As President Biden took office, the reflation trade that had boosted energy broadly (read more) gave way to regulatory concerns, which pressured the sector. Energy practically matched financials as the worst-performing sector last week, and the Alerian Midstream Energy Index (AMNA) fell 3.1%. This note briefly discusses the implications of recent news around Keystone XL and upstream activity on federal lands for midstream/MLPs and why the reaction in equities feels overdone. From an oil and gas policy standpoint, President Biden has largely delivered on campaign promises that were well telegraphed in the past.
On January 20, President Biden revoked the presidential permit for Keystone XL, consistent with promises made as early as May 2020. Recall, a pipeline crossing national borders requires a presidential permit. The action was taken despite recent improvements made to the project by owner TC Energy (TRP/TRP CN). These include a partnership with Natural Law Energy (a coalition of Indigenous Peoples) allowing NLE to make an equity investment in the project, commitments to achieve net-zero emissions for the project upon startup, and plans to completely power the pipeline with renewable energy by 2030.
While the news around Keystone XL was aggrandized in media reports, it has no real readthrough for the rest of midstream and has not substantially changed the outlook for TRP. As TRP announced it was suspending activity on the project, the company restated dividend growth guidance of 8-10% for 2021 and 5-7% beyond 2021, while highlighting a robust $25 billion project backlog without Keystone XL. Because TRP was the only midstream company with an interest in the pipeline, the implications for the rest of midstream and MLPs are limited.
The uniqueness of the pipeline (border crossing, long-time media attention, etc.) also limits the readthrough for the rest of midstream, as there are not similar greenfield projects in the works. In fact, the news likely has more impact on those at opposite ends of the proposed pipeline - Canadian producers and US refiners - than midstream. Despite this reality, the headlines seemed to weigh on the midstream space and dampen sentiment. However, after a 4.5% decline on January 18, shares of TRP CN ended the week of the announcement essentially flat, down just 0.3%.
Additionally on January 20, the Interior Department announced a 60-day moratorium for issuing new leases and permits for drilling on federal lands and waters. Subsequently, on January 27, President Biden signed an executive order pausing new leases for drilling on public lands and waters to allow for a review of current leasing and permitting practices. Importantly, the order does not impact ongoing operations or permits for existing leases. During the campaign, Biden had discussed banning new permits for drilling on public lands and waters, but the focus of the executive order on new leases seems somewhat softened.
Given that policy changes for upstream activity on federal lands were widely discussed (see this Alerian note from December 2019), producers stockpiled permits ahead of President Biden taking office. In fact, the industry has 7,700 unused permits for drilling on federal lands and waters. The management of Devon Energy (DVN) indicated at a conference in November that they had four years of permits in inventory for federal lands - in other words, longer than the presidential term. Approved permits are good for two years or until a lease expires, whichever is sooner, but producers can apply for two-year extensions for permits. DVN's four-year inventory would require those extensions, which have historically been straightforward.
Even if the pause on new leases persists, there should be little medium-term impact to the industry, including midstream companies providing pipeline services for production from federal lands. Current upstream operations are able to proceed, and a runway of permits should allow for activity to continue on federal lands for quite some time. Until oil prices are sustained at higher levels, upstream activity is likely to remain somewhat muted anyway.
If activity on federal lands is restricted, producers will shift to private acreage, offsetting some of the impact. Over a longer time horizon, banning new leases on federal lands or limiting permits could have negative implications for US production and ultimately require oil imports from parts of the world with lower environmental standards and worse emission profiles. From a natural gas perspective, management of Kinder Morgan (KMI) noted at their Investor Day on Wednesday that they estimated the growth in natural gas production would be 1-2 billion cubic feet lower than what would be expected otherwise by 2025, assuming producers can drill on existing leases.
For context, the Energy Information Administration estimates 2020 dry natural gas production in the US averaged 90.8 billion cubic feet per day, with KMI's forecast pointing to only a minor impact on the outlook for the growth in US gas production. Importantly, President Biden made clear on Wednesday that his administration is not going to ban fracking.
Bottom line
The cancellation of the presidential permit for Keystone XL and restrictions around oil and gas activity on federal lands should have been expected from the Biden administration. The announcements have very little impact on the midstream space, particularly in the medium term, making the negative equity response feel overdone.
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