So far 2018 has been an interesting year for the midstream and MLP sector. As the space recovers from the March lows, related to the FERC decision on tax allowances for some pipelines’ cost of service, the fundamental backdrop continues to improve.
The recent quarterly results from Kinder Morgan, Enterprise Products and MPLX, among others, were very positive and started to reflect how the fundamental changes in the landscape are now finally showing up in the cash-flows of the midstream operators.
Many fundamental themes are helping margins for most operators. For instance, production break-evens have dropped 42% since 2012 and are now generally in the $40 per barrel range; such drastic reduction reduces pressure on midstream clients (producers) and secures sufficient levels of production that need to be moved, stored and exported by midstream operators. Demand growth is experiencing great tailwinds from international markets via crude oil exports, LNG growing business to Asia (and perhaps Europe in a not too distant future) and petrochemical products sales.
In terms of infrastructure projects, it is estimated that in the next two years approximately $120 billion wort of pipelines and related structures will be built (source: Tortoise).
Last week, we also had one major simplification deal; Energy Transfer GP has indicated its intention to buy ETP (its MLP) for a 11% premium. The deal will also eliminate IDR payments from the LP to the GP and it will result in a stealth distribution cut in 2019 of approximately 30% for unitholders of the LP. The transaction will be tax free and it will allow Energy Transfer to reduce its leverage and refocus its cash-flow toward strategic M&A opportunities.
The market is beginning to warm up again to the space and now the YTD performance is ahead of the S&P500 benchmark (including distributions). On this subject, we have noticed money flowing back into funds and a conversation with a large money manager dedicated to the space has confirmed renewed institutional interest.
From a price action perspective, it is interesting to notice that July was the 4th month with 5%+ gains in 2018. Howard Hinds, a specialized MLP money manager, reports that in every previous year in which we had so many 5%+ months, the MLP index returned by the end of the year at least 35% (see table below; courtesy of www.mlpguy.com). Of course, this year we also experienced 2 months in which performance was negative by more than 5%, making it a very volatile and somewhat anomalous year in itself.