Triangles background

Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Viewed 2454 times

Under-Piped: Holes in Your MLP Exposure

The one-year anniversary of the FERC policy statement for MLPs was last week.  While MLPs stock prices recovered from the initial negative price reaction to the FERC ruling last year, the lasting impact of that announcement continues to play out today, and the ripples of that announcement may impact performance going forward.

FERC’s initial statement provided cover for companies to roll-up their MLP subsidiaries with natural gas pipeline exposure (e.g. BWP, DM, EEP, SEP, WPZ).  Those names joined other MLPs with gas pipeline assets that had already transitioned to a corporate structure (like KMI and OKE), and as a result the underlying exposure to natural gas pipelines within the MLP Indexes is now less than 10%, as shown in the chart below (see further below for detailed breakdown of the exposure in each index).

FERC Ruling Impact = Greater MLP Oil Price Correlation?

In my weekly post this week, I referenced MLP Index correlation to oil prices.  Given that more of the MLP Index is now comprised of gathering & processing or liquids-focused assets, it stands to reason that the MLP Index returns may be more correlated to oil prices going forward than a broader midstream index that is more inclusive of natural gas pipelines.

Why Gas Pipelines are Important

When you think about the most irreplaceable midstream assets in North America, what specific assets come to mind? Any short list would probably include the assets below:

  • Texas Eastern Transmission (TETCO) – owned by Enbridge (original pipeline route pictured below)
    • The original cross-country pipeline built in 1943 to win WWII
  • Transco – owned by Williams
    • Often cited as the best midstream asset (by WMB mgmt. more than anyone)
    • Built in 1949, took less than 2 years to construct by losing bidders for TETCO
  • Tennessee Gas Pipeline – built in 1944, now owned by Kinder Morgan
  • Canadian Mainline – completed in 1958, owned by TransCanada
    • The longest pipeline in the world for two decades
    • TransCanada’s sprawling footprint now also includes the Columbia Gas pipeline systems

What do each of those assets above have in common? A few things, including:

  • More insulated from competition and generate high-return investment opportunities
  • More stable cash flows profiles, with demand-pull customers and take-or-pay contracts
  • These are core energy infrastructure assets that would be prohibitively expensive to re-create today
  • They are not owned by MLPs and are therefore not accessible via vehicles that own only MLPs

How is this still a thing?

In recent conversations with current and potential MLP/midstream investors, it was surprising to find that the major passive MLP vehicles still have traction.  AMLP has AUM of more than $10bn, so it shouldn’t be surprising, but it doesn’t seem right for vehicles like AMLP and AMJ that track MLP-only indexes to still be “a thing”.

We have been vocal in chronicling the transition of the midstream sector from mostly MLPs in 2014 to now less than 50% MLPs by market capitalization.  We wrote in the blog in January 2018 and published a whitepaper “Elephants in the Room” in September 2018, where I discussed the concentration within the MLP sector and how difficult it would be for the MLP mutual fund complex structured to own MLPs (as opposed to corporations) to continue to operate within the MLP sector. 

We have also written on the need for a new benchmark for midstream given the limitations of the most widely-referenced Alerian MLP Index, publishing a number of posts and a whitepaper on that topic.

At the institutional level, we are seeing changes.  Investment restrictions have been changed for open-end MLP funds to be more inclusive of corporations (even if owning corporations in a corporation is a bad tax answer), and we’ve seen benchmark changes across institutional allocations to better reflect the broader midstream universe.

Why You Should Care

Maybe you don’t care about the index discussion we’ve been leading across the midstream space, maybe you don’t care what massive institutions are being forced to do in their portfolios.  Maybe you don’t care that they charge high active management fees, but structurally can’t be active in MLPs.  I would argue that it does matter if you own these passive vehicles that track MLP-only indexes (and at more than $10bn in AUM, a lot of you own MLP exposure that way). 

It matters because MLPs are just 50% of the universe and may materially underperform during good times (like this year so far).  It matters because in a big drawdown, the underlying assets of MLPs lack the core pipeline exposure to limit volatility and provide stability in the index performance.  It matters because owning just MLPs exposes you to more competitive situations where MLPs are competing with each other and with private equity to build lower return assets.  It also matters because for the fees those passive vehicles charge you, you should have better midstream exposure.

Holes in Your Underlying Asset Exposure

In the below chart, we highlight individual MLPs and midstream corporations with meaningful natural gas pipeline assets.  Then, we went through each one to break down exposure within their company to gas pipelines.  The outcome of the analysis showed that the midstream universe had nearly 3x the exposure to natural gas pipeline assets than the MLP Indexes. 

Past performance is not indicative of future results.  The MLP universe is much different than it was in the last oil price meltdown, and we’d expect divergent performance across midstream and MLPs downturn, not just based on structure of the companies, but also based on assets.

Side Note: Downstream NGL Infrastructure

NGL infrastructure is another area where midstream operators have higher barriers to competition and are able to invest at high rates of return.  EPD’s Mt. Belvieu NGL fractionation complex or its entire integrated NGL value chain is among the best midstream assets.  Energy Transfer (ET) also has several very high-quality assets.

When ET CEO Kelcy Warren says “A monkey could make money in this business right now. It’s not hard”, do you think he is talking about the latest Delaware Basin processing plant or oil pipeline project out of the Permian basin?

He’s talking about downstream NGL infrastructure and natural gas pipelines, areas with limited competition from private equity because of the unique existing footprints owned by midstream operators.  While EPD and ET are the biggest NGL infrastructure players, by limiting exposure to the MLP Indexes, you miss out on exposure to OKE and TRGP, who are also expanding their NGL footprints across the value chain.