Crude oil prices had a wild October. This volatility dragged a fair number of energy firms along with it, and November’s outlook is unclear.
But hold your horses, say experts that follow master limited partnerships (many of whom are from Texas). Like a bucking bronco, stability returns quickly to the group.
This case, made by experts with Dallas-based Cushing Asset Management during a webinar Monday, can be complex. However, it’s worth understanding as the U.S. energy renaissance continues, the experts note.
“In the month of October, we saw significant volatility in our markets. Specifically as it relates to North Sea, Brent and West Texas Intermediate prices, with pullbacks of over 20%,” said Parker Roy, Cushing’s senior managing director.
That’s made for a difficult but interesting market, adds Jerry Swank, chief investment officer and founder of Cushing Asset Management — especially for upstream and midstream MLPs.
“Things went down, and things came back,” explained Swank. “And volatility can give you opportunities, which we saw.”
How likely is it that MLPs will recover (and even outperform) after weakening tied to falling energy prices?
After a 10% or more decline, the Alerian MLP Index has had positive returns averaging 19.5% in 13 out of 15 periods, according to Cushing analysis.
What’s driving the dramatic movement in crude oil prices? In terms of seasonality, October marks the end of the driving season for many travelers, and it’s when refineries shut down for maintenance and conversion to “the winter blends,” Swank says.
“On top of that, we had the dollar strengthening. And crude is priced in dollars, so we get an inverse relationship,” he explained.
The CIO believes the “market way overreacted,” and he reminds investors that, in general, the MLPs sector has very little direct commodity price exposure. This is because many MLPs are locked into long-term contracts (such as the pipeline providers or midstream operators) and have hedged prices.
There are brief periods when the correlation, which has been about 0.42 on a 10-year basis, rises toward 1. “You get whipsawed — which gives you a profit opportunity on the other side,” Swank said. “And it does go back to a regular correlation soon.”
Upstream companies, which are involved in production, are usually affected the most.
“We were surprised at the magnitude and velocity of some of the movement,” the expert said, noting these firms “are stable producers … energy price drops do not really effect their growth.”
He points out that these MLPs are “very hedged, 87% this year, for instance.”
In addition, MLPs have churned out stable distributions to unitholders on a quarterly basis despite such price declines over the years. This is tied to their cash flow stability, which is associated with production stability, hedging and related factors.
Swank shares that the yields of MLPs run about 11.5% for upstream and 5.5% for midstream firms, but those results do come with some volatility.
On the other hand, stability is usually the name of the game. “It takes a long, long pullback in prices to impact these firms that have long-term contracts,” he explained. “And MLP earnings are very strong.”
On the horizon, Swank points out, is likely a strong wave of further infrastructure spending in the energy sector that could further propel the performance of MLPs.
According to IHS Global, a research group, capital expenditures on midstream energy infrastructure projects should hit $87 billion in 2014. On a cumulative basis, that figure could roughly double to $173 billion in 2015.
Growth through 2020 should hit $568 billion and reach $889 billion in 2025. Much of this spending will be for pipelines, gathering projects and storage facilities used by midstream MLPs.
“This chart is the driver [of the business] and why folks want to be involved in this space,” Roy said.
Exports of liquefied natural gas and other products could provide another tailwind, Cushing experts add.