuit denied the Atlantic Coast Pipeline’s (ACP) request for an en banc rehearing related to the court’s invalidation of the project’s U.S. Forest Service Appalachian Trail crossing authorization (press release)
    • Dominion (D) expects an appeal to be filed to the Supreme Court in the next 90 days
  • Late Friday, Enbridge (ENB) announced Minnesota has provided permitting timeline for Line 3 Replacement project (press release)
    • Timeline indicates permits will be received in November
    • Pushes back ENB’s target in-service date to second half of 2020 (as opposed to end of 2019 previously)