Why The Natural Gas Bottleneck Persists In The Permian

|
Includes: BOIL, DGAZ, GAZB, KOLD, UGAZ, UNG, UNL
by: Tortoise
Summary

Takeaway capacity out of the Permian basin for natural gas is expected to alleviate in the fourth quarter when new capacity comes online.

The Permian Gulf Coast pipeline project could be scrapped, reducing a possible overbuild situation.

Highlights from a recent conference include upstream company capex expectations and how LNG contracts might be impacted by trade conflicts with China.

The start of 2019 has been impressive for energy equities, making up for a dismal fourth quarter of 2018.

By Managing Director and Energy Portfolio Manager James Mick

Happy April Fool’s Day everyone. We here at Tortoise have a long history of elaborate celebrations, to the point that our CEO actually strongly prefers we no longer pull any pranks! And so I will not regale you with stories that might be picked up somewhere potentially scaring investors. Rather, we’ll delve into the sports world, where we are down to four. I would be highly impressed if anyone you know picked this final four for college basketball. Not entirely improbable, but we do have two teams that are making their maiden voyage to the big event, including the Tigers. No, not you Mizzou, but rather Auburn. In more discouraging news from the weekend, the Royals bid to go 162 and 0 is now over with a weekend loss to the White Sox. Hope typically springs eternal, but I’m not sure Royals fans feel that way this year. As such, we’ll take what may end up a rare series win. As we move into the second quarter of 2019 and say goodbye to 1Q, I for one am ready for some warmer and hopefully drier weather here in the heartland.

We’ll start things off with market performance for the week that was:

  • On the commodity front, crude oil continued its trend, higher by 2%, while
  • Natural gas went the opposite direction, with spot prices down just over 2%
  • Shifting to equities, the broader S&P Energy Select Sector Index® rose almost 1%
  • Exploration and production companies, as measured by the Tortoise North American Oil & Gas Producers IndexSM were strong, up 1.9%
  • And finally MLPs were generally flat, as the Tortoise MLP Index® declined by 13 bps
  • It was a pretty quiet week on the news front, so I wanted to highlight just a few noteworthy items before recapping a major energy conference and touching on the first quarter’s performance for energy.
  • Natural gas priced at the Waha hub in West Texas went negative this past week. Likely due to some temporary issues on Kinder Morgan’s (NYSE:KMI) El Paso pipeline, yet the bigger issue is the persistent bottleneck due to lack of takeaway capacity out of the Permian. This will alleviate eventually, but probably not until the fourth quarter when new capacity comes online
  • Magellan Midstream Partners said in a press release it was no longer pursuing the Permian Gulf Coast, or PGC pipeline and as a result, reduced capex projections for 2019 and 2020. It’s been rumored that this pipeline, with partners Energy Transfer (NYSE:ET), MPLX and Delek (OTCPK:DLKGF) would be scrapped and the partners may join the Wink to Webster pipeline project commissioned by Exxon (NYSE:XOM), Plains (NYSE:PAA) and Lotus Midstream

o We would view this very favorably as it reduces the probability of an overbuild situation

o While the pipeline is not dead, we would assume it will not proceed and just the broader trend of the continued use of midstream JVs is encouraging as companies are doing a better job of allocating capital

  • Finally, Energy Transfer and Phillips 66 Partners (NYSE:PSXP) announced the second phase of the Bayou Bridge pipeline as completed and ready for service

We had several members of the team attend the Howard Weil energy conference in New Orleans last week. From the notes they took, it appears they actually even went to meetings! Just kidding, they took copious notes with the main themes centered on:

  • One, upstream companies continue to reiterate they will not raise capex if crude prices increase
  • Two, crude quality out of the Permian is a mounting concern, given most of the incremental production is a very light, sweet crude

o This will result in a greater need for segregation of barrels

  • And three, on the LNG macro front, China is the big wildcard, with current trade issues throwing a wrench into longer term contracting

Finally, let’s wrap up with a quick look at the first quarter performance numbers

  • Crude oil had a banner quarter, up 32% as inventories did not build as many expected

o In fact, while the last 5 years have seen on average a 40 million barrel build in the U.S., we are essentially flat this year

  • Natural gas was again on the opposite end of the spectrum, declining 14% as the solid start to winter weather tapered off
  • From a stock perspective, it’s been a great start to the year for equities.

o The S&P Energy sector index is up about 16%

o E&Ps are up just shy of 17%

o MLPs are up almost 18%

o And utilities finished up a little over 10%

  • More broadly, the S&P 500 finished positive 13% for the quarter

So while it’s been an impressive start to the year for energy equities, we are essentially just making up for the dismal fourth quarter of 2018. In fact, taking MLPs as an example, the combined return of both 4Q 2018 and 1Q 2019 is still slightly negative. All that is to recognize that yes, while we have had a good start to the year, energy still has plenty of room to run. And just to make sure there is no confusion that is not an April Fool’s prank!

The S&P 500® Index is a market-value weighted index of equity securities.

The PCE inflation rate is the Personal Consumption Expenditures Price Index. It measures price changes for household goods and services. Increases in the PCEPI warn of inflation while decreases indicate deflation.

Broad Energy = The S&P Energy Select Sector® Index is a capitalization-weighted index of S&P 500® Index companies in the energy sector involved in the development or production of energy products.

Producers = Tortoise North American Oil & Gas Producers IndexSM

The Tortoise North American Oil & Gas Producers IndexSM is a float-adjusted, capitalization-weighted index of North American energy companies primarily engaged in the production of crude oil, condensate, natural gas or natural gas liquids (NGLS). The index includes exploration and production companies structured as corporations, limited liability companies and master limited partnerships but excludes United States royalty trusts.

MLPs = The Tortoise MLP Index® is a float-adjusted, capitalization-weighted index of energy master limited partnerships (MLPS). The index is comprised of publicly traded companies organized in the form of limited partnerships or limited liability companies engaged in transportation, production, processing and/or storage of energy commodities.

The indices are the exclusive property of Tortoise Index Solutions, LLC, which has contracted with S&P Opco, LLC (a subsidiary of S&P Dow Jones Indices LLC) (“S&P Dow Jones Indices”) to calculate and maintain the Tortoise MLP Index®, Tortoise North American Pipeline IndexSM and Tortoise North American Oil and Gas Producers IndexSM (each an “Index”). S&P® is a registered trademark of Standard & Poor’s Financial Services LLC (“SPFS”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); and, these trademarks have been licensed to S&P Dow Jones Indices. “Calculated by S&P Dow Jones Indices” and its related stylized mark(s) have been licensed for use by Tortoise Index Solutions, LLC and its affiliates. Neither S&P Dow Jones Indices, SPFS, Dow Jones nor any of their affiliates sponsor and promote the Index and none shall be liable for any errors or omissions in calculating the Index.

Disclosure: I am/we are long MMP, ET, KMI, PSXP, DKL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Nothing contained in this communication constitutes tax, legal, or investment advice. Investors must consult their tax advisor or legal counsel for advice and information concerning their particular situation. This article contains certain statements that may include “forward-looking statements.” All statements, other than statements of historical fact, included herein are “forward-looking statements.” Although Tortoise believes that the expectations reflected in these forward-looking statements are reasonable, they do involve assumptions, risks and uncertainties, and these expectations may prove to be incorrect. Actual events could differ materially from those anticipated in these forward-looking statements as a result of a variety of factors. You should not place undue reliance on these forward-looking statements. This article reflects our views and opinions as of the date herein, which are subject to change at any time based on market and other conditions. We disclaim any responsibility to update these views. These views should not be relied on as investment advice or an indication of trading intention. Discussion or analysis of any specific company-related news or investment sectors are meant primarily as a result of recent newsworthy events surrounding those companies or by way of providing updates on certain sectors of the market. Tortoise, through its family of registered investment advisers, does provide investment advice to Tortoise related funds and others that include investment into those sectors or companies discussed in these articles. As a result, Tortoise does stand to beneficially profit from any rise in value from many of the companies mentioned herein including companies within the investment sectors broadly discussed.