MLP yield spreads, as measured by the AMZ yield relative to the 10-Year U.S. Treasury Bond, narrowed by 47 basis points (bps) over the month, exiting the period at 487 bps. This compares with the trailing five-year average spread of 462 bps and the average spread since 2000 of approximately 362 bps. The AMZ indicated distribution yield at month-end was 7.6%.
Midstream MLPs and affiliates raised $1.8 billion of marketed new equity (common and preferred, excluding at-the-market programs) and $3.5 billion of marketed debt during the month. MLPs and affiliates announced approximately $1.9 billion of asset acquisitions during January.
Spot West Texas Intermediate (WTI) crude oil exited the month at $64.73 per barrel, up 7.1% over the period, and 22.6% higher year-over-year. Spot natural gas prices ended January at $3.34 per million British thermal units (MMbtu), up 8.1% over the month, and 19.7% higher than January 2017. Natural gas liquids (NGL) pricing at Mont Belvieu, Texas, exited the month at $30.97 per barrel, 6.1% lower than the end of December, and 4.6% higher than the year-ago period.
IDR Eliminations and Corporate Simplifications Continue. Three midstream entities announced transactions to eliminate the incentive distribution rights (IDR) mechanism to improve cost of capital and, in turn, business development opportunities. Archrock, Inc. (NYSE: AROC) announced the acquisition of its MLP, Archrock Partners, LP (NYSE: APLP), effectively retiring AROC’s IDR interest in APLP. USA Compression (NYSE: USAC) announced a multi-part transaction through which it doubled its compression fleet by acquiring Energy Transfer Partner’s (NYSE: ETP) CDM Resources subsidiary and eliminated its IDRs. Finally, Spectra Energy Partners (NYSE: SEP) announced an agreement with its sponsor, Enbridge, Inc. (NYSE: ENB), to eliminate its IDRs.
Major Project Announcements. ONEOK, Inc. (NYSE: OKE) announced plans to invest approximately $1.4 billion to construct a new pipeline and related infrastructure to transport NGLs from the Rocky Mountain region to the company's existing Mid-Continent NGL facilities. Enterprise Products Partners (NYSE: EPD) announced an expansion of its butane isomerization facility at its complex in Mont Belvieu, as well as a joint venture to build a new ethylene export facility along the U.S. Gulf Coast. Additionally, Plains All American Pipeline (NYSE: PAA) announced plans to proceed with construction of the Cactus II Pipeline from the Permian Basin to Corpus Christi, Texas, after receiving sufficient binding commitments on its initial open season.
Private Equity and Other Strategic Players Demonstrate Continued Interest in Permian Basin Midstream Assets. A joint venture between Riverstone, a private equity firm, and Goldman Sachs, acquired Lucid Energy Group for $1.6 billion. Lucid operates natural gas gathering and processing assets in the Permian Basin. Additionally, Andeavor, Inc. (NYSE: ANDV), a major refining operator and sponsor of Andeavor Logistics (NYSE: ANDX), acquired Rangeland Energy, which owns and operates a crude oil pipeline and crude oil storage terminals in the Permian Basin. Terms were not disclosed.
Thought of the Month
With strengthening economic and labor market data, investor anxiety over the potential impact rising rates may have on the equity markets has begun to intensify. In fact, the Dow Jones Industrial Average experienced a 2.5% drop on Friday, February 2, the worst one-day performance since June 2016, an apparent investor reaction to a bump in Treasury yields. Whenever the market appears to be potentially entering a rising interest rate environment, investors often seek to understand how the midstream sector has historically performed over such periods.
As discussed below, over long-term periods, midstream equities, specifically MLPs, have not demonstrated meaningful correlation to interest rate changes. However, short-term periods of weakness have occurred in response to dramatic interest rate moves.
Over the past decade, there have been four periods over which interest rates rallied by at least 100 bps:1
- In the wake of the 2008 financial crisis, the yield on the 10-Year U.S Treasury increased by 189 bps. Over this period, MLP equities, as measured by the AMZ Index, appreciated 33% while utilities, as measured by the Dow Jones Utilities Index, and real estate investment trusts (REITs), as measured by the Dow Jones Equity All REIT Index, declined 5% and 6%, respectively. Utilities and REITs are often cited as yielding equity-sector comparisons.
- From late 2010 to February 2011, the 10-year yield increased by 135 bps. Over this period, the AMZ appreciated 7% while utilities and REITs increased 3% and 8%, respectively.
- From June 2012 until September 2013, the 10-year yield increased by 154 bps. Over this period, the AMZ appreciated 22% while utilities and REITs increased 1% and 7%, respectively.
- From July 2016 through the end of January 2017, the 10-year yield increased by 124 bps. Over this period, the AMZ declined 4% while utilities and REITs each declined by 10%.
The current period of interest rate pressure appears to have begun in September 2017 and, thus far, the 10-year yield has risen 64 bps. Over this period, the AMZ has increased 3% while utilities and REITs have declined 6% and 4%, respectively. Exhibit 1
Whether this latest move in rates soon exceeds 100 bps or soon moderates is uncertain. Though we believe history reveals that MLP price performance over these periods is not necessarily dictated by the rate change.
The correlation statistic of MLP price performance to changes in the 10-Year Treasury yield over these periods also suggests the interplay between rate changes and the midstream sector is fairly weak or fleeting. In fact, over several of these periods, the correlation between MLPs and yields was moderately positive, with MLP equities actually moving higher as the 10-year rate increased. Interestingly, utilities and REITs demonstrated greater negative correlation to rising interest rates over these periods, meaning both subsectors demonstrated a greater propensity to trade lower on rising rates. Exhibit 2
As noted above, short-term periods of midstream equity weakness have occurred in response to dramatic interest rate moves. Of course, over such periods the broader equity markets, as well as REITs and utilities, also often reflect trading weakness. However, over time MLP equities have exhibited little sustained impact from interest rate changes, as the data above demonstrates. In fact, since 1996 (the earliest date AMZ data is available) the monthly correlation of MLPs to the 10-Year Treasury is only 0.22.
We believe the low correlation figures cited above suggest that, over time, underlying business fundamentals are a significantly greater driver of investor interest than is the interest rate environment. In other words, it appears that over these historical periods of rising rates and the resulting increased return offered by alternative fixed-income securities, the perceived total return potential of MLPs generally remained good enough that few investors chose to sell MLPs to purchase these other assets.
Of course, like every market-focused commentary ever written, we caution investors not to rely on historical results to predict future performance. However, we do believe that the midstream sector is positioned well given our belief that the U.S. energy sector outlook is stable and that U.S. production growth is set to continue to increase moderately while midstream equity valuation metrics sit at historically attractive levels.
- ^Source: Bloomberg, for all historical data.
The February 2018 outlook reviews events in the MLP market through January 31, 2018. It is important to note that MLPs, along with the rest of the market, experienced a decline in early February primarily in response to investor fears about rising interest rates. We will provide a more detailed analysis of the MLP sector’s performance in our next monthly update. In the meantime, please reference OppenheimerFunds CIO, Krishna Memani’s blog “Will Rising Rates Kill the Bull Market?”
OppenheimerFunds is not undertaking to provide impartial investment advice or to provide advice in a fiduciary capacity.
The mention of specific companies does not constitute a recommendation by OFI Global.
It should not be assumed that an investment in the securities identified was or will be profitable.
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.
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