For the year through July, the AMZ is up 1.3% on a price basis, resulting in a 5.9% total return gain. This compares to the S&P 500 Index’s 5.3% and 6.6% price and total returns, respectively. The Upstream group has produced the best average total return year-to-date, while the Natural Gas Pipeline subsector has lagged.
MLP yield spreads, as measured by the AMZ yield relative to the 10-Year U.S. Treasury Bond, narrowed by 49 basis points (bps) over the month, exiting the period at 480 bps. This compares to the trailing five-year average spread of 477 bps and the average spread since 2000 of approximately 367 bps. The AMZ indicated distribution yield at month-end was 7.8%.
Midstream MLPs and affiliates raised $0.5 billion of marketed new equity (common and preferred, excluding at-the-market programs) and $0.5 billion of marketed debt during the month. MLPs and affiliates announced approximately $0.1 billion of asset acquisitions during July.
Spot West Texas Intermediate (WTI) crude oil exited the month at $68.76 per barrel, down 7.3% over the period and 37.1% higher year-over-year. Spot natural gas prices ended July at $2.82 per million British thermal units (MMbtu), down 5.2% over the month and 0.7% lower than July 2017. Natural gas liquids (NGL) pricing at Mont Belvieu exited the month at $35.52 per barrel, 0.6% lower than the end of June and 33.0% higher than the year-ago period.
FERC Softens the Blow. The U.S. Federal Energy Regulatory Commission (FERC) announced updated policy guidance related to MLP treatment of the Income Tax Allowance (ITA). Recall that in March, the FERC announced that it would no longer allow MLPs to recover an ITA in their cost-of-service for FERC-regulated assets (e.g., interstate natural gas pipelines). However, in July FERC updated policy guidance related to the ITA. In essence, FERC will allow MLPs to temporarily, under a three-year moratorium period, recover an ITA in a pipeline's cost-of-service so long as the pipeline lowers the tariff to reflect the new lower corporate tax rate of 21%. The updated FERC policy guidance also gives both pipelines and shippers future recourse to justify further cost-of-service changes to support reasonable rates and fair returns. Further, FERC provided favorable guidance for MLP treatment of Accumulated Deferred Income Taxes (ADIT) that, in many instances, could potentially mitigate the negative impact of an ITA removal. For additional details, see our recent blog FERC Issues Final Rule on Pipeline Tax Policy.
Energy Transfer Announces Simplification. On August 1, Energy Transfer Equity (NYSE: ETE) announced an agreement to acquire Energy Transfer Partners (NYSE: ETP) at an 11% premium. In connection with the transaction, ETE’s incentive distribution rights (IDRs) in ETP will be cancelled. The transaction, which will not trigger tax consequences for ETP unitholders, is expected to provide reduced costs of capital, improved distribution coverage and balance sheet strength, and simplify the overall structure.
Second-Quarter Earnings Season Begins. Second-quarter reporting season began in July. Through month-end, 61 midstream entities had announced distributions for the quarter, including 26 distribution increases, two reductions, and 32 distributions that were unchanged from the previous quarter. Through the end of July, 13 sector participants had reported second-quarter financial results. Operating performance has been, on average, better than expectations with EBITDA, or Earnings Before Interest, Taxes, Depreciation and Amortization, coming in 3.2% better than consensus estimates and 4.6% higher than the preceding quarter.
Thought of the Month: Record Energy Exports Bolstering Midstream Growth
Energy exports continue to shine as a source of growth for midstream sector participants as exports of crude oil, refined products, natural gas, and natural gas liquids continue to hit record levels via strong growth rates. For example:
- Exports of crude oil hit a record 2.0 million barrels per day (MMbbls/d) in May and have averaged 1.7 MMbbls/d during 2018, up 50% from the 2017 average of 1.1 MMbbls/d.
- Exports of finished petroleum products (gasoline, diesel, jet fuel, etc.) hit a record 3.7 million barrels per day in April and have averaged 3.4 MMbbls/d during 2018, up 3% from the 2017 average of 3.3 MMbbls/d.
- Exports of natural gas hit a record 9.9 billion cubic feet per day (Bcf/d) in February and have averaged 9.4 Bcf/d during 2018, up 8% from the 2017 average of 8.7 Bcf/d.
- Exports of natural gas liquids, most notably ethane, propane, and butane, hit a record 1.7 million barrels per day in May and have averaged 1.6 MMbbls/d during 2018, up 12% from the 2017 average of 1.4 MMbbls/d.
Midstream businesses are benefitting handsomely from these growing export volumes via new pipelines to the coasts, docks, dockside storage and terminal facilities, and the physical shipments of hydrocarbons abroad. For example:
- On their earnings conference call, Enterprise Product Partners (NYSE: EPD) noted partnership operational records included record NGL marine terminal volumes of 0.6 MMbbls/d and record crude marine terminal volumes of 0.8 MMbbls/d. Additionally, EPD recently announced expansions of multiple port facilities along the Houston Ship Channel, and plans for a new offshore facility capable of loading vessels transporting up to 2 million barrels of crude oil at a time.
- Magellan Midstream Partners (NYSE: MMP) recently announced another expansion of its crude oil export terminal by adding storage, dock capacity, and a new connection to MMP’s strategic Houston crude oil distribution system.
- Targa Resources (NYSE: TRGP) is expected to discuss recent exports of NGLs from their Houston area facilities along with second-quarter financial and operating results on August 8, after highlighting robust butane and propane exports during its first-quarter call in May.
The Port of Corpus Christi, TX is also seeing increasing inbound volumes of crude, natural gas, and NGLs. Additionally, numerous growth initiatives are underway to export these volumes, including meaningful projects benefitting Buckeye Partners (NYSE: BPL), Cheniere Energy Partners (NYSE: CQP), Magellan Midstream Partners, NuStar Energy (NYSE: NS), Phillips 66 Partners (NYSE: PSXP), and Plains All American Pipeline (NYSE: PAA/PAGP).
With U.S. crude oil and natural gas production continuing to set new records, exports can, likewise, be expected to continue to eclipse even recent records, and midstream sector participants will be handling the logistics of transporting these hydrocarbons through the supply chain, stimulating cash flow growth. In fact, according to Energy Intelligence, by 2023, 75% to 80% of incremental U.S. crude oil production (which could equate to one-third of total U.S. supply) will need to flow to export markets.1
Coupling this growth outlook with attractive current valuations, and the industry’s reduced need for external equity capital, the sector continues to be well positioned for long-term investors seeking an attractive blend of current income and moderate growth.
- ^As of July 24, 2018.
OppenheimerFunds is not undertaking to provide impartial investment advice or to provide advice in a fiduciary capacity.
The views presented herein represent the opinions of OFI Global Asset Management (“OFI Global”) and are not intended as recommendations, as investment advice or to predict or depict the performance of any investment. These views are based on the information available as of the date noted and are subject to change at any time based on subsequent developments.
The Alerian MLP Index is a float-adjusted, capitalization-weighted index measuring master limited partnerships, whose constituents represent approximately 85% of total float-adjusted market capitalization. The S&P 500 Index is a broad-based measure of domestic stock market performance. The Dow Jones Equity All REIT Index is designed to measure all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. The Dow Jones Utility Average, also known as the Dow Jones Utilities Index, aims to represent the stock performance of 15 large, well-known U.S. companies within the utilities industry. Indices are unmanaged and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any investment. Past performance does not guarantee future results.
Investing in MLPs involves additional risks as compared to the risks of investing in common stock, including risks related to cash flow, dilution and voting rights. Each Fund’s investments are concentrated in the energy infrastructure industry with an emphasis on securities issued by MLPs, which may increase volatility. Energy infrastructure companies are subject to risks specific to the industry such as fluctuations in commodity prices, reduced volumes of natural gas or other energy commodities, environmental hazards, changes in the macroeconomic or the regulatory environment or extreme weather. MLPs may trade less frequently than larger companies due to their smaller capitalizations which may result in erratic price movement or difficulty in buying or selling. Additional management fees and other expenses are associated with investing in MLP funds. Additionally, investing in MLPs involves material income tax risks and certain other risks. Actual results, performance or events may be affected by, without limitation (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) changes in laws and regulations, and (5) changes in the policies of governments and/or regulatory authorities. Investing in MLPs may generate unrelated business taxable income (UBTI) for tax-exempt investors both during the holding period and at time of sale. Diversification does not guarantee profit or protect against loss.