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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

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Week Thoughts: Pain Making it Rain in Midstream

Even with a full complement of tailwinds at play this week, midstream trading was choppy and the week ended with minimal gains.  Those tailwinds include: strong broad stock market (S&P 500 up for 5 straight days), oil price gains, spiking NGL prices, and wide location differentials for oil and NGLs.  The big tailwind that’s missing: investor enthusiasm, interest or even acknowledgement.

East Coast Rain Event, West Tex Pain Event

This week saw more downstream NGL infrastructure announcements on the heels of last week’s announcements.  The commercial focus for midstream companies of late is to capitalize on the recent blowout in NGL prices to expand downstream infrastructure, including pipeline capacity, fractionation facilities and export capacity.  The midstream business is at its best when large bottlenecks create pain points for customers who are then willing to commit volumes to remove the bottlenecks.

One such pain point is oil transportation from the Permian Basin while the sector waits for a wave of new pipeline capacity to come online at some point next year.  A potential temporary solution made waves in the market this week when those building the EPIC NGL pipeline suggested potentially using the line for crude oil service on a short-term basis in mid-2019.  Sell-side analysts were skeptical in reports I read, but that’s nothing new for the EPIC folks, who’ve faced skepticism at every turn.

Midstream fundamentals are strong, and midstream companies are hoping to turn those fundamentals into a storm surge of cash, like the virtual flood waters in the Weather Channel’s storm surge simulation that went viral this week.

Self-Funding Rubber to Meet the Road in 2019

The inevitable result of the steady project announcements is a rising tide of capital expenditures.  In the rush to solve all the bottlenecks, midstream capex in 2018 and 2019 is likely to reach levels never seen before, more than $40bn each year.  The shift to self-funding growth capex is still in transition in 2018, and long-term adoption of that model remains uncertain, maybe serving as a headwind for sentiment.

Midstream companies have sold nearly $20bn in assets this year to help bridge the capex funding gap.  Less than $3bn of equity has been issued.  Another round of asset sales of that magnitude in 2019 is unlikely, so investors in midstream today must believe the full self-funding model will take hold across the sector or prepare for much more equity in 2019.

If there is another $30-40bn in growth capital expenditures next year, how much equity will midstream issue in 2019?

  • $5bn to $15bn (63%)
     
  • Less than $5bn (23%)
     
  • Greater than $15bn (14%)
     

Total Voters: 152

My personal take is enough of the sector will be operating at full Midstream 2.0 (coverage above 1.2x, leverage below 4.0x and no IDRs) by 2019 that the sector will be positioned to self-fund.  Steady progress has been made over the last few years with coverage solved by distribution cuts, leverage improved by assets sales and cash flow growth, and we’ve all see the accelerated IDR eliminations.

Winners & Losers

Not much rhyme or reason to the top 5 this week, as far as I can tell, given no news on any of the top 5 specifically.  ENBL has been trading poorly since a large block trade sale from a major holder in August, but it traded up this week.  The bottom 5 included WES and NBLX, both large midstream players in Colorado where a ballot initiative has the market spooked, setting up an easy short for hedge funds with a clear end date (election day).   So, the daily beatings may continue for a bit.

DM made it two straight weeks in the top 5, while ENLK and WES went from top 5 last week to bottom 5 this week.  CCLP and NBLX repeated near the bottom.  Looking at the YTD leaderboard, every one of the top 5 from last week was down, except ETP.  No changes among the biggest YTD losers.

GPs and Midstream Corporations

Median return for GPs and Midstream Corporations was basically in-line with the MLP Index return.  AMGP led the group on the high side this week, as the special committee review period approaches its stated end date (end of September).  Very robust NGL prices benefit many midstream operators, including TRGP, which outperformed.  WGP was the biggest loser in the group, trading down along with its subsidiary WES.  TGE and SEMG may have been drawn into the negative Colorado trade discussed above, however unwarranted it may be.

KMI and ENLC outperformed the group for a second straight week.  On the YTD leaderboard, the roster of biggest winners was unchanged, although TRGP joined the +20% club this week.

Canadian Midstream Corporations

Canadian midstream underperformed U.S. corps and MLPs this week, especially on a market cap weighted basis.  The largest 3 companies performed worst, while the smallest 3 performed best, basically a reversal of last week’s relative action.  TRP announced indigenous tribe agreements for its Coastal Link project, but there was little other news to point to in Canada.

Gibson Energy is in the midst of a round of U.S. investor meetings that may have contributed to its rebound this week.

News of the (Midstream) World

News flow continues to be light on the merger or acquisition front for midstream, but the steady flow of new growth project announcements and asset sales continued this week.  On the non-fundamental side, ETP CEO had a large insider purchase this week ahead of the ETE/ETP merger close, and Alerian’s quarterly rebalance was announced, with few changes following the 4 intra-quarter re-balances we’ve already had.

Capital Markets

  • Plains All American (PAA) filed S-3 to refresh its shelf registration for up to $1.1bn of debt and equity securities (filing)
    • PAA noted it has no immediate plans to use the shelf registration
  • Per Factset, a 1.2mm block of Semgroup (SEMG) stock traded at $23.75/share on Thursday morning

Growth Projects / M&A

  • Enterprise Products (EPD) announced expansion of its LPG export capacity at the Houston Ship Channel terminal (press release)
    • The expansion would increase LPG export capacity by 175,000, or 32%
    • EPD did not disclose the cost of the expansion, but CEO Jim Teague described it as a nominal capital investment in the press release
  • Oneok (OKE) announced expansion of West TX LPG Pipeline System (press release)
    • OKE plans to spend $295mm to add 80,000 barrels/d of mainline NGL capacity and to add infrastructure necessary to connect West TX LPG into OKE’s Arbuckle II Pipeline (under construction)
    • Expansion expected to be completed in 1Q 2020
    • Supported by long-term dedicated NGL production from 6 processing plants in the Permian Basin expected to produce up to 60,000 bpd of NGLs
  • NGL Energy (NGL) announced purchase of Backham and McCloy ranches in New Mexico for $93mm total (press release)
    • The ranches combined include 122,000 acres, 11.6mm barrels of annual freshwater rights and 20 potential locations for saltwater disposal wells
    • NGL indicated full run-rate EBITDA potential of $18mm, but did not indicate how much capex would be required to reach that EBITDA
  • Targa Resources (TRGP) announced sale of non-core terminal assets for $160mm in proceeds to ArcLight (press release)
    • Assets include refined products and crude oil storage and terminaling facilities in Tacoma, WA and Baltimore, MD
  • TransCanada (TRP-CA) announced agreements with all indigenous tribes (20 total) along its Coastal Link gas pipeline route (press release)
  • Reuters reports Kinder Morgan (KMI) has hired bankers to sell its remaining Canadian assets (Reuters)
    • Report estimates assets could fetch as much as $1.8bn

Other

  • Alerian announced changes to its index series for its quarterly rebalance, effective on 9/21/18 (press release)
    • Alerian MLP Index (AMZ) – CVR Refining (CVRR) to be removed
    • Alerian Midstream Energy Index (AMNA) – Altagas Ltd (ALA-CA) and Cheniere Energy Partners LP Holdings (CQH) to be removed, Southcross Energy (SXE) to be added
    • Alerian Midstream Energy Select Index (AMEI) – Altagas Ltd (ALA-CA) to be removed
  • Energy Transfer (ETP) CEO Kelcy Warren purchased $44.8mm of ETP units (Form 4)