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March 13, 2016

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Week Thoughts: MLPs Pause, Head on a Swivel

The MLP rally stalled out even as oil prices and the broader market powered higher this week.  MLPs finished down 1.0% on the week, recovering after a 6.1% decline Tuesday.
The IEA’s report provided further confirming evidence that oil supply and demand is growing more balanced.  Central bank actions continue to encourage risk on behavior in the broader stock market. Natural gas also rallied nearly 9% from multi-decade lows in a broad commodity rally.  Basically everything was up this week, including typically risk-off utilities.  Everything but MLPs.  Notable that oil has now gone positive for the year, certainly an encouraging sign that MLPs may reclaim flatness next.
Certain Uncertainty
Back in 3Q 2014, MLP multiples were at all time highs and the justification was that clear paths to organic development and drop-down growth.  Clearly massive fund flows into the sector helped push multiples higher, but cash flow growth was viewed to have a high level of certainty such that increasing amounts of future cash flow were baked into MLP valuations.  This “certainty premium” was clearly misplaced and overdone as we continue to see the pace of new infrastructure development slow in 2016.
MLP price action since August 2014 has reflected the re-rating of MLPs to reflect an era of unprecedented MLP uncertainty.  MLP valuations now reflect an embedded “uncertainty discount”.  Fund outflows and shorting have been the primary mechanisms for building the discount.  Oil prices rising 47% over the last 4 weeks have removed some uncertainty, and helped MLPs rally.
But a fresh round of uncertainty was introduced this week with the Sabine bankruptcy court ruling that even in that particular case offered no final resolution.  Energy Transfer has clouded the future of several large MLPs over the last few months, and this week’s transaction continued that trend.  The market also has fresh questions about the future of the Columbia Pipeline complex, which seemed to be committed to its independent growth plan prior to this week’s M&A reports.
Some of the known unknowns are trending in a positive direction in the MLP sector, helping prices begin to recover.  This week’s action was a reminder that unknown unknowns are still out there and that the market hates uncertainty.  As a colleague mentioned to me this week, managing MLP investments these days requires a “head on a swivel” mentality as headlines, filings & rumors seem to emerge daily that threaten to blindside any MLP portfolio.
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Despite all the negative headlines and renewed uncertainty, MLPs held up well overall this week, and have outperformed the S&P 500 since the KMI cut in December.  MLPs did finally disconnect from oil prices this week, to the detriment of MLPs.  At some point if oil stops going up and stabilizes (however unlikely), MLPs may be able to sustain a rally even absent an oil price tailwind.
Winners & Losers
Overall, the winners and losers seemed to be more driven by actual news this week. Despite the negative court headline for Sabine and the possible read through to CEQP’s pending bankruptcy court ruling, CEQP landed in the top 5 this week.  Less surprising, PAA lands in the top 5 in a strong oil price week.  Friday, it was announced that NGL would be removed from the Alerian MLP Infrastructure Index (tracked by massive ETF AMLP), which seemed to cause NGL’s large underperformance Friday.
CPPL dropped like a rock soon after the reports that its GP was in merger discussions with TransCanada.  CPPL has ROFO rights on the remaining interests in the Opco controlled by CPGX, but in this environment uncertainty loses.  Speaking of uncertainty, WPZ made the bottom 5 as well, driven by pipeline delays and fresh questions on the Energy Transfer merger following the ETE preferred.
TLP separated itself further from the rest of the sector and is the only traditional midstream MLP in the top 5 year to date.   On the downside, the constituents shuffled around and CEQP climbed out of the bottom spot.
General Partner Holding Companies
GPs outperformed MLPs on average, but the gap between CPGX’s huge move and ETE’s latest collapse was huge.  WMB was dragged down with ETE, while PAGP underperformed PAA, but made the top 5.
News of the (MLP) World
Outside of the big headline from the ruling in the Sabine Oil & Gas case, it was a fairly quiet week of actual transactions.  Stealth preferred equity, rumors of merger discussions among major natural gas pipeline owners, project delays and denials, and unusual index rebalancing all happened. Actual merger announcements, public equity offerings or even a press release from Energy Transfer did not happen.
Energy Transfer / Williams
The rumors, transactions and new reports concerning the Energy Transfer and Williams engaged families are coming so fast, its hard to keep track of it all.  This week, we’ve set aside a section of just ETE/WMB/ETP/WMB/SXL “news”. ETE issued a new class of equity only available for certain insider investors that seems to offer some level of distribution protection even if distributions get cut.

  • In an 8-K, Energy Transfer Equity (ETE) announced a private offering of Series A Convertible Preferred Units representing L.P. interests in ETE issued to certain insider investors (filing)
    • Positives: Effectively saves ETE $518mm in cash over the next 2 years, which can be used to reduce leverage
    • This transaction and creation of a separate class of units owned by insiders exclusively was not accompanied by a press release or attempt to explain the transaction by management beyond required disclosure
    • Apparently WMB did not approve of these units being offered to all existing unitholders, so ETE went forward with it for just insiders
  • Jamie Welch reportedly suing Energy Transfer for breach of contract following his dismissal last month (Reuters)
  • Energy Transfer Equity (ETE) reportedly has held discussions to sell GP of Sunoco LP (Reuters)
    • This is not surprising now that ETP has successfully exited the retail business through drop downs
    • Unclear who might have an appetite and ability to take down such a large footprint of retail assets
  • FERC denied approval for Jordan Cove LNG facility (owned by Veresen) and Pacific Connector Pipeline (to be owned by WPZ and Veresen), citing lack of customer demand for the projects (press release)
    • Only tangentially related to Williams
    • While the market seems to have totally written off this project and new LNG offtake agreements in general, this announcement was a surprise

Other News

  • Federal bankruptcy judge ruled that Sabine Oil & Gas can reject certain midstream contracts (Dow Jones)
    • Several midstream contracts between Sabine and its midstream provider were not rejected, highlighting the contract-specific nature of all potential contract rejections
    • This ruling reinforces the biggest risks that midstream operators have as it relates to counterparties filing for bankruptcy, including:
      • High MVC deficiency payments with no corresponding volumes
      • Above market rates
      • Easily replaceable or substitutable midstream services
    • The ruling sets a precedent, but the relevance of that precedent will depend on specific issues related to each future case
    • Also, the judge noted that her ruling isn’t binding, which probably means further litigation before a final resolution
  • Buckeye Partners (BPL) filed equity distribution agreement to sell up to $500mm in common units at-the-market (filing)
  • News outlets reported that TransCanada (TRP) was engaged in merger discussions with Columbia Pipeline Group (CPGX), but that talks had stalled due to valuation (Reuters)
    • TRP issued a press release stating that it was engaged with a third party in merger discussions, but nothing was imminent
    • No comment from CPGX, not even to reiterate its MLP’s business plan and right of first offer (ROFO) protection subsidiary MLP CPPL has to protect its drop-down dowry
    • The market has seen what happens when a GP of a high growth MLP gets acquired and all the drop downs are effectively taken away (see EPB, QEPM)
  • Alerian announces quarterly rebalance to Alerian MLP Index, reducing number of MLPs in its broad MLP index to 43 from 49 (press release)
    • Cheniere Energy Partners (CQP) added
    • Before this change, 2005 was the last time the index was rebalanced to include less than 50 names
  • Alerian announces NGL Energy (NGL) removed from Alerian MLP Infrastructure Index, but Boardwalk Pipeline (BWP), Antero Midstream (AM) and Cheniere Energy Partners (CQP) added
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