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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: Midstream Wins Mortal Monday

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…

Winners & Losers

MLPs

Small, refinery sponsored MLP DKL was far and away the biggest winner this week, rallying 62% this week, including more than 58% on Thursday alone.  DKL announced a small distribution increase (despite a 35%+ yield) and the market was receptive.  The rest of the top 5 was dominated by gathering & processing MLPs, the best performing group in this risk-on energy week.  The bottom 5 included a different small, refinery sponsored MLP (HEP) that surprised with a 48% distribution cut after being one of the most consistent distribution payers since IPO in 2004. 

CEQP repeated in the top 5 this week, continuing to be supported following its distribution announcement (no cut) last week.  NBLX went from bottom 5 last week to top 5 this week, but it remains the worst performing MLP this year to date.  EVA remains the YTD leader at less than 10% decline.  Two others in the top 5 have rallied such than they are down less than 20% YTD too (CQP and SRLP).  DCP and DKL rallied out of the bottom 5, replaced by NGL and ARLP.

Midstream Corporations

The midstream corporation group on average underperformed the MLP group again this week.  There were some huge gains from more gathering & processing stocks in this group.  There were a few negative names among the large midstream corporations, most notably KMI, which reported results and an outlook that were worse than expectations.

AM, HESM and RTLR repeated near the top of the group.  LNG, OKE and KMI repeated near the bottom.  On the YTD leaderboard, HESM has climbed into second place, ahead of KMI.  AM moved into the top 5 after consecutive 35%+ weeks.  ENLC moved up a few spots from the cellar, leaving TRGP in the bottom spot, down more than 75% this year.

Canadian Midstream

Canadian midstream wasn’t as volatile as the U.S. this week, less influence of animal spirits up there, it appears.  Keyera’s announcement of more deferred capital projects and turning off the DRIP helped it outperform.  TRP had some news on NGTL that was positive on the margin, but not much was going on in Canadian midstream generally. 

GEI went from first to worst week over week, and TRP went from worst to close to first.  On the YTD leaderboard, TRP is still on top of the group by a wide margin. The bottom end of the return range is much better (IPL at -56%) than the bottom end of the U.S. midstream groups.

News of the (Midstream) World

Limited news flow: more distribution cuts, more capex cuts, and more borrowing. 

Capital Markets

  • NuStar Energy (NS) announced $750mm unsecured term loan agreement with Oaktree and 45% reduction in capital expenditure plans (press release)
    • 3-year term loan with 12% interest rate
  • Inter Pipeline (IPL-CA) announced that it has entered into a new $1bn unsecured revolving credit facility (press release)

Growth Projects / M&A

  • Energy Transfer (ET) identified pipelines where up to 2mm barrels of oil could be stored (Bloomberg)
  • TC Energy (TRP) announced 5-year revenue requirement framework for NGTL to cover new investment, with ROE unchanged at 10.1% (press release)
    • Lower interest rates not impacting returns for TRP for de-bottlenecking investment, which is planned to be more than CAD14bn
  • Keyera (KEY-CA) announced deferral of construction of its KAPS pipeline system for approximately one year and also suspended its dividend reinvestment program (press release)
    • Growth capital for 2020 is expected to be $475mm to $525mm, down from $750mm
    • CEO also agreed to reduce salary by 20%, among other executive salary reductions

Distributions

  • 5 more MLP distribution cuts this week
    • HEP probably the most surprising shift in strategy, had been running very low coverage for a long time, but apparently the recent demand collapse was too much
      • HEP had the longest streak of quarterly distribution growth at 59 quarters dating back to 2004 up until last year when it stopped growing it
    • USDP had raised its distribution every quarter since IPO (20 quarters in a row) before the cut this week
  • After 5 cuts this week, we are up to 17 cuts total for the quarter (not double counting ETRN/EQM and PAA/PAGP, which would add 2 more)