Focused on Fundamentals: The 2016 Midstream MLP Roundtable

Some master limited partnerships have business models that support distributions and expansion, even in challenging times. To best grasp the diverse factors affecting midstream MLPs today, we spoke with three leading industry observers for their analyses and outlook.

This year’s panel includes:

• Kenny Feng, president & CEO of Alerian in Dallas;

• Brian Kessens, managing director and portfolio manager, Tortoise Capital Advisors in Leawood, Kansas; and

• Quinn T. Kiley, managing director with Advisory Research in St. Louis

Which subsectors of the midstream-MLP field have the most favorable short- and medium-term outlooks, and why?

Kenny Feng, Alerian: We do not believe that short- and medium-term MLP performance will be primarily divided along subsector lines. Absent a sooner-than-expected recovery in the macro environment, the companies that are best positioned for 2016 outperformance are those with the lowest degree of uncertainty and highest margin for error, i.e.:

• growth visibility,

• low leverage,

• high distribution coverage,

• an investment grade credit rating,

• a supportive sponsor,

• favorable contract structures, and

• asset, counterparty, and geographic diversification.

That can come in the form of a mid-cap refinery logistics MLP with a clear path to multi-year, double-digit distribution growth; a small-cap gathering and processing MLP with a well-capitalized upstream sponsor in a low-cost basin; or a large-cap diversified MLP with limited financing requirements.

Brian Kessens: Tortoise Capital Advisors: Natural gas pipelines, as measured by the Tortoise MLP Natural Gas Pipeline Index, declined 31% in 2015 despite a favorable growth backdrop.

We estimate approximately $26 billion in natural gas pipeline capital expenditure from 2015-2017 and expect this investment to drive distribution growth in the sector. The majority of this investment targets the Northeast, where production from the Marcellus and Utica shale now tops 20 billion cubic feet per day (Bcf/d), with expectations to reach 30 Bcf/d by 2020.

Wide basis differentials continue to indicate the need for more takeaway capacity in this geography. Furthermore, we believe an additional 10 to 15 Bcf/d of natural gas demand will emerge between now and the end of the decade in the form of exports via LNG and to Mexico, coal to natural gas switching in the power sector and increased industrial activity.

Quinn Kiley, Advisory Research: Infrastructure that is tied to demand-driven volumes should fare well even in the “lower for longer” commodity price environment. This will include those liquids MLPs tied to a refiner parent.

As demand for refined products grows, albeit at a slower pace than GDP growth, the volumes handled by infrastructure supplying crude to the refiners or taking refined products away from the refineries should be flat to growing. Natural gas pipelines that are tied to major demand centers, i.e., the Northeast, Southeast, and the West Coast should fare better than others as our economy grows and natural gas prices remain low.

Which factors are likely to most influence the performance of midstream MLPs in general over the next year or so, and why?

Feng: We believe the most influential factor on overall midstream MLP performance in 2016 will be certainty. If the path to a recovery in commodity prices becomes clear, production volumes stabilize and distributions are convincingly secure, then the pace of investment dollars flowing into MLPs will increase from current anemic levels and provide valuation support.

The absence of one or more of those drivers will allow uncertainty—and the volatility that comes with it—to persist. In other words, we expect finicky investor sentiment to again play a meaningful role in 2016 alongside midstream fundamentals.

Kessens: We believe that crude oil prices will be key to a turnaround in market sentiment, and that prices will improve once supply and demand are in better balance, but we expect them to be “lower for longer.” In the meantime, we believe there are tremendous values in the pipeline energy space, as there seems to be a market assumption of “no growth” priced into current valuations.

Additionally, we believe MLP distribution sustainability is another key factor. In our view, distribution cuts within the midstream space will be the exception, as companies have multiple levers to pull to weather this downturn, including reducing capital expenditures.

We maintain a view that midstream MLPs will continue to have stable to growing cash flows.

Kiley: The obvious answer here is crude oil pricing, as this impacts investor sentiment for MLPs more than the other factors. We don’t expect a meaningful rebound in crude oil prices in 2016.

Therefore, the ability of MLP management teams to support the long-held view that midstream assets provide stable cash flows and this stability supports stable distributions could be more impactful over the next year. If midstream MLPs are able to defend their distributions, investors may be rewarded even without an oil price recovery.

What new developments (like exports) could push midstream MLPs in new directions over the next year or two? And how about in the immediate and long term?

Feng: We continue to observe with interest the evolution of the Northeast from a natural gas demand center into a prolific source of supply. These new volumes will need to go to Mexico, on carriers for export as LNG (liquefied natural gas), to domestic power plants, and to new ethane crackers built by foreign-domiciled petrochemical companies.

We expect MLPs to again provide the necessary infrastructure to connect the wellhead to the end user. We also expect technological advances upstream to continue to lower breakeven costs for producers, indirectly providing volume and cash flow support for fee-based midstream assets.

Kessens: We think the recent exportation of liquefied natural gas will have a significant impact over the long term, though LNG export facilities do not come online in a meaningful way until 2020; and exports to Mexico will be incremental as the country builds additional natural-gas-fired power generation.

We think another long-term opportunity will be crude oil exports. Currently, West Texas Intermediate (or WTI) and Brent trade near parity. Over the longer term, production growth from U.S. shale rock should return, and there is a need for this additional production to be exported.