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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: MLPs Selloff On Purpose

Risk was definitively off this week across energy stocks, commodities and the broader stock market.  Naturally, utilities and REITs caught a bid, and midstream did not.  Within midstream, Canada held up well and helped AMNA outperform the AMZ and AMUS. Despite MLPs posting their second worst week of 2019, MLP and midstream indexes are on track to finish September positive, but more on that after the close Monday. 

Oil prices closed out the week below its 200-day and 100-day moving averages.  We have now reverted to prices from just prior to the largest oil outage in recent memory.  The market’s 2 week shrug off of that supply disruption news leaves sentiment worse off that before, with seemingly no news capable of serving as a sustainable positive catalyst for the commodity, at least until producers release 2020 spending plans.

Coupled with stagnant oil prices, news flow continues to point to a broad migration away from traditional energy investing.  This leaves the market apathetic towards existing companies with critical midstream infrastructure in the ground today.  It also leaves the market ambivalent to those announcing plans to spend more “on-purpose” capital to acquire or to develop more infrastructure, like we saw the last two weeks with ET, EPD, GEL and NGL announcements.  In EPD’s case, it was a decision to build a second plant to produce “on-purpose” propylene because less propylene is being produced by naptha cracking or refineries as there has been historically.

Flailing Fall Fund Flows

Anecdotally, last year institutions with “MLP” allocations addressed weak MLP performance and increased concentration by expanding the universe to include midstream corporations in the U.S. and Canada.  This year, some of those same institutions are throwing in the towel by officially reducing or eliminating specific allocations to the group.  Those allocations  are being diverted to listed infrastructure strategies, private equity or just plain old global equities. 

MLPs have lost the special designation as a separate allocation within real assets that the sector has enjoyed over the years.   That fund flow headwind is the biggest impediment to midstream performance the rest of 2019, especially if oil prices are going to remain a headwind.

The selloff in 2008 was followed by a quick bounce back in 2009 was so short, the tide had barely gone out before it rushed back in with even more yield chasers that before.  If we were going to equate that scenario to injuries in professional sports, that 2008-2009 period was more like a clean bone break with a known recovery and positive prognosis, like the broken foot that sidelined Michael Jordan for 64 games in his second season in the NBA. 

In contrast, the last 5 years have felt more like a degenerative series of injuries from which a once-dominant players faded over time, like the series of injuries that cut short the career of Super Bowl XXXII MVP running back Terrell Davis. 

“We’re putting cover sheets on all TPS reports BEFORE they go out…”

Here at this website for years now,  we have called out the evolution of the sector and expressed concern over just how the large dedicated midstream asset managers would adapt in the face of a shrinking opportunity set to be active.  We called it the Elephants in the Room at the beginning of 2018, or the big huge issue that no one was talking about.  Other smaller midstream and infrastructure managers are starting to talk about it now (see recent reports here and here that echo the points we’ve raised).

Larger managers are likely to just try to go about their business and ignore the elephant in the room for as long as they can.  Loyal readers probably feel like the main character in the film Office Space, Peter Gibbons, who throughout his day is given the same reprimand about TPS reports by several bosses that always included the question: “did you get the memo?”. 

Even when Peter says he has the memo, the bosses continue with the spiel on TPS reports.  To those of you tired of hearing about this transition and its impact on fund flows, I’m sorry, but please know that I’m just as eager to change the narrative when evidence allows.

Winners & Losers

CINR and WLKP were the best performing MLPs this week, which feels somehow related to new project announcements by GEL and EPD in related businesses to CINR and WKLP, respectively.  Other relative winners were smaller MLPs outside the midstream indexes and away from the outflow traffic.

The bottom 5 performers were all gathering & processing MLPs, which appear to have been sold on falling commodity prices and some strategic uncertainty.  NBLX was the worst performer after management at WMB talked down their interest in acquiring NBLX.  MPLX was a close second in the bottom 5, sold hard as a potential loser in the activist efforts of Elliot Management this week.  WES also underperformed and remains in need of a firm announcement on the future of its sponsor relationship with OXY/APC.

SMLP went from top 5 performer last week to the bottom 5 this week.  On the YTD leaderboard, weakness for CEQP dropped it from the top 5 group, while USAC’s positive week helped it climb into the 3rd spot.  NBLX is now in the bottom 5, replacing CINR.

Midstream Corporations

Weakness across the midstream corporation group this week, even for some of the midstream sector ballasts.  But there was some rotation among northeast natural gas gathering & processing names this week, with ETRN and AM appearing to benefit on the margin from selling in MPLX (see above).

OKE slightly underperformed the group for a second straight week, which is rare.  TRGP and ALTM flipped from top 5 to bottom 5. 

Canadian Midstream

Canadian midstream stocks were mixed this week, but on a market-cap weighted average they were positive, because the two largest stocks were the best performers (ENB and TRP).  Enthusiasm for ENB is slowly returning to the market with potential for further regulatory updates from Minnesota to come this week.

ENB and TRP were near the top of the group last week as well.  Keyera and IPL repeated near the bottom of the group.  On the YTD leaderboard, ENB re-joined the 20%+ total return club, along with every other midstream corporation in Canada not named Kinder Morgan. 

News of the (Midstream) World

Capital Markets

  • NGL Energy Partners (NGL) entered into an agreement with institutional investors for the private placement of $200 million of NGL’s Class D Preferred Units and warrants to purchase common units (press release)
    • Units bear an initial preferred distribution rate of 9.00%, are redeemable at any time at NGL’s option, and are redeemable at the option of the holders after 8.5 years from 7/2/19
  • Genesis Energy (GEL), in conjunction with its Granger facility expansion, announced agreement with GSO Funds for sale of up to $350mm of preferred interests in the GEL subsidiary that owns the alkali business
    • Preferred holders will receive PIK distributions during the construction period for the plant
    • $55mm of preferred interests will be funded at closing

Growth Projects / M&A

  • NGL Energy Partners (NGL) announced the acquisition of Hillstone Environmental Partners from Golden Gate Capital for $600mm (press release)
    • Hillstone provides water pipeline and disposal infrastructure solutions to producers in the Delaware Basin
    • NGL will fund the acquisition with preferred equity and debt
    • NGL estimates the transaction price at a 7x EBITDA
  • Enterprise Products (EPD) and LyondellBasell (LYB) announced long-term contracts to support construction of EPD’s second propane dehydrogenation plant (PDH 2) at its Mt. Belvieu complex (press release)
    • PDH 2 will have the capacity to consume up to 35,000 bpd of propane and produce up to 1.65bn lbs/year of polymer grade propylene
    • The facility expected to begin service in H1 2023
  • Genesis Energy (GEL) announced plans to invest $300mm to expand its existing Granger production facility to increase soda ash production (press release)
  • Tellurian (TELL) and Petronet announced they have signed an MOU where Petronet intend to purchase up to 5 Mtpa of LNG from Driftwood, concurrent with its equity investment, which remains subject to further due diligence and approval of its board (press release)
  • Kinder Morgan (KMI) announced that Gulf Coast Express Pipeline Project was placed in service on September 25, ahead of schedule (press release)

Other

  • Brookfield Infrastructure Partners (BIP) announced plans to create a Canadian corporation exchange vehicle, called Brookfield Infrastructure Corporation (BIPC) (further details)
    • BIPC will be listed on both Toronto Stock Exchange and NYSE under ticker “BIPC”
    • Not corporate conversion, meant to be a way for investors without the ability or interest to own MLPs to own the stock
    • BIPC shares exchangeable into BIP MLP units and will have same dividends as BIP units
    • BIPC listed the following reasons for pursuing this structure: expands investor base, broader index inclusion, tax advantages for some
    • Index inclusion may be specific to Canadian indexes, because for most U.S. indexes that matter, a half-measure corporate structure such as this is not enough to be eligible
  • Elliot Management sent a letter to the board of Marathon Petroleum Corp (MPC) outlining a path forward to unlock value which involves separating MPC into three independent entities of RetailCO, MidstreamCO, and RefiningCo (letter)
    • Under the plan, MidstreamCO would become stand-alone MPLX and convert from an MLP to a C-Corp
    • MPC currently owns 63% of MPLX
  • TPG Capital canceled agreement to acquire private company Goodnight Midstream for $930mm after Goodnight was unable to satisfy a key condition to closing (Bloomberg)
    • Goodnight midstream handles produced water in the Permian and Bakken