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Technical Analysis and MLPs: A Look at the Charts

While we do not claim to be expert chartists, we do like to use technical analysis to get a sense for where we might be headed. Looking at the charts of master limited partnerships (MLPS) alongside those of crude oil and the broad energy sector, we think there is a reason to believe MLPs may be on the verge of picking up positive momentum.

Below we have three charts, the AMZ MLP index, the XLE, an ETF that tracks S&P 500 energy stocks, and finally a chart of crude oil. Each chart is stacked evenly going back to the beginning of 2017. Looking at the AMZ and XLE charts, you notice that since February their charts look nearly identical, and both feature a pristine downtrend as defined by the yellow line. Each chart’s 50-day moving average (light blue line) also closely track the trendline. Looking at the crude chart, it also closely resembles the other two, forming a neat downward trend.

oil chart.png

 In mid-June, oil took a turn up and after initially looking like it might yet again fail to break through resistance (50-day moving average for this analysis), it took another shot at it and successfully broke through. Since then, the 50-day moving average (DMA) has turned into support and oil has been forming an uptrend, as seen in the chart. After this occurred, the XLE reacted positively and broke through its 50 DMA. It did not last long though, and confirmation of a breakout failed as the XLE quickly retreated back into downtrend territory. Its next attempt, however, was emphatically successful. The XLE screamed through its downtrend line, then it 50 DMA, and as of this writing, it is even trading above its 200 DMA (pink line). From the breakout of the trendline to today, the XLE as returned just about 10%. From the breakout of oil’s trendline to today, crude oil has returned about 8%.

 XLE USENEW.png

 mlp USENEW.png

Then there are MLPs. MLPs have hardly budged since oil began recovering. In fact, since oil began recovering off the low 40s, MLPs have been roughly flat. This performance has been disappointing and quite perplexing considering that MLP fundamentals are as strong as they have been in years. However, hope is not lost. Looking back at the charts, we can see that the AMZ is trading above its downtrend line which is the first time it has done that since it was formed on the chart. It is also above its 50 DMA. Remember, while liquid, MLPs are far less so than the broad energy stocks that make up the XLE. This often results in a slower moving and less reactive market. The AMZ index is also heavily weighted towards a few big name companies. One of those, Energy Transfer Partners, recently did a large secondary that hurt the sector’s performance and further dented investor confidence. Another event that has been hanging over the sector was a disappointing earnings result from a large member of the AMZ, Plains All American, that led them to cut their distribution for the second time in the past year. This bruised investor sentiment even more.

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While the rest of the energy sector was busy breaking out, MLPs needed time, as they always seem to need, to digest, deliberate and move past these negative outcomes. These are some of the reasons we think MLPs haven’t reacted to the improving investor sentiment that is taking place across the broad energy sector. That said, and taking the optimistic view, it is easy to see why we think MLPs may be set up to “catch up” to the performance of the rest of the energy sector. Of course, charts can only give us clues about where we may be headed, and there is no guarantee this scenario will play out.

 

 

Master Limited Partnerships: 2Q17 Review

Master Limited Partnerships: 2Q17 Review

2017 is shaping up to be a transition year for midstream MLPs. Domestic production of hydrocarbons has reversed trend and is once again on a growth trajectory. Crude oil production is up 910,000 barrels/day in the last 12 months and is expected to cross 10 million barrels/day of production in 2018. Demand for natural gas continues to grow driven by exports and new gas-fired electricity power plants. Natural Gas Liquids (NGLs) demand is set to spike as new petrochemical facilities begin operations. The large capital investments in pipelines and associated infrastructure from previous years are coming on-line and hydrocarbon volumes through pipelines are set to see growth in the second half of the year. MLP price performance has been challenged so far due to a 19% decline in crude oil prices this year. The elevated correlation between crude prices and MLPs remains, but we believe this will begin to dissipate as the OPEC production cuts begin to lower global crude oil inventories in the coming months. MLPs continue to trade at a discount to historical valuation metrics. As of June, 30th 2017, Wells Fargo calculates a price to distributable cash flow (P/DCF) ratio for 2018 of 10.7x, this compares to the 5yr average P/DCF ratio of 12.9x, a 17% discount to historical levels. This discount exists despite the improved balance sheet health and renewed growth outlooks for the sector. We believe this elevated short term correlation with crude oil is presenting extremely attractive investment opportunities for long-term investors. MLP earnings are driven by volumes moving through the pipelines, not the price of the commodity. As volumes return, many MLPs will see earnings growth just by filling underutilized assets. As the market starts to recognize the strong fundamentals underlying MLPs, the crude correlation will go down. MLPs have several tailwinds that will play out in the coming months.

 

MLP Q2 Update

MLP prices were under pressure in Q2 as oil/energy sentiment turned negative due to bloated global crude inventories. The short-term volatility in crude prices does not impact most MLPs business operations and is obscuring the long-term value of the midstream sector. During the quarter, we traveled to Orlando for the MLP Association Conference where we met with management teams to get a feel for their view on their business and the sector. Many management teams expected 2017 to be a transition year as strengthening balance sheets and building distribution coverage are priorities. Many were bullish about greater utilization of their existing assets, and potential growth projects. The predominant view was MLPs will eventually break out of the high correlation with crude oil as the market sees additional data on improving fundamentals. We discussed reasons for possible weakness with fellow MLP investors at the conference. The prevailing view on weakness pointed towards the oil price correlation, low retail fund flows into the sector and too much equity issuance. The rig count, which counts the number of rigs drilling for oil and gas in the U.S has increased by over 100% in the last year. This increase is a leading indicator on volume growth, which is why we fully expect to see significant volume increases in the back half of 2017. Another tailwind for the MLP sector is the positive legislative support from the Trump Administration. Under President Obama, many pipeline projects were delayed or cancelled, Trump has reversed this and wants to capitalize on our domestic resources as we march towards energy independence. MLPs that operate in key shale basins such as the Permian and Marcellus continue to announce strong earnings and guidance surrounding growth. Permian production continues to rise and several new pipeline projects for natural gas, NGLs, and crude have been announced in recent months. The midstream industry continues to see opportunities to optimize our energy infrastructure system. Another positive for the sector, is we are entering a phase of massive new domestic energy demand from exports, petrochemical and manufacturing facilities.

 

 

Growing Demand

Volume growth is coming for natural gas, natural gas liquids (NGLs) and crude oil pipelines. Demand for natural gas continues to grow driven by LNG exports, pipeline exports to Mexico and increasing investment in natural gas-fired electricity power plants. The Energy Information Agency (EIA) projects gas-fired generating capacity to increase by 11.2 gigawatts in 2017 and 25.4 gigawatts in 2018. That is enough capacity to power over 20 million homes. Many of these new electricity plants are in the mid-Atlantic and being powered by Marcellus Shale gas. We like MLPs that deliver gas to these facilities as the contracts are typically 10-20yrs with minimum volume commitments from investment grade counterparties. We expect natural gas to play a significant role in electricity generation for decades to come as coal and nuclear plants are phased out. MLPs are playing a vital role in the buildout of infrastructure to support LNG exports. The U.S is currently exporting roughly 2 billion cubic feet (bcf) of gas from Cheniere Energy’s Sabine Pass facility. By 2021, the EIA projects exports will reach 9.2bcf as new facilities come online. MLPs actively participate in building and operating these facilities along with the pipelines that feed the facilities gas.

 

 

Another industry reaping the benefits of shale is the petrochemical industry. According to the American Chemistry Council, domestic chemical companies have invested $161B in 264 new projects since 2010. Domestic chemical manufacturing is on the verge of a renaissance due to the low-cost and abundant shale gas that has lowered feedstock prices and energy costs for chemical companies. Two of the primary natural gas liquid feedstocks being used by domestic petrochemical companies are ethane and propane. These feedstocks are processed into ethylene and propylene, both building blocks of plastics. As demand for natural gas liquids continues to grow, we wouldn’t be surprised to see chemical companies becoming joint-venture partners on associated pipeline projects. Enterprise Product Partners (EPD), the largest MLP by market cap, estimates demand for ethane is estimated to grow by 340,000 barrels/day in 2017 as petrochemical plants come on-line. Additional demand growth of 430,000 barrels/day is expected through 2020. MLPs that operate natural gas liquids pipelines and processing facilities stand to benefit from this increasing demand.

Oil Upside?

In the beginning of 2017, OPEC announced production cuts of 1.8 million barrels/day. The market rewarded OPEC by pushing the prices towards $55 per barrel as it was believed global inventory levels would begin to rapidly decline. At that point, domestic oil companies used the strength in prices to hedge their production at higher prices. Since then, oil prices have drifted to the mid $40s. The negative oil price action has been driven by two factors; rapidly increasing oil production in the U.S (good for MLPs) and global inventory levels remaining frustratingly high. We think some energy investors are failing to see the forest through the trees. Before the cuts were implemented, many OPEC countries boosted their production so they would be able to cut production from a higher baseline. This ramp in production delayed inventory withdrawals for a few months. However, in the past month, we have seen inventory levels begin to decline at an accelerating pace. While U.S production continues to increase, the increases are not enough to offset the OPEC cuts, natural declines in oil fields and the lack of investment in new oil projects for the last 3 years. The lack of investment in new oil projects has some industry observers concerned that we could see a violent price swing to the upside as demand continues to increase and supply can’t keep up. Low oil prices continue to spur demand growth. Global oil demand is slated to increase by 1.3 million barrels/day in 2017 and an additional 1.4 million barrels/day in Source: International Energy Agency
2018. That would put global demand at 99.3 million barrels/day. Much of the new demand is being driven by developing countries such as China and India. The chart above illustrates that global supply/demand balance is finally flipping towards a supply deficit. We believe the trend continues in the coming months which should push down inventories enough to see oil rally towards $50-$55 by year end.

 

Conclusion

With our expectation of improving energy fundamentals in the coming months, we believe MLPs have rarely been more attractive as an investment. A shift in sentiment will drive positive fund flows into the MLP sector as valuations remain very discounted versus historical levels. In recent weeks, we have seen strong insider buying, positive dividend announcements, and several new growth project announcements. MLPs continue to place multi-billion dollar projects into service, enhancing their cash flow and growth visibility. The increasing utilization of existing assets will drive earnings and distribution growth with minimal investment needed. Midstream management teams learned valuable lessons throughout the downturn which has led to better capital decisions and ultimately a stronger sector overall. The growing sources of demand for energy due to manufacturing and petrochemical companies moving back to the U.S creates demand for additional infrastructure investment. With commodity prices stabilizing and the Alerian Index yielding 7.3%, we believe MLPs offer a compelling opportunity for the long-term investor.

Best Regards,

Dave DeWitt

Bob Milnes

 

 

How Trump's Tax Plan would Boost MLPs

The White House tax proposal announced April 26, 2017, would tax income from pass-through entities (MLPs) at a 15% rate instead of the individual's ordinary income tax rate.  The Trump Proposal would, therefore, make MLPs a more lucrative investment by decreasing the amount of tax paid by the individual owner. Currently, an investor in the 39.6% tax bracket with  $100 of ordinary income from an MLP  would pay $39.60 in Federal income taxes.  Whereas with the Trump proposal, a  $100 of income would only require taxes of $15.

If this proposal made into law, it would be a tremendous benefit to MLP investors. Distributions that are currently tax-deferred would stay the same.  However, if you sold an MLP, the deferred income would be taxed at 15%.  The government would also tax the ordinary income at 15%.

For investors looking to invest in MLPs, the following should be good news:  According to the Energy Information Administration (EIA), an oil shortage is feared by 2020 due to lack of new development in the era of low price oil.  American shale producers would not be able to offset the shortfall.  This shortfall in supply would be very positive for MLPs since there has been a correlation with oil and the price of MLPs. Here is a link to the article:

 

https://www.wsj.com/articles/iea-says-global-oil-discoveries-at-record-low-in-2016-1493244000

Master Limited Partnerships- Q1 2017 Review

North American energy producers are fighting back and winning, the war against OPEC. The pressure on OPEC countries continued to build until the point they ultimately decided to cut production by 1.2m barrels. The result of this capitulation by OPEC was oil prices soaring and maintaining a level in the mid $50s. As oil prices moved up, North American E&P companies have added over 400 drilling rigs, with more being added each week. This rebirth of the North American Shale Boom is releasing a wave of new production that flows th rough MLP pipelines on the way to end-users. Not only are the producers getting back to work, but a wave of new projects are being developed by MLPs to support further production growth. MLPs remain an attractive investment for many reasons including; improving underlying energy fundamentals, valuation metrics towards historical lows, cash flow that is rising, and volume growth in the coming years. MLPs with assets in the low-cost basins such as the Permian and Marcellus will benefit from rapid volume, and cash flow growth as producers focus on those locations. Another tailwind for MLPs is the expected completion of up to seven world-class petrochemical facilities that will significantly boost demand for ethane and propane. After a tough two and a half years in the energy markets, it is certainly a welcome development to have tailwinds at the back of MLPs once again.

MLP Q1 Update

MLPs continue to bounce back as underlying energy fundamentals improve. The Alerian MLP Index returned 4.8% in the first quarter. At several MLP conferences we have attended this year, sentiment was quite optimistic versus a year ago. MLP management teams have been encouraged by recent energy stability, recent sector financings at low discounts and several large projects have received go-ahead. MLPs continue to trade at significant discounts to historical valuations. Midstream MLPs now yield 7.3% (median) and trade at an estimated 2018 Price/DCF and EV/EBITDA multiples of 11.0x and 11.6x. This compares to 5yr averages of 6.5%, 13.5x, and 13.4 x, respectively. Not only are MLPs trading at cheap valuations, but they are re-entering a phase of distribution growth. These discounts offer a compelling investment opportunity for the long-term investor.

The U.S. continues to transform into a major energy export player in world markets as excess products are sold into world markets. MLPs invested tens of billions to support the export effort. Companies with marine dock facilities or pipelines leading to export facilities are positioned well as we expect exports to continue to grow rapidly. Mexico continues to pipe in an increasing amount of gas exports from the U.S for power generation and industrial use. I have been told that all the pipelines going into Mexico will be deep enough to avoid any potential border wall. U.S gas exports to Mexico are critical because Mexico has no domestic gas storage, and their domestic production has been declining for years. This production decline creates a large and growing demand for U.S gas.

Speaking of Mexico, the Trump Administrations goal of energy independence and the efforts to cut certain regulations will be beneficial to MLPs as energy infrastructure demand grows. Trump’s support of energy infrastructure was highlighted on his second day in office when he signed an executive order expediting the Dakota Access and Keystone XL pipelines. Members of OPEC stayed true to crude oil production cuts and will likely extend the cuts for another six months as global oil inventories rebalance. The production cuts have pushed oil prices into the mid-$50s which have led to a significant increase in the drilling rig count. The increase in rig count is a leading indicator for future volume growth in pipelines. One theme that continues to strengthen is identifying opportunities in low-cost shale basins.

Permian Basin

“People just don’t seem to realize how big the Permian is. It will eventually pass the Ghawar field in Saudi Arabia, and that is the biggest in the world”. – Scott Sheffield, founder of Pioneer Resources

Production of crude oil in the Permian Basin continues to defy expectations. It was the only shale basin that continued to grow production during the oil price crash. The Permian currently produces a little over 2 million barrels per day of crude oil (Mb/d). Analysts are confident that the Permian will double production to over 4 Mb/d by 2020. Many analysts project production will double again by 2025. Much of this production is possible due to efficiency gains due to technological developments in drilling techniques. According to the Energy Information Agency, in March 2012, the typical Permian well was producing approximately 102 barrels of crude per day. In March 2017, that number increased to 660 bbl/d or an increase of nearly 550%. M&A is extremely active in the Permian with nearly $20B worth of deals completed in 2016. Several MLPs participated in the Permian deals. Sunoco Logistics, Targa Resources, and Plains All American all acquired private companies with core Permian assets. The companies paid a premium as they project the new assets being synergistic with their existing Permian assets and expect the price paid ultimately to look cheap in the coming years.

All this new production creates a significant need for new infrastructure investment. Figure 1 illustrates the need for pipeline takeaway capacity in the coming years. When producing crude oil, you typically produce byproducts such as natural gas and natural gas liquids. The significant production of all three hydrocarbons has created substantial investment opportunities for MLPs that operate in the basin. One surprise of the Permian has been the amount of natural gas it produces. The Permian produces approximately 8 billion cubic feet per day (Bcf/d) which compares to the Marcellus at 19 Bcf/d. Several MLPs are developing projects to provide additional takeaway capacity from the basin. In fact today, April 10th, Enterprise Products announced a massive project that will carry as much as 600,000 barrels per day of natural gas liquids from the Permian to the Gulf Coast. As recently as eight months ago, analysts and even MLP management teams were worried about potential overbuild of pipelines in the Permian. New analysis suggests that the Permian could be experiencing a shortfall in takeaway capacity as soon as the end of 2018.

Figure 2 illustrates how many barrels per day existing pipelines can move out of the region, which totals roughly 2.2mb/d. With the expansions underway, takeaway capacity will be nearly 3mb/d by year end. Some other regions we are focused on are the SCOOP/STACK formation in Oklahoma. It’s early in the development of the SCOOP/STACK play, but initial production rates have been comparable to some areas of the Permian.  The Marcellus Shale in Pennsylvania continues to grow. The only thing that is currently slowing Marcellus growth is the lack of pipeline takeaway capacity. There are several pipeline projects currently being developed or proposed to solve the problem, but many are facing delays. It’s much easier to build a pipeline in Texas than the Northeast. As pipelines are completed in the Northeast, we expect the Marcellus to see a step-up in production to fill up the new pipelines.

Conclusion

Almost all the question marks that have weighed on MLPs over the past twenty-four months have been answered. Fundamentals have improved markedly and suggest growth is coming. Volumes are increasing, crude and gas prices are steady, and new projects are coming online. For the first time in at least eight years, politics are not a headwind. Abundant, cheap natural gas supplies in the Marcellus shale have attracted opportunistic manufacturers to move within our borders as new petrochemical plants come online. We have seen OPEC comply with their production cut, and in some cases, members even cut more than they agreed to. Investors do not often come across a sector with solid current and future fundamentals that is significantly undervalued to historical averages. MLPs, though, are exactly that. While of course not without risk, it seems there are currently far more reasons to invest than not to invest in MLPs.

Best Regards,

David DeWitt  Bob Milnes

 

 

Income Investing and Master Limited Partnerships

David DeWitt, President and Portfolio Manager of DeWitt Capital Management, was recently interviewed by Money Matters and explained how investors can earn income through master limited partnerships.  If you are looking to add income to your portfolio while participating in the American energy infrastructure boom, watch this 2-minute video:

If you want to discuss how MLPs can add income to your portfolio, contact our team at DeWitt Capital Management today.

Tags: income investors, infrastructure investments, income investing, income investments Master limited partnerships, master limited partnership income, income investor interview, master limited partnership investing, MLPs

What is the Trump Administration's Impact on Energy Infrastructure?

David DeWitt, President and Portfolio Manager of DeWitt Capital Management, sat down for an interview with Money Matters to discuss what impact the Trump Administration will have on energy infrastructure. If you are wondering what to expect from this new administration, be sure and watch this video.

If you'd like to discuss energy infrastructure in more detail, please contact us today and a member of our team will get back to you.

Tags: Energy infrastructure, Trump infrastructure plan, Trump energy, Trump energy plan, master limited partnerships Trump, President Trump energy infrastructure, oil, gas, MLPs

Barron's Back on Board

Barrons ran an article on January 2, 2017, that suggested investors should steer clear of MLPs in 2017. They suggested that when using traditional valuation metrics, MLPs look expensive compared to electric utilities and telecoms. They also commented that for many MLPs to continue paying their “generous” distributions, they would have to access the capital markets which have been unfriendly. To quickly evaluate how their recommendation turned out, let’s look at what happened in the sector over the past month. Exactly zero MLPs cut their distribution while several raised it. Also, since their article ran, the Alerian MLP index has been up 7.6%.

This weekend, Barron's ran an article with a much different take on the sector titled “Is It Too Late to Get In on MLPs’ Latest Bull Run?”[i] In a clear change of heart, the article comments that "MLPs make money when crude and natural gas flow through their pipelines and volumes are likely to increase with President Donald Trump making US energy development a priority."[ii] Although the index is up 75% from the low, it is down 40% from its high and is attractive on a historical basis. According to the article, “MLPs yield 6.8% on average, more than most other dividend stock sectors and more than many junk-rated corporate bonds, and distributions are growing at the rate of 4 to 5% on average. Add up the average dividend, growth forecasts, and an expansion in multiples, and portfolio managers see gains in the mid-teens for the next few years."[iii]

In their previous article suggesting avoiding the sector, they painted the idea of 5% distribution growth as a negative, as it the number is down from historical averages. Now, however, Barrons seem to have adjusted their lenses and are now seeing how the combination of growth, yield, and fundamentals portend a much brighter future for MLPs than they believed a month ago.

[i],[ii], [iii] Is It Too Late to Get In on MLPs? Latest Bull Run? | MLPs ... (n.d.). Retrieved from http://www.investorvillage.com/smbd.asp?mb=5028&mn=74632&pt=msg&mid=

The Pipeline President

On Tuesday, his fourth day in office, President Donald Trump took steps to show he is serious about peeling back regulations and removing political roadblocks on critical energy infrastructure projects in the United States. Among the actions taken was an executive order designed to expedite permitting and environmental reviews of “high-priority infrastructure projects.”

Specifically cited as projects deemed “high-priority” were the Dakota Access Pipeline (DAPL) and the Keystone XL Pipeline. The Obama administration halted construction of DAPL in September of last year due to often violent protests by environmentalists and rejected the Keystone proposal in 2015. He also signed an order telling the Commerce Department to develop a plan to impose a requirement that all new pipelines in the United States be built using “United States Steel.”

These actions are significant for master limited partnerships (MLPs) that have been building or are intending to build new pipelines. Energy Transfer Partners, the MLP behind DAPL, led the sector higher Tuesday as reality set in that these executive orders would reduce the often costly and lengthy permitting process for new pipelines. Perhaps just as important, these actions from President Trump signal that the rule of law will be respected and he will not grant special treatment to protesters, activists, or organizations who oppose projects that have already been approved through the legal process.  A pro-energy infrastructure administration will serve to remove much of the political risks that had become an increasing headwind for MLPs under the Obama administration.

These developments are yet more positives for MLPs as much-needed pipelines are now going to face a more efficient and swift permitting and approval process. This allows the MLPs that operate the pipelines to go from proposal to construction to earning revenue in what should be a significantly shorter period.

Master Limited Partnerships: 2017 Outlook

The outlook for MLPs continues to strengthen. After two dismal years, MLPs bounced back in 2016 and the Alerian MLP Index generated a total return of 18.3%. It was an especially notable performance when considering the Alerian Index’s plunge of -28.2% to start the year. Higher commodity prices drove the strong performance, investors moving back into the energy sector and the widely held view that the Trump administration will emphasize developing energy infrastructure. We expect the same factors to provide a tailwind to MLPs as we move into 2017. The underlying business fundamentals have improved blog 1-18-17 1significantly over the last several months as commodity prices have rallied and US producers have added rigs and increased drilling budgets for 2017. This bodes well for the MLP sector as more drilling will lead to additional volumes in the pipelines without much capital investment from the MLPs.  A major driver behind the increase in oil prices was a deal among OPEC members and Russia which agreed to cut global production by 1.8 million barrels a day or nearly 2% of global production. This cut led to oil surging to over $50 a barrel and is expected to accelerate the rebalancing of global inventories. Natural gas prices also enjoyed a strong 2016 driven by increased domestic demand, the startup of a Liquefied Natural Gas (LNG) export facility, and increasing exports to Mexico. With the improvement in underlying fundamentals and MLPs trading at a discount to historical valuation metrics, we believe this represents a great entry point for long-term investors.

What happened in 2016?

MLPs bounced back as underlying energy fundamentals improved over the course of the year. U.S natural gas exports by pipelines into Mexico and LNG export and a slight production decrease bolstered the outlook for natural gas prices. Oil price strength was driven by speculation of an OPEC deal and then rallied more as an actual deal came to fruition. Natural Gas Liquids (NGLs) prices increased significantly as petrochemical companies have invested billions of dollars in new facilities that will use NGLs, specifically ethane, as a feedstock. All the above are very positive for U.S energy production, and 2017 should see energy production back on a growth track. Expectations of production growth is a major benefit for MLPs as volumes/profits will increase and demand for new pipeline projects will rise. MLPs positioned in low-cost shale basins (Permian, Marcellus/Utica, SCOOP) generated strong returns as production continued to increase despite the low price environment. The Permian Basin in West Texas now produces over 2 million barrels of oil per day, and many industry insiders think production can easily double from these levels. All the new production will flow through existing pipelines, and we expect to see demand for additional infrastructure.

There were seven mergers announced during the year, and four MLPs eliminated their incentive distribution rights (IDRs). IDRs are essentially a management fee which the MLP pays to their general partner. By eliminating IDRs, MLPs lower their cost of capital which enables them to see a better investment return on projects. Distribution growth slowed in 2016 as most MLPs opted to strengthen their balance sheets by retaining more cash and paying down debt. We view the choice to reduce leverage rather than increase distributions as a positive that will ultimately make the sector stronger in the long run. MLPs got back on track in 2016, but they have a long way to go to get back to 2014 highs.

The Trump Effect

The Trump administration is shaping up to be one of the most pro-energy administrations in decades, if not ever. While information regarding exact policy is scant, many executives in the energy industry are very encouraged with recent appointments.   These include former Exxon Mobil CEO Rex Tillerson for Secretary of State and former Texas Governor Rick Perry for the Department of Energy. Rick Perry was involved in unleashing the shale boom in Texas, and until his appointment, he sat on the board of Energy Transfer Partners (ETP), the owner of the delayed Dakota Access Pipeline (DAPL). The Trump Administration is adamant about developing domestic natural resources, and to properly develop them, additional energy infrastructure is essential. We believe a significant amount of red tape will be cut away with projects like DAPL (and perhaps the Keystone XL pipeline)  able to move forward. President-elect Trump frequently discussed infrastructure investments during the campaign, and it is evident he understands the importance of energy infrastructure.

What to expect in 2017

United States oil and gas producers won the war against OPEC. Technological improvement in drilling led to lower breakeven costs as the United States becomes one of the global low-cost producers of hydrocarbons. Energy infrastructure will continue to play a key role in developing US Shale. We expect MLPs to continue their move upwards in 2017. Supportive policies from the Trump administration will open up drilling and create additional demand for infrastructure. MLPs with assets in the Permian and Marcellus/Utica will continue to deliver strong distribution growth with robust distribution coverage ratios.

Several MLPs are completing significant pipeline projects throughout 2017, and as they come on-line, we expect to see increased volumes as producer’s ramp up production for the new pipelines. MLPs with gathering and processing assets will benefit from the significant uptick in demand for ethblog 1-18-17 2ane. Ethane rejection occurs when ethane is left in the natural gas stream instead of processing it; this has been a major problem over the last 5yrs as ethane prices were low and it was uneconomic to process. Nearly 700,000 barrels per day of ethane were rejected in 2016. Those rejected barrels will find new demand centers as chemical companies complete their facilities which use ethane to produce ethylene, the building block of plastics. MLPs with NGL pipelines should benefit from these increased ethane volumes.

Exports will continue to be a major theme in 2017. In the coming years, demand for natural gas exports (pipelines to Mexico and LNG) will rise to nearly 8 billion cubic feet per day, nearly 10% of current domestic production. The chart above shows the growth in natural gas exports since the beginning of the shale boom.  Additional production from the Marcellus/Utica region is needed to meet the export demand. MLPs with natural gas assets in this region will benefit from the supply growth. Industry consolidation and the elimination of IDRs will continue to be a theme in 2017. It’s been a tumultuous road for MLPs since 2014, but the future remains bright as we return to growth in the energy sector.  DeWitt Capital Management strives to put its clients in the MLPs participating in the growth areas and provide index-beating returns to its investors.

Conclusion

We remain optimistic on the MLP sector in 2017. Several major pipeline projects coming on-line in the next 12-18 months will further enhance cash-flow for many of the MLPs we invest in. Midstream management teams learned valuable lessons throughout the downturn which should lead to better capital decisions and ultimately a stronger sector overall. We are long-term bullish on the future of natural gas. The INGAA, a natural gas association, recently released a report that estimated over $500B in new natural gas infrastructure would be needed to meet supply growth through 2035. We are equally bullish on the growth in natural gas liquids such as propane and ethane.   With commodity prices stabilizing and the Alerian Index yielding 7.1%, we believe MLPs off a compelling opportunity for the long term investor.

 

 

 

Disclosure

 

 

 

 

 

 

Bad Call by Barrons?

 

Barron’s January 2017 headline regarding their best income ideas reads, "European dividend stocks, including Nestle and Royal Dutch, look like the best bets for the year ahead, with yields up to 7%. Electric utilities and U.S. dividend stocks are also attractive. But steer clear of Treasuries, telecom, and MLPs". [i]

This is the kind of headline that reflects typical human behavioral investing.  Many studies have shown that investors tend to invest when recent performance has been good and pull out when recent performance has been bad.  Investors also reflect on the most recent market events when forecasting the future.  For example, who was predicting $27 oil when it was trading at $100?  Certainly, no one that I am aware of.

To be sure, MLPs have suffered poor performance from mid-2014 through February 2016.  However, even after this period, MLPs have averaged 13.7% average total return from 1998 through the end of 2016. That is higher than REITs, utilities, the S&P, bonds, and the NASDAQ.

Barron's dismissed MLPs because the growth in the payouts may "slow to five percent or less, with some growing their distribution only two percent."  However, the magazine did say the current payouts were around seven percent, higher than any of the other recommendations it was promoting.

At DeWitt Capital we would say it differently: First of all, what is wrong with five percent? MLPs have come out of the downturn mostly stronger, with healthier balance sheets and a new focus on financial discipline. If growing at five percent is partially a function of more discipline and stability, then we do not see much to complain about. Furthermore, many MLPs will still be growing their distributions well above five percent. Some will be growing as much as twenty percent.  Of all the asset classes we reviewed; MLPs offer the highest yield (which is mostly tax deferred).  MLP prices suffered due to an unprecedented correlation with oil during the downturn which created an  equally unprecedented value proposition for the sector.

MLPs beat the S&P every year from 2000 through 2011.  It has outperformed every other sector since 1998.  A return to the mean would provide investors a solid income and the real potential for significant gains over the next few years.

 

[i] Source: "This Weekend's Barron's: Best Income Ideas of 2017 ..." Yahoo! Finance. N.p., n.d. Web. 09 Jan. 2017 <https://finance.yahoo.com/m/16880e98-4e53-387d-a138-41e53d2da457/ss_this-weekend>.

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