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February 4, 2018

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Week Thoughts: E-Brakes Slam Midstream

In a rough week for stocks of all kinds, energy stocks and midstream/MLPs stood out as particularly weak.  The MLP Index declined 5.9%, including distributions, the first 5%+ decline week in nearly two years (since February 2016).  The 10-year treasury rate rose another 17 basis points, and sits just 17 more bps from 3.00%.  Oil prices held up well and propane prices were positive even as natural gas prices cratered.

Pulling the E-Brake
The backdrop for midstream stocks was negative due to a nasty confluence of macro and micro factors, coincidentally starting with the letter E:

  • Energy Sector Weakness
    • Guidance and updates from independent US producers were not well-received
    • Exxon dropped 5% Friday on poor results, which didn’t help
  • Earnings
    • Reaction to EPD’s results confused many in the market, but it seems like commentary on Permian competition/rates and/or equity issuance spooked the market
    • Earnings season has been a manifestation of the levelling up concept I wrote about a few weeks ago
    • MPLX proved that a big MLP can announce solid results and trade up, but it has been rare this quarter (see KMI, EPD, MMP)
  • Ex-Dates
    • MLP distribution ex-dates tend to be a trigger for selling each quarter
  • Equity Issuance
    • SHLX did the largest MLP equity deal ($680) since August
    • Even with improved midstream sentiment, that’s a lot of equity to digest

Given that Friday was Groundhog Day, it may be tempting to look at very recent MLP price action and assume midstream stocks are doomed to repeat another false start and fade.  But, I believe the sector-specific factors above are transient and minor when compared with two big factors that should eventually play through to results and stock prices, both starting with the letter F:

  • Fundamental Backdrop
    • U.S. production of hydrocarbons is at record levels
    • Exports and demand (especially petrochemicals) continue to grow
    • Growth across U.S. basins and across the hydrocarbon mix is more visible than its been at any point in the last 3 years
  • Financial Structure
    • Midstream companies better positioned financially than at any point in last 3 years
    • Midstream companies have made hard choices to reduce leverage and increase coverage by slowing or cutting distributions
    • IDR eliminations (and their near-term dilution) have happened for most of the large players, removing that headwind and cash leakage

A 600+ drop in the Dow Friday aroused fear-casting on TV and on Twitter this week.  If the broad market does correct, it’s clear that long-time midstream/MLP investors are much better prepared psychologically for the return of volatility in the stock market than non-midstream/MLP investors.  We have the scars to prove it.
So, notwithstanding a positive outlook for midstream fundamentals and financials, if a broad market correction is upon us, we will keep our cool while others are frantic.  If investors were characters in the movie Central Intelligence, midstream/MLP investors are Dwayne “the Rock” Johnson’s character and the rest of the market is Kevin Hart’s character.

No Super Bowl preview here, but by the time you read this, chances are fans in the greater metropolitan area in which I live (Philadelphia) will be aflame, either in celebration or angst.  Should be fun either way in the office Monday.
Status Update
The MLP Index has posted back-to-back strong months.  With a fade towards the end of the month, January finished 200 bps above the average January return for the MLP Index (5.8% vs. 3.8%).  That’s still a strong start, but not the near record pace we started off with.  The best-ever January was 15.3% in 2009 (also the best of any month ever), followed by 12.6% in 2013.

Looking ahead, February returns over time have been more muted than January, a function of distribution capture trading that seems to impact the second month of every quarter.  The range of historical returns in February is tighter as well, with an all-time high return of 4.6% and low of 7.9% in 2002.
Switching to the AMEI, that index largely missed the rally over the last few months (up 0.5% vs. 5.8% for AMZ), but given the exposure to Canada and to midstream-oriented utilities, AMEI outperformed in 2017.

Looking at historical returns for AMEI (with data back to 2008), February has been a better month for this group, including positive returns for each of the last 8 years, compared with 6 of 8 for AMZ.
Winners & Losers
There were several MLPs that actually traded up this week, although none of them were in the Alerian MLP Index, a sign of the passive times.  CNXM continues to show up in the top 5 week after week.  CAPL and SRLP have been among the more consistent small cap MLPs in distribution increases over the last few years, and their retail following has grown over time.  The biggest losers this week were all down 10%+, notable among them was SHLX, which was slammed Friday after its equity offering Thursday.

Year to date, CNXM surged into the top 2 this week, while SHLX went from near the bottom to the worst performer in the group this year.  Its hard to envision SHLX remaining at the bottom after clearing its equity needs for the year.  Other AMZ members GLOP and BWP slipped into the bottom 5 this week.

General Partners & Midstream Corporations
Midstream corporations and general partners matched the AMZ in performance this week as a group.  PAGP was near the bottom, likely on negative readthroughs from EPD and MMP earnings.  Both discussed competitive challenges in the Permian that sets expectations low for PAA results this week.  NGL-focused players TRGP and OKE held up better than most, along with WGP, which has traded well all year.

LNG gave back most of its gains from last week, ETE gave up more than its gains from last week.   YTD performance from this group is still less than MLPs, with a few standout performers like OKE and NSH, both up around 10% so far.

Canadian Midstream
Canadian Midstream did not bounce back this week, with the group basically matching the performance of U.S. midstream counterparts despite woeful absolute and relative performance year to date.   The sagging Canadian oil price due to lack of takeaway capacity and lack of help from congested rail networks is a factor dragging down the energy complex in Canada (and infuriating officials in Alberta).
There was some differentiation though, with KML outperforming despite being at the center of a constrained oil takeaway situation and a spiraling political scene surrounding the Trans Mountain expansion.  Gibson Energy was the worst performer after announcing an aspirational series of asset sales to fund a focus on its core business at its analyst day.

Gibson had been the best performing Canadian midstream stock through last week, but KML took over the top spot and has the distinction of being the only stock in the group in the green so far this year.  ENB was near the bottom again this week and took over as the biggest loser in Canada.

News of the (Midstream) World
February kicked off with a massive equity offering, the first $500mm+ offering since ETP in August, and it proved to be a tough pill for the market to swallow after a rough week for the sector.  On the positive side, TRGP announced another JV that seems to reflect what the market would like to see in terms of prudent deployment of capital and more consolidation of projects and footprints.
Capital Markets

  • Shell Midstream (SHLX) priced public offering of 25.0mm units at $27.20/unit, raising $680mm in gross proceeds (press release)
    • Bought deal, priced at 6.3% discount, and traded down 3.7% from pricing in the next session, complicated by the ex-date Friday for the quarter’s distribution ($0.33/unit)
    • $300mm of additional units (11mm) sold to Shell Midstream LP Holdings LLC in a concurrent private placement at the same price as the public offering
    • All of the above prices work for SHLX as a cost for funding source for accretive drop-down acquisitions, which is the paradox of owning drop-downs in a constrained capital market
  • Enterprise Products (EPD) priced $2.7bn worth of notes (press release), including:
    • $750mm of 2.80% senior notes due 2021 at 99.946% of par
    • $1,250mm of 4.25% senior notes due 2048 at 99.865%
    • $700mm of junior subordinated notes due 2078 at par, with coupon of 5.375% through 2028, then a floating rate on three-month LIBOR rate plus 257 basis points
  • American Midstream (AMID) filed $2bn mixed shelf (Form S-3)

Growth Projects / M&A

  • Enterprise Products (EPD) and Navigator Gas (NVGS) announced a 50/50 JV to build a new ethylene export facility along the Gulf Coast with capacity to export 1mm tons of ethylene per year (press release)
    • Facilities are expected to be in service by Q1 2020 and the project is supported by long-term contracts with anchor customers
    • EPD is also developing a high-capacity ethylene salt dome storage facility at its Mont Belvieu complex which is expected to be in service in Q1 2019 and is building a new ethylene pipeline from Mont Belvieu to Bayport, TX which is scheduled to begin service in 2020
    • No details on costs or returns for the project
  • Targa Resources (TRGP) and MPLX announced expansion of its 60/40 natural gas processing JV, Centrahoma Processing (press release)
    • The JV will construct a new 150 MMcf/d cryogenic natural gas processing plant (Hickory Hills) in Central Oklahoma expected to begin operations by 4Q 2018
    • TRGP is contributing its recently-acquired and to-be-relocated Flag City Plant and its 120 mmcf/d Tupelo Plant
    • TRGP will retain 60% of the JV and will receive a cash distribution, MPLX is contributing cash and will maintain a 40% interest in the JV
    • Second G&P JV in two weeks involving TRGP in a basin outside of the Permian, seems like a strategic push to focus capital on Permian and engage in partnerships elsewhere
  • Summit Midstream (SMLP) announced open season for Double E pipeline which will provide natural gas from the Delaware Basin to the Waha Hub (press release)
    • The 120-mile pipeline with capacity of 1.0 Bcf/d, expandable to 1.4 Bcf/d is expected to be in service by Q1 2021
  • Magellan Midstream (MMP) announced an extension of the open season for a proposed 375-mile, 350,000 bpd pipeline to transport crude oil from the Permian and Eagle Ford to Corpus Christi (press release)


  • The British Columbia government announced a new regulation in bid to block Kinder Morgan’s (KML) Trans Mountain expansion pipeline project until a study is completed to tell whether diluted bitumen spilled in water can be effectively cleaned up (Reuters)
    • BC’s law proposes to stop any increase in the shipments of heavy oil sands crude by rail or pipeline while the study is being completed
    • Alberta officials responded with threats to stop purchasing power produced by BC (HuffPost Canada), and PM Trudeau reiterated Federal support for the pipeline project (Reuters)
    • This project continues to be very political and both sides continue to dig in, but KML’s price is holding up in a very ugly tape in Canada
  • Targa Resources (TRGP) promoted several executive positions including current CFO Matthew Meloy to President and Jennifer Kneale to CFO (press release)

Distribution Announcements
9 more distributions announced.  Most notable was ETP holding its distribution flat for the first time since 2Q 2005, breaking a streak of 49 straight quarters (most of those from when the company was called Sunoco Logistics).  EPD has the longest active quarterly growth streak at 54 quarters, followed by HEP (52), WES (35), MMP (32) and ANDX (27).