Midstream is on pace for its best month ever after another big positive week. MLPs posted their 4th straight week with more than 7.5% gains, the best 4-week stretch ever (off a low base). Midstream was positive in a negative week for oil prices, the broad market and utilities. This is a big win, but obviously, the YTD and YOY scoreboard tells a very different story.
It does feel like the institutional selling of MLPs and terminating of midstream allocations has paused in recent weeks. Replacing that selling has likely been value and retail investors dipping their toes back into the group, along with algorithms supporting those moves.
Mortal Kombat
Stay with me on this one, I’m going to attempt to connect midstream stocks to my recollection of a video game I haven’t play in 25 years. Mortal Kombat was a popular fighting game when I was of prime video game age in the early 1990s.
It debuted as an arcade game in 1992 that I would have played at a movie theater, a Mr. Gatti’s pizza parlor or at a Dave & Busters. In 1993, the game was released as a port to the major home gaming systems of the day: Sega Genesis and Super Nintendo. The release of the port versions happened across both systems on the same day (9/13/93), a day that was dubbed “Mortal Monday”.
Sub-Zero Wins
Oil prices had their own Mortal Monday this week, as the May oil contract rolled into June and the may oil price went “Sub-Zero”. The headlines that followed the price collapse seemed to be a positive catalyst for energy stocks this week. The widely reported super-duper contango situation caught investors’ attention. Investors were buying energy stocks, including MLPs, as a logical (to them) way to play an eventual rebound in oil prices.
Higher oil prices in the near-term will necessitate production shut-ins, medium term higher oil prices will likely necessitate reduced drilling and development of U.S. shale resources. At a high level, those two imperatives to higher oil prices aren’t bullish for midstream volumes.
I don’t mean to suggest that the inverse (low oil price) is great for midstream volumes either. So, at issue is how much a slowdown in volumes and tariffs is “priced in” today. The hope this week appears to stem from the idea that oil can’t go lower than it did this week, and if the bottom is in, buying midstream stocks makes sense to investors from here.
The concern with buying midstream stocks today is the unsettling start to midstream earnings season that was KMI’s Wednesday release. The results for refined products volumes and activity in the Bakken seemed to be worse that most expected and did not seem to be priced in to KMI’s stock, which underperformed dramatically Thursday. That seems to portend further potential surprises as earnings season continues, especially after the 70%+ bounce off the bottom MLPs have enjoyed.
Quality to Survive the Storm
Weathering the storm is a phrase I see in research reports constantly these days. Being “well-positioned to weather the storm” should be a minimum criterion when assessing midstream investments today. That means companies with liquidity, diverse and healthy customers, healthy balance sheets, quality assets insulated from competition, contracts with volume protection, reasonable governance and disciplined management teams.
Midstream stocks that check all those boxes are tough to identify in this environment, especially when many of those boxes are moving targets. But striving for exposure to quality in midstream, at least on a relative basis, feels like the play from here, as opposed to the upstream-exposed, high-beta names that have led the recent rally.
In the original Mortal Kombat, Liu Kang was the easiest player to play with, designed with the most accessible special moves. He was modeled after Bruce Lee to be the best player. There was another character, Rayden, who could call down lightning in his attacks. In the current state of play for midstream stocks, companies with fewer impediments to success, the higher quality players should be called upon to defeat the ongoing lightning strikes being thrown at the group. In short, you need to do more diligence than most recent buyers of USO did…
