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January 21, 2018

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Week Thoughts: Pausing Midstream

Midstream stocks sold off this short week, taking a breather from their sprint off the bottom.  MLPs had traded up in each of the last 5 weeks, so a pause isn’t surprising.  The MLP Index traded down the first 3 days of the week, before a reversal and positive finish Friday.

The U.S. 10-year interest rate rose 11 bps to 2.66%, which when combined with lower oil prices, offered a reason for profit taking.  The broader stock market marched higher by nearly 1%, shrinking the lead year-to-date for the MLP Index down to 250 bps.
The AMEI index, which represents a broader midstream universe (including Canadian midstream, U.S. midstream, certain utilities and MLPs), has underperformed to start the year.  The recent midstream rebound has been led by MLPs, evidence of positive fund flows into MLP-directed passive vehicles and into MLPs themselves after poor 2017 performance.
The initial seasonal rush back into MLPs is behind us, but action Friday seems to show there is capital that wants to be involved with the (latest) midstream recovery but has been waiting on a pause.  Earnings season will be important for investor confidence from here.  The market is watching for signs of an ongoing operational recovery and follow through on self-funding and return on capital rhetoric we heard last quarter.  KMI’s results were a step in the right direction, with year over year growth in some lagging business segments and geographies.
Stopping IDR Payments Before They Become a Problem
USA Compression’s big deal and adoption into the Energy Transfer MLP Family was the news of the week.  3 weeks in and both major compression MLPs have eliminated their IDRs.  Interestingly, neither one of them had a high % of cash flow going to the IDRs (for APLP because of a recent distribution cut), so it was more about optically removing them and positioning to attract broader investment interest.
For smaller MLPs that struggle at times to garner attention from investors, removing IDRs when they aren’t a problem is a positive move.  Others in the sector (AM this week) have said the IDRs are not mature enough to eliminate right now.  In 3Q, large MLP Western Gas (WES) acknowledged that while the math still works for them to maintain IDRs and still develop projects with returns above their cost of capital, the market is saying IDRs should be eliminated, and thus they plan to address them sooner than they would have otherwise planned.
Waiting until the IDRs are a problem may be too late.  Investors can build diversified midstream portfolios that are also IDR-free.  It’s a brave new IDR-less world, not unlike the futuristic sci-fi classic film Minority Report, set in a world where crimes are stopped before they happen, but Tom Cruise still gets to ride a motorcycle and sprint on camera like he does in all of his films.

Winners & Losers
USAC’s transformative acquisition and IDR elimination series of transactions were well-received this week, send it up nearly 8% this week.  Also in the top 5 were two MLPs with significant Bakken exposure on the G&P side of things, OMP and CEQP outperformed.  CEQP benefitted from some upgrades and was playing catchup after lagging the rally off the bottom.  There seemed to be some rotation among compression MLPs this week, with APLP dropping 5.5% after strong gains in the opening weeks of the year.  PAA and GEL were among the losers this week in a flashback to last year.

CNXM and APLP, among the best performers through the first two weeks, were surpassed on the YTD leaderboard by the likes of TOO and CELP this week.  Still not many MLPs negative for the year so far, but there are some early trends: smaller refinery subsidiary MLPs (HEP and DKL) and propane MLPs (SPH and FGP) are underperforming.

General Partners & Midstream Corporations
Midstream corporations and general partners matched MLP performance with a 1.5% decline at the median.  NSH was the runaway winner of the group on no news, and LNG was a relative winner after announcing a new LNG supply agreement.  Last week’s big winners EQGP, WGP and PAGP were near the bottom this week.  Notably absent from the top and bottom 5 this week was KMI, which traded well ahead of earnings and sold off Thursday and Friday for a middling overall result for the week.

For the year so far, MLPs are still beating midstream corporations and GPs.  NSH took over the top spot as the only double-digit gainer so far, followed by OKE, but still early days.

Canadian Midstream Corporations
Canadian midstream outperformed U.S. midstream this week, with KML as the major outlier on the positive side with a big move Friday after a positive regulatory data point Thursday night for Trans Mountain.  Not much differentiation in performance beyond KML, but TRP was an outperformer, perhaps helped by its announcement of commercial support for Keystone XL.

TRP went from worst last week to relative winner this week, but it remains near the bottom YTD.  Pembina, a favorite among U.S. investors for its best-in-class financial profile, has underperformed early in the year.

News of the (Midstream) World

Capital Markets

  • SemGroup Corp (SEMG) priced private placement of 350,000 7% Series A Convertible preferred shares at $1,000/share, raising $350mm in gross proceeds (press release)
    • Shares are convertible at a conversion price of $33/share after 18 months, at the purchasers’ option, and after three years at SEMG’s option
  • Buckeye Partners (BPL) priced public offering of its $400mm 6.375% Junior Subordinated notes due 2078 at 99.474% of par (press release)
    • Notes will accrue interest of 6.375% up to January 22, 2023, then switch to 3-month LIBOR +4.02%
  • Teekay Offshore Partners (TOO) priced public offering of 4.6mm of its 8.875% Series E Fixed-to-Floating rate cumulative redeemable perpetual units at $25/unit, raising $115mm in gross proceeds (press release)
    • Distributions fixed at 8.875% through February 15. 2025, then switch to 3-month LIBOR +6.407%

Growth Projects / M&A

  • Energy Transfer Equity (ETE), Energy Transfer Partners (ETP), and USA Compression (USAC) announced a $1.8bn transaction with several moving parts (press release)
    • ETP will divest its compression business to USAC, USAC IDRs will be eliminated, and ETE will own a 100%, non-economic interest in USAC’s GP, adding another MLP to the Energy Transfer family
      • ETP: Sold CDM Resource, its compression business, to USAC in exchange for $1,225bn in cash and 19.2mm USAC common units and 6.4mm USAC Class B units for a total value of $1.7bn at an estimated 10x 2018 EBITDA
      • ETE: Acquired all of the equity interest in USAC’s GP and 12.5mm USAC common units in exchange for $250mm
    • ETE will cancel USAC GP’s IDRs and convert the USAC GP interest into a non-economic GP interest in exchange for an additional 8mm USAC common units
    • Transaction is expected to be accretive to USAC’s 2018 DCF and help decrease its leverage to mid-4x by the end of 2018
    • USAC will have the ability to buy its (now non-economic) general partner back from ETE in the future for $10mm once ETE/ETP’s L.P. ownership falls below 12.5mm units (will hold 46mm units after the series of deals above)
  • Cheniere Energy (LNG) and Trafigura signed a 15-year LNG sale and purchase agreement under which Trafigura agreed to purchase 1mm tons per annum of LNG from Cheniere on a free on-board basis (press release)
    • Trafigura will pay Henry Hub plus a fee to Cheniere
  • TransCanada (TRP-CA) announced it has successfully concluded the Keystone XL open season, securing 500,000 bpd of firm, 20-year commitments, positioning the proposed project to proceed pending (press release)
    • Commitments represent 60% of total expected capacity of the pipeline
    • Construction preparation has started and will increase as the permitting process advances throughout 2018, with primary construction expected to begin in 2019
  • MPLX announced joint binding open season for Cushing-to-Patoka pipeline expansion (press release)
    • Project will expand the capacity of the pipelines by 15,000 bpd to 360,000 bpd and is expected to begin service in 3Q18
  • Ferrellgas (FGP) announced sale of Bridger Energy to an undisclosed buyer (press release)
    • FGP acquired Bridger Energy and its small oil marketing business with its 2015 acquisition of Bridger Logistics
    • The assets sold did not generate a material amount of EBITDA and shouldn’t have much impact on financials going forward


  • Kinder Morgan (KMI) supported the National Energy Board’s (NEB) decision to established a generic process to address future provincial and municipal permit issues regarding the Trans Mountain project (press release)

Distribution Announcements
20 distribution announcements, including 11 quarterly increases this week.  Importantly, no quarter over quarter or year over year decreases.