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Could Sequential Distribution Increases Attract Investors Back To Midstream?


Noteworthy production and demand growth highlights from OPEC's December market report.

What we expect will drive MLP sequential distribution growth in 2019.

How Kinder Morgan characterized their exposure to PG&E in their earnings call.

By Senior Managing Director and Energy Portfolio Manager Matt Sallee

Hello folks, happy belated Martin Luther King Jr day. If you’re thinking I sound a little hoarse today it’s because, well, I am. I attended the first ever AFC championship played at Arrowhead Stadium and nearly blew out a lung screaming only to have my heart broken yet again. Let’s move on before I start back in with the profanities. I do have some good news though, energy markets were up again last week with midstream MLPs up 2% and C-corps 3%. Likewise, oil was up 4% and the S&P Energy Select Sector® Index up 3%.

Switching to news, last week OPEC released their December market report which contained a few noteworthy points:

  • December production from OPEC was down 750 mbpd from November led by Saudi Arabia which was down half a million barrels per day. Additionally despite waivers on sanctions from the U.S., Iran dropped yet again. Also, as expected Venezuela’s decline continued.
  • 2019 U.S. liquids supply growth is estimated at 1.7 mbpd which seems pretty aggressive to me with tight infrastructure across various basins but 2018 surprised me too.
  • Demand growth forecast continues to be robust with an expected 1.3 mbpd higher consumption

Earnings kicked off last week with Kinder Morgan and Schlumberger.

Starting with Kinder, results were in line with our expectations for a strong quarter. Refined product volumes were up 1%, crude volumes were up 10% and natural gas volumes were up a whopping 15%. One big discussion topic on the call was their exposure to PG&E who recently announced plans to file for bankruptcy due to liability from the California wildfires. We believe Kinder’s only exposure is $100 million per year of revenue on the Ruby Pipeline or about 1% of EBITDA, so manageable. Regardless, when PG&E had to file in the early 2000s from poor regulation which didn’t allow pass through of increasing supply costs, they didn’t reject any transportation contracts so that is a promising precedent. That said, with the bankruptcy there is obviously uncertainty.

I will comment more on PG&E shortly but sticking with earnings, Schlumberger also reported last week. Despite poor North American results where margins contacted and revenue fell sharply the stock traded up 8% on the report. So what gives? Well, we see a few reasons. They held the dividend, called for improvement in their international business and let’s face it, the OFS sector got destroyed last year so anything short of a train wreck may be rewarded. This will be interesting to watch this quarter.

I’ve said this before but I love earnings season because it gives us a chance to get the latest health checkup on our portfolio and grade ourselves on our forecasts and our picks. And the other really cool thing is distribution announcements. So how has it been so far? In the MLP space we’ve had 21 declarations with an average 1.6% sequential increase. In fact as we look forward in 2019 we estimate the combination of healthy profits, the near completion of the simplification trend and heathy coverage and balance sheets result in sequential distribution increases for MLP indices which we think is a key ingredient to attracting retail investors back to midstream.

So I want to get back to PG&E. I covered gas transmission contracts but what about all those legacy power purchase agreements they’ve signed over the last several years from solar and wind projects? The unique factor here compared to gas transmission is due to significant decline in the cost of renewable projects over the last 10 years many of their PPAs are way out of the money compared to current market price per MWh. For context, PG&E has many PPAs in the mid $100 per MWH and as high as $180 per MWh versus $30-$50/MWh market price today. This is a huge uncertainty for those companies but there is a strong argument these contacts won’t be reset as this would significantly impair California’s ability to meet its lofty renewable goals. Specifically for PG&E it is hard to imagine them having the ability to procure additional PPAs anytime soon. Further, while it’s uncommon for a utility to be forced into bankruptcy, project developers may already be requiring a higher hurdle rate across the country following PG&E’s recent troubles.

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.

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