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March 4, 2018

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Week Thoughts: Midstream Steel Down

It was another rough week for Midstream overall, but MLPs held up better than broad midstream for a second straight week, and they also outperformed utilities.

This week’s selloff seemed more like guilt from association with energy than anything specifically related to midstream. 4Q results released over the last month indicate improving fundamentals and a need for more infrastructure (including some outside the Permian Basin for a change).  But with weakness across the stock market, lower oil prices and the potential for a new headwind to project returns (albeit modest) in steel tariffs, it was hard for midstream to gain any traction.
Business Model Behavior
The path forward is continued execution this quarter towards the Midstream 2.0 model of lower leverage, lower payout ratios and no IDRs that enables some self-funding that I have been espousing here for 2+ years.  Midstream can get there with cash flow growth, asset sales, capital discipline and more simplification deals.  New promises have been made, and as those promises are kept, interest in midstream can return.
In the meantime, the midstream companies that already embody the Midstream 2.0 model (and their investors) are getting tired of being whipsawed around by negative sentiment surrounding the bad actors of the sector.  With the glut of midstream stocks relative to demand, and with passive vehicles seeing big swings in fund flows, there is little differentiation among good and bad MLPs at the moment.
If such trading dynamics continue, expect the shift away from the MLP wrapper as the preferred midstream vehicle to continue.  In light of these dynamics, the potential for an EPD corporate conversion should be a hot topic at EPD’s analyst day this week.
Timing is Everything in a Snow Storm
I’ve written about snow here in the past.  The first time was when I lived in Boston, and I compared a glut of equity deals to snow that was constantly in need of shovelling.  Back then (circa 2012), it was understood that the equity capital market might get bogged down a bit from time to time, but retail demand would eventually sop up the oversupply of MLP equity and set things up for the next round of issuance.
The second snow analogy came in January 2016 when MLP pessimism was peaking, but it felt like MLPs were poised to bounce back sharply once the market turned.  I compared the situation to a trampoline sagging under the weight of several inches of snow.
This Friday’s surprise March snow storm has some parallels to the current midstream environment.  The storm started as just rain with most predicting some light snow.  But then, it turned into a full on blizzard of sideways snow that lasted for several hours.
Around 2pm folks started to realize traffic might be a problem and began filing out of the office, but the roads hadn’t been cleared and traffic was at a standstill.  By 4pm, I had a decision to make: I could either (a) get in my car and inch home over the course of an hour or two, or (b) wait an hour or two in the office, then proceed home at a more reasonable, but still cautious, pace on much clearer roads.
Bringing it back to midstream, it feels like investors who are long midstream are caught out in the snowstorm of negative sentiment, inching along.  It is almost universally acknowledged that things are improving and eventually traffic will clear and midstream will trade better.  But it also feels like plenty of investors are waiting for the storm to clear before heading out there.
But when the storm clears and investors do venture out there, it doesn’t feel like we return to the 2011/2012 fully functioning capital markets.  Like last night when I got on the roads, which were clear and had been salted, I still went slow and it took me longer than normal to get home…

Status Update: 28 Days Later…
February ended up being the worst February ever for the MLP Index, and the Index’s worst month since January 2016.  The MLP Index did outperform S&P 500 energy stocks for the second straight month.  The nearly 10% pop on the index through the first 3 weeks of the year provided some cushion such that the Index is down just 4.5% since the start of the year (including distributions).
February saw the largest outflow from the biggest MLP ETF (AMLP) ever recorded at more than $500mm.  The outflow contribuetd to broad-based selling of all MLPs in that index, contributing to the lack of differentiation discussed above.

In the last 3.5 years, there have been 12 months of greater than 4% decline for the MLP Index, including 4 in the last 12 months.  In the previous 10 years combined, there were just 12 months with 4% or greater declines.

The AMEI likewise had a bad month.  Weakness among larger holdings in that index, including MIC and SEMG, were contributing factors to underperformance relative to the MLP Index.

Winners & Losers
NS was the worst performing MLP again this week, its downfall over the last year has been stunning.  Some final 4Q results were reported this week that helped a few names like SHLX and OMP.

APLP went from top 5 to bottom 5 week over week, which sent its YTD position from 2nd best two 4th best.  NS is far and away the worst performing MLP so far this year, but SMLP is now second worst.

General Partners & Midstream Corporations
SEMG results were not well received, PAGP and OKE continue to trade well, and TRGP continues to bounce around.

Just one name in this group is positive for the year (OKE), and 3 are down 20%+.

Canadian Midstream Corporations
Canadian Midstream underperformed MLPs and performed roughly in-line with U.S. corporations.  It was a pretty orderly selloff, with a tight range of returns from -3.7% to -6.6%.   Altagas (diversified energy company with some midstream assets), not pictured below, dropped nearly 13% this week on M&A headwinds.

ENB has yet to attract mean-reversion interest and continues to lag other larger players (also gets no positive readthrough from DCP trading up this week).  The market appears to be waiting on asset sales and Line 3 permitting news.

News of the (Midstream) World
News this week included M&A among smaller, liquids-focused MLPs and capital markets activity among larger MLPs, including a private placement at a steep discount.  Equity capital markets remain challenged, but capital is available at the right price in private placements, and dropdown MLPs are still pushing forward with ATM programs in anticipation of better opportunities to issue common equity in the future.

Capital Markets

  • Williams Partners (WPZ) priced public offering of $800mm of its 4.85% senior notes due 2048 at 99.515% of par (press release)
  • Buckeye Partners (BPL) announced private placement of 6.2mm Class C units at price of $42.60/unit, raising $265mm in gross proceeds (press release)
    • Implied 9.4% discount from common unit price on prior day
    • Sold to private investors, including affiliates of Kayne Anderson Capital and Tortoise Capital
    • BPL has have the option to pay the distribution in cash or in more Class C units
    • Eliminates equity needs for 2018 and 2019
  • Phillips 66 Partners (PSXP) entered equity distribution agreement to sell up to $250mm in common units at-the-market (filing)

Growth Projects / M&A

  • NGL Energy Partners (NGL) and Magnum Liquids announced JV to focus on NGLs and refined productss by combining NGL’s Sawtooth Storage Facility with Magnum’s refined products rights and adjacent leasehold (press release)
    • NGL will sell an interest in the Sawtooth storage facility (with 6.1mm barrels of capacity) to Magnum for $45mm in cash
    • NGL will own 67.6% of the JV and Magnum will own the remaining 32.4% with an option to acquire an additional 21.6% interest under similar terms with an additional option to acquire NGL’s remaining 46.0% interest within three years of closing
  • Delek Logistics Partners (DKL) announced the dropdown of Big Spring Logistics for $315mm with an expected EBITDA of $40.2mm, implying a 7.8x multiple (press release)
    • Assets include:
      • Storage tanks and salt wells with 2.9mm barrels of aggregate shell capacity in Duncan, Oklahoma
      • An asphalt terminal that operated 3,900 bpd during 2H 2017 and a light products terminal with 54,000 bpd throughput capacity
    • DKL also will provide services for Delek US necessary to market refinery products produced at the Big Spring refinery
  • Energy transfer Partners (ETP) announced binding expansion open season for DAPL (press release)
  • MPLX announced successful joint binding open season on Cushing-to-Patoka pipeline expansion (press release)
    • Expansion is expected to begin service in Q3 2018
  • Antero family (AR, AMGP, AM) announced in separate releases that their boards have formed special committees to explore, review, and evaluate potential measures to address valuation discount (press release)