Center Coast Brookfield MLP & Energy Infrastructure Fund (NYSE:CEN) Q3 2021 Results Earnings Conference Call November 2, 2021 2:00 PM ET
Nicole Pecoraro - Director, Mid-Atlantic Region
Joe Herman - Portfolio Manager, Brookfield Asset Management
Tom Miller - Managing Director and Portfolio Manager, Infrastructure Securities
Boran Buturovic - Director & Portfolio Manager, Public Securities Group
Jeff Jorgensen - Portfolio Manager and the Director of Research on the Energy Infrastructure Equities
Rob Chisholm - Managing Director and Portfolio Manager on the Energy Infrastructure Equities
Good day, and welcome to the Center Coast Brookfield MLP And Energy Infrastructure Fund Q3 2021 Webcast. Today's call is being recorded.
Now, I'd like to turn the call over to Nicole Pecoraro. Please go ahead.
Thank you, Paula. And welcome everyone to the Q3 update. As the operator mentioned, my name is Nicole Pecoraro, and I'm the Regional Director for the Mid-Atlantic at Brookfield Oaktree Wealth Solution. Today, we have with us Portfolio Managers, Rob Chisholm, Jeff Jorgensen, Boran Buturovic, Joe Herman and Tom Miller. Midstream equities took a bit of a breather in Q3 with the two major indices hosting negative total returns for the first time since Q3 of last year. And despite the modest negative Q3 performance, both indices have still returned near 50% year-to-date. So personally, I'm excited to hear from our PMs to discuss the current environment and the future market outlook.
So with that, I'll just kick off the call to Joe Herman. Joe, if you could lead us off and discuss just what you saw in Q3, and what you all are seeing for the remainder of the year? We thank you, all.
Thanks, Nicole. Hello, everyone. Thank you for joining our market update call for the third quarter for the Center Coast Brookfield MLP & Energy Infrastructure Fund or CEN. There is a lot of excitement around the energy patch right now is supply demand fundamentals have really steadily improved and the world is now starting to price in something that we've believed and discussed for a long time. The hydrocarbons will be around for longer than some probably believe. And that recent underinvestment throughout the industry is really threatening the availability of reliable, cheap and critical energy supplies for many parts of the world.
But before we get into the rest of our slides and our market update, we've recently announced the addition of Tom Miller, an additional PM on the Fund. Rob, Jeff, Boran and I have worked with Tom for more than 3.5 years now, since we joined Brookfield, and have collaborated together through many management portfolio and internal committee meetings. We're really excited to have him on board as a PM and believe that CEN investors should benefit from his experience since he's been a PM on our Broader Infrastructure Strategy since 2016, and we think that that'll provide unique and really valuable cross-sector insights for our products and strategies, particularly as the energy sector navigates the energy transition.
So with that as a brief overview, I'll give Tom a moment to provide some detail on his background. His addition as PM of the Fund before we kind of jump back into the market update. So, Tom?
Thanks, Joe. I'm excited to get to work with Joe and Boran on CEN, and continue our collaboration, which began almost four years ago when Brookfield acquired Center Coast Capital. The energy infrastructure sector has always been a core part of our broader global listed infrastructure portfolios. And prior to taking on the Portfolio Manager role for our global listed infrastructure funds, I spent several years as the infrastructure team’s dedicated midstream analyst, thus having great familiarity with this space.
Over the last few years, myself, Joe and Boran, along with the rest of the BEI team have had continuous dialogue around the midstream sector where we've exchanged notes and ideas, attended the same company meetings and conferences, and expressed our views to management teams on how to best move this sector forward and navigate an ever-changing energy landscape.
Given our prior work together and like-minded approach to investing, the announced integration of the BEI team into the [GLI] team, seems more of a formality than anything at this point. And I very much look forward to what the future holds for our combined strength and platform.
Back to you, Joe.
So, on Page 2, here just a summary of what we're going to discuss today and what's topical in the area infrastructure sector. As Nicole mentioned with regards to third quarter performance, both major indexes, the AMNA and the AMZ were negative, only slightly through but they were negative for the first time since Q3 of 2020. And even though they were negative during the third quarter, performance in October was positive for both benchmarks and has been buoyed by some of the bullet points you'll see on this page.
So, first the fundamental backdrop continues to be really supportive for energy and midstream equities we believe. As OPEC+ compliance, increasing global demand for commodities coming out of COVID, and the natural decline of production has caused a tighter market than maybe even we had anticipated occurring at this point in 2021. I feel like we've been pretty consistent in saying that upstream underinvestment could eventually lead to higher prices and better drilling returns for producers. But I guess I'll just speak for myself, when I say that the rapidity with which crude hit $80 per barrel and natural gas is $5, $6 per MCF, surprise me. And I think the setup is indicative of the fact that, even as we increase market share of renewables in the power sector, and even as EVs starts take increasing market share throughout the next decade and into the 2030s, there is still a need to develop reliable sources of oil, natural gas and natural gas liquid supply.
The result of this confluence of factors has resulted in some pretty catchy headlines, I think you've seen recently in the mainstream media. Often labeling these elevated prices and supply shortages that we're seeing today is the start of an energy crisis. And we think that, this energy crisis has potentially pretty critical geopolitical implications. I think you'll see that a lot of these headlines referenced Putin and Russia as potentially being in favor of Europe, if they can fill undersupplied gas storage, in addition to China being mentioned and incentivized to secure energy supplies at “All Costs”. For now, however, many of the world’s gas markets are seeking out U.S. liquified natural gas or LNG deliveries in order to replenish inventory levels. And that's had the added effect of pushing up prices for landed LNG in Asia to the highest levels ever recorded according to Bloomberg. And that's just one reason why U.S. LNG exporters are expected to send out a record amount of LNG this year.
What's going on in the natural gas and LNG markets is just one example of why we think the U.S. energy sector is really sitting in a good spot. We're generally at the lower end of the cost curve, especially for natural gas and NGL production, and we think short cycle of shale production can answer the call if needed, so to deliver reliable supplies to global markets, really due to the expansive midstream infrastructure already in place. We've been pretty consistent in saying that we've favored the vertically integrated midstream companies that can offer a bundled service offering from the supply base and all the way to the export dock. These companies tend to be the larger midstream companies that are typically supported by well-capitalized counterparties, and we know that exports will continue to be a critical outlet for U.S. supplies for the foreseeable future.
Finally and with the indexes being negative on the quarter and the S&P 500 generating slightly positive returns, this last bullet and the chart on the next page might seem familiar, because they're generally a carryover that even with a solid year-to-date performance, we still believe the value proposition for Energy Infrastructure is strong with traditional midstream equities offering approximately 2x of free cash flow yield of the broader market, according to some sell side estimates.
And as you can see here still on Page 3, Midstream Equities continue to outpace the S&P Global Clean Energy Index on a year-to-date basis through the end of the third quarter, despite some strong tailwinds for that part of the energy infrastructure sector as well.
So with that, as a backdrop, I'll hand it back to Tom to provide his perspective on the energy crisis, and the European gas market as kind of one specific example. Tom?
Thanks, Joe. It's almost impossible to turn on the news lately and not hear some reference to what's transpired over the last several weeks across global energy markets. Crisis has been the term of the day and the short movements in key commodities such as natural gas, coal, and to a lesser extent crude oil has come as quite a surprise to the world now used to several years of low and declining energy prices.
Although Fund ends will have you believe the seeds of this crisis were sown squarely by one culprit or another, we believe the severe tightness in energy commodities has been driven by a multitude of factors. A colder than normal 2020, 2021 winter in Asia; curtailment of coal supplies given emissions concerns, as well as geopolitical disputes; weak hydrological conditions at low wind speeds, impacting power generation availability; reduction in CapEx for fossil fuels across the globe; and finally, a sharp demand -- a sharp jump in demand as life starts to normalize as we emerge from the pandemic.
Despite the lack of clarity as to when prices begin to normalize, one thing has been made abundantly clear throughout this time, and that is the need for affordable, dependable, and environmentally conscious carbon supply. We firmly believe North American energy producers and the infrastructure providers who service them have a critical role to play in this regard. While the impact of higher commodity prices is being felt around the globe, the impact has been particularly acute in Europe, due to that region's high reliance on imported sources of energy.
Natural gas storage levels in the region are well below five-year average levels, which has led to a record high prices of certain key hubs. As demand for natural gas has continued to grow at a robust pace in Asia, Europe has had fewer supplies in the global marketplace. The pull on U.S. exports remains strong with LNG exporter set to benefit from higher prices in their spot marketing portfolios, as well as increased appetite to sign long-term contracts needed to underpin sorely needed expansions of export capacity.
All of this is indicative of the role that natural gas will continue to play for many decades ahead, not only as a bridge fuel and reliable source of backup power capacity as the world moves forward and decarbonization, but also as a tool to help lower emissions as a substitute for coal.
Now, I’ll pass it on to Boran to discuss more of the supply and demand backdrop for hydrocarbon markets.
Thanks, Tom and welcome to the team. I'll move on to Slide 6. So this is the slide that Joe presented on our last call before the global situation we just discussed started unfolding. And what it was meant to show is that even in the IEA’s net zero scenario, which is the scenario representing the pace of renewable adoption required to get us to net zero by 2050, there was still a certain level of upstream oil and gas investment required in the interim. So the blue bars represent the historical investment levels with the orange line here representing an estimate for required investment to get us through 2030, and you’ve seen upstream investments plunge in 2020, and you’ve probably seen headlines indicating that is the case. By and large public producers are sticking to budgets at these levels as we look to 2021 and beyond, and they are facing pressure from investors to not grow production.
So Tom just alluded to under investment in fossil fuels being one of the factors that led to the current high price and supply concerns around the world. And we think it's a pretty important factor. I think that the awkward place that world leaders and institutions find themselves in is for the last few years, there has been a push to limit fossil fuel producers from producing in the name of climate change. And right now we've ended up in a place where supply constraints decades ahead of a comparable change in demand. And so we're dealing with this paradox and this moment of global reckoning that's a little bit different than what we had before. So we're not sitting here saying the energy transition is not happening. I think from this room, we all fully expect that at some point in the future, the way we consume energy will look very different than today, but we do believe there's a very long interim period. And as we change the way people consume energy, which is the demand side of the equation, we've got to keep the supply side of the equation in mind. And I think over the last few years, we've seen producers influenced by the push to restrain supply, which partly has its roots in a misguided notion that if you can keep a barrel on the ground, you're going to reduce reliance on it. And that's not turning out to be true. People still need that barrel, now they just have to get it from someone else and at a higher price. And the bottom line is in order to meet the world’s energy demands through the transition, we will need significantly higher investment in fossil fuels in order to keep global economies coming. And we're going to need a strong global economy to execute the energy transition itself.
So, if we accept the notion that we are going to need more investment and higher supply, we set up for ourselves where the supply should come from. We continue to believe that North American hydrocarbons are the single most compelling affordable, reliable, and environmentally conscious energy as Tom already alluded to.
On Page 7, you can see the EIA is in fact forecasting meaningful growth for U.S. oil, NGLs and gas. Although for oil, it is still not enough to offset the losses in production experienced from COVID. And importantly, infrastructure assets today are largely already in place to withstand these increases from the infrastructure build out of the 2010 through 2020 decade.
Beyond 2022, on this chart, we believe the U.S. is the logical place for the world to continue to come to grab those hydrocarbons. There's a patent absurdity to some of the headlines we see today where world leaders with access to robust domestic resources are calling on OPEC to increase capacity as if an OPEC barrel or a Russian barrel, Brent cleaner than a U.S. barrel.
In addition, U.S. hydrocarbons are arguably the world's most affordable traditional fuel source that several other large exporting countries use proceeds from oil operations to fund social budgets. For example, Saudi Arabia has a fiscal breakeven oil price at $76 compared to breakeven below $50 for most of U.S. producing regions, where producers are drilling for profitability. In addition the United States has a compelling infrastructure advantage that enables us to offer more reliable supply. This vast energy network, which our companies operate can provide multiple outlets in virtually any basin and the ports and docks around the country. And it's partly why numerous international counterparties have turned to U.S. liquified natural gas over the last several years. This reliability advantage has surfaced multiple times recently. Currently, we're living through a period where Russia is undersupplying Europe and it can manifest in other ways. Most notoriously, I'm sure some of you will remember in 2019, there was a drone attack on Saudi processing facilities. It took nearly 2 million barrels a day offline for weeks, leading to a 20% one day surge in crude prices.
In addition to these attacks in recent years, several oil tankers have been attacked or seized in the Strait of Hormuz, a conduit for one-fifth of the world's oil exports. The U.S. Gulf Coast simply does not have to deal with literal pirates in the water. And while we haven't been totally immune to issues, we did see the fiber attack take down refined product pipeline this year, the effects are generally reasonably isolated and quickly resolved with ample alternatives available when an asset is impacted.
And then finally, I'd say there are rather obvious geopolitical implications from energy supply demand business, and we're seeing those play out today as well. As we've seen in headlines, leaders of oil exporting countries can exercise significant geopolitical influence, and not all of these leaders are what we would consider as friendly. So, it did go back to the original point about keeping the barrels on the ground. If you keep a U.S. barrel on the ground, that barrel will still get consumed. It will just have to be at a higher price and it may have the pockets of an effective authoritarian or regime with a questionable human rights record.
One more slide here on Page 8, and I'll go through it quickly. So, we do expect U.S. supplies to be called upon, but we do still expect there to be regional literacy. Despite the U.S. still being well off of its record high oil production from pre-COVID, the Permian, the premier oil producing basin in the country is about to eclipse Q4 2019 levels, with several of the nation's top gas producing regions on the right side of the page also at a pre-COVID levels. We continue to believe that at this point is the right basin to extend the benefits to a greater degree and sooner than second and third tier basins around the country, some of which may still be in decline for several years.
I'll pause there and turn it back over to Tom to discuss valuation.
Thanks, Boran. So, so far on this call, we discussed the attractive fundamental backdrop for the midstream sector, but I wanted to spend a few minutes just talking about the value proposition that we see across this space. And the value proposition of midstream remains compelling as highlighted by the robust free cash flow generation, driven by persistent capital discipline, which is keeping investment programs at low levels, as well as modest expected growth in EBITDA. We expect this high level of cash generation to persist for the next several years, with excess cash allocated to balance sheet de-leveraging and increasingly towards shareholder remuneration in the form of share buybacks, as well as the resumption in dividend growth.
Now, one of the advantages I have, by my way of, my other role as Portfolio Manager for our broader listed infrastructure funds, is a broader lens for evaluating the attractiveness of the midstream opportunity set versus competing sources of funds, such as global utilities, communications infrastructure, and transportation infrastructure across the globe. We remain significantly overweight the midstream sector compared to our opportunity set, reflecting our conviction and the future outlook for the midstream space. I believe it is only a matter of time before the broader market recognizes the opportunity ahead and increases its own allocation to the sector.
On Slide 10, we wanted to highlight just how far traditional energy companies have remained out of favor, which is evidenced by the historically low weighting of energy in the S&P 500 Index at around 3%. This is despite the significant excess returns generated by the sector thus far in 2021. As the prospect of persistently higher inflation and potentially higher interest rates increases, we believe energy is to be one of the beneficiaries of this dynamic. And as generalists become more comfortable with the positive fundamental backdrop, and attractive valuations, any changes to future allocations could have a disproportionate positive impact on equity performance. While this impact would be most directly felt in the C-Corp midstream names that are in the index, we believe a rising energy tide should lift all boats, pulling the rest of the midstream universe in a positive direction as well.
Now, I'll pass it back to Joe to talk a little bit about the prospects for dividend growth.
Thanks Tom. Before I discuss those consensus expectations for distribution growth looking into 2022, I'll discuss the recent dividend and other fund level information for CEN. The Fund declared a quarterly dividend at $0.225 per share in September or $0.90 per share on an annual basis, based on the September 30th posted NAV and the market closing price of [$17.58] and $13.91, respectively, the Fund had an NAV yield of 5.1% and a market yield of 6.5% as of the September 30th close. It implied market price discount to NAV was approximately 21% as of that same date.
Now turning to Page 11. As you can see here in the title of the slide, consensus expectations are currently for return to distribution growth from both major and midstream indexes in 2022. The AMNA year-over-year historical and projected implied annual distributions on the left and the AMZ, Alerian MLP index on the right. For the AMNA this amounts to approximately 4% and for AMZ it’s around 2%. This would be the first time that both indexes have grown on an annual basis since 2014. We speak frequently about this, potentially being really powerful psychological scientists, we as investment managers and we know our investors also have been frustrated with the consecutive years of reduced income. And our hope is that consistent payouts will bring more attention from asset allocators back to the sector as this changes.
Finally, I’d just like to point out that the negative bars you see here for 2021 have already put through on a year-to-date basis, and we're not expecting any material changes to the implied index distribution through the end of this year. The good news is that, we think throughout this, all the business model for midstream has really proven out, but cash flow is resilient during one of the sharpest and largest crude oil demand corrections in modern history. And that included WTI turning negative during Q2 of 2020. And while the last round of COVID related distribution cuts was painful, we do think that it has set up the sector for the longer term better than it's ever been and I will explain here why, very briefly.
We would generally characterize dividend and distribution yields for the sector around 6% to 8%, historically. That still holds true today, maybe slightly lower on the margin. But the important thing to keep in mind is that same income level today has been really come with a complete overhaul of the corporate finance model, when previously all growth capital needs were financed with equity and debt and all of operating cash flow was paid out as distributions. Today, the story is much different. Free cash flow can generally cover the entire CapEx budget, dividends, and in some cases the buyback program or continued de-leveraging if needed. We think that outlook can be achieved even in a flat crude oil production environment from here due in large part to the diversity of cash flow and the strength of the fee-based contracts. The result hopefully is less reliant on the capital markets; and again, hopefully a more insulated sector over the long run.
Now, before we jump into a Q&A, wanted to mention that the same press release that showed Tom Miller was joining the CEN team as a Portfolio Manager indicated that Rob and Jeff would be transitioning out of their roles during the first quarter of 2022. I worked with Rob since I joined Center Coast in ‘14 and Jeff since he joined UBS Investment Bank in 2011. Although the energy market hasn't been kind to us over the last seven years, I can tell you that these guys really have -- and I know that Boran and I have really appreciated their guidance, insight and friendship, we'll miss them. Clearly and greatly appreciate their contributions to the front to Center Coast and to Brookfield.
So with that, before we get into Q&A, we'd like to give them a moment to speak to their outlook or provide any other insights they might have.
Thanks, Joe. Thanks for the kind words. It indeed has been a fun ride, and it's been a pleasure working with all of you. Tom, you included. I agree with everything what you said here today. I think it's an exciting time energy, a very exciting time for the energy transition. I think the U.S. is well positioned, and I believe the Fund is well positioned and I think been in good hands and at a fantastic [part].
Thanks, Jeff. I think the keywords that Joe mentioned there was a -- is transition. When we started Center Coast part of Brookfield, my operational experience was heavily involved on the exploration side of the shale then. Since that point, a lot has happened, and we have definitely shifted into the production side. And Joe, Boran and Tom have definitely grown up on the production and supply increase side of the world. When we started Center Coast, as Joe mentioned we have access to capital, our growth CapEx was externally funded and operational cash flow is passed back to the investor. Times have changed. There has been a transition, access to capital has been cut off to the space, underinvestment is the key word, and regulatory battles inside the courtroom also determine the outcome of the markets these days.
And so, these gentlemen have a depth of experience in this new phase of the energy sector. And we feel that the transitioning to these stands leaves the Fund in great hands. And we look forward to seeing it flourish in the future.
So, with that, I think we'll turn it over to Q&A.
A - Joe Herman
I don't think I have anything to say on the when. As to the how, there are a number of plausible, I would say, exits. So we are just talking about the investment a little bit. We are now in the seventh year since we made the initial commitment. In that time, the asset itself had undergone the build outs that necessitated the financial partner in KKR, which is how we entered the investment. And it's now spitting off free cash flow, as a majority of our other companies are. And so, while there's no longer a need for external capital, at least not one that's visible, so it's fund out to further assets. I think it's a fair question on to start thinking about exits. Unfortunately, we do not have visibility into all of them, but the plausible exit I think would be -- I think the most obvious one would probably be an exit of the position by KKR, and which we would participate in the one by them.
I think other than that, I think theoretically, you could see KKR agreed to IPO, its JV interest in the business. And then finally, I think there is a plausible outcome where we monetize our LP interest aside from KKR. But again, I don't think I could comment on the when there.
There's another question here on valuation. I think we've spoken about this a number of times and the best detail is probably in the Q. So, I'll leave most of the details to that. But the valuation is looked at frequently, and there are inputs in the valuation methodology that do rely on -- that are informed by market multiples. And those are updated as needed to make sure that the asset is requesting what we believe is fair value on a regular basis.
Okay, Nicole, I think the remaining questions have all kind of been answered in some form and other. So, we appreciate -- yes. Sorry, go ahead, Nicole.
Yes, no, fantastic. I do -- I'm reviewing the queue and I think we are complete on our questions. So, if you all have nothing further to add, I basically just want to thank you guys for your comments and commentary today. Rob and Jeff, thank you so much for your management and dedication to the Fund, as well as Boran, Joe and Tom, we are really looking forward to the future. So thank you everyone for joining us today and please feel free to reach out to your respective Brookfield Oaktree contact with any specific questions you might have, or if anything wasn't answered. And with that being said, have a great rest of the year.
Thank you. And that does conclude today's conference. We'd like to thank everyone for their participation. You may now disconnect.