Some Bright Spots in the Gloom
In last week’s MLP Investing Insider, I covered last year’s top performers among the publicly traded partnerships. Refining MLPs shone thanks to plummeting oil prices and a crude export ban that allowed them to buy oil on the cheap and export the refined fuels made from it.
Crude oil prices are certainly still depressed, but I don’t think they will stay below $40/bbl all year. Further, the crude oil export ban that so greatly benefitted refiners during the shale oil boom is no more.
Thus, while I think refiners will still perform well as long as crude oil prices remain depressed, there is a lot more downside risk in the sector than there was a year ago. So I think it’s unlikely that refiners will repeat as top performers in 2016.
Who might this year’s winners be? It’s early of course, but we can look to fourth-quarter returns for some guidance as to which partnerships had momentum at the end of last year. Bear in mind that it was an abysmal quarter for most MLPs.
- Q4 2015 Return = Q4 2015 equity return including distributions
- EV = Enterprise value in millions as of Jan. 11, 2016
- EBITDA = Earnings before interest, tax, depreciation and amortization for the trailing 12 months (TTM), in millions
- Debt/EBITDA = Net debt at the end of the most recently reported fiscal quarter divided by TTM EBITDA
- FCF = Levered free cash flow for the most recent fiscal quarter, in millions
- Yield = Annualized yield based on the most recent quarter’s distribution
Note that 8Point3 Energy Partners (NASDAQ: CAFD) conducted its IPO in June, so its data is only for part of a year. Also, note that its data is for Q2, while the rest of the list which shows Q3 free cash flow.
Three of the companies on the list — CAFD, Enviva Partners (NYSE: EVA), and Green Plains Partners (NASDAQ: GPP) are all involved in renewable energy and are thus likely to benefit from rules adopted late in 2015. This includes not only the spending bill that extended tax credits for renewable energy last month, but also the Environmental Protection Agency’s decision to raise quotas for ethanol that must be blended into the gasoline supply above previously proposed volumes.
The other pattern is that several of the standouts are high-growth partnerships with well-capitalized sponsors. This category includes Shell Midstream Partners (NYSE: SHLX), Phillips 66 Partners (NYSE: PSXP), Columbia Pipeline Partners (NYSE: CPPL), Antero Midstream Partners (NYSE: AM) and Spectra Energy Partners (NYSE: SEP).
Of the group, SHLX and PSXP are the most expensive, but they clearly benefit from their sponsor’s name recognition and large inventory of assets that can be sold to the affiliated MLP.
The worst performers in Q4 were the beaten-down oil and gas producing partnerships. Those that manage to stay solvent should rebound as oil prices recover, but there is still significant downside risk in the group. Bankruptcy may loom for some. As always we will attempt to identify momentum shifts in MLP Profits this year as we strive to stock the portfolios with 2016’s big winners.
Shale Not Out of Bullets in Price War
This isn’t news specific to a portfolio recommendation, but rather something relevant to most of them. The latest U.S. Energy Information Forecast issued on Jan. 12 predicts a 7.4% drop in U.S. crude production in 2016, Natural gas production, meanwhile, is expected to increase 0.7%.
Why isn’t domestic oil and gas production dropping faster despite the well known tendency of shale wells to suffer big production drop-offs after the first year? Mainly because the supply of capital available to the producers hasn’t really dried up, and the most efficient drillers haven’t stopped doing their thing.
Notably, Pioneer Natural Resources (NYSE: PXD) said last week it’s aiming to increase its output by 10-15% in 2016. Pioneer is benefiting from prolific Permian Basin wells its says are delivering a 30% internal rate of return at current prices, as well as the foresight to hedge the bulk of this year’s expected crude output at an effective price of more than $50 a barrel.
Production gains are a big factor in the formula used to award management incentives. Investors have also incentivized growth, noted the CEO, telling The Wall Street Journal that “[competitors] that announced production declines into 2016, their stocks are getting hammered.”
In contrast, Pioneer’s stock is down just 17% over the last year despite last week’s $1.4 billion equity sale, which diluted prior shareholders by at least 8%. The money raised will cover a little over half of this year’s budgeted capital spending.
The availability of so much equity capital on relatively favorable terms is bad news for the endangered species of crude bulls but a welcome development for the midstream sector that needs the U.S. oil and gas to keep flowing.
Besides the prospect of pipeline flows drying up, the other bogeyman for midstream investors has been the threat of distribution cuts necessitated by financing shortfalls for expansion projects. But two master limited partnerships this week locked down their 2016 fundraising without resorting to equity sales that no longer make economic sense given their double-digit yields.
Plains All American (NYSE: PAA) said it has satisfied its “equity financing needs for all of 2016 and, in all material respects, all of 2017” by means of a convertible preferred placement. The securities pay annual interest of 8% and can be converted into PAA units after two years at a 33% premium to the current price.
In a related development, PAA announced a quarterly distribution matching the prior quarter’s payout. The preferred issue largely takes off the table the risk of a cut to a distribution currently yielding 14%.
Meanwhile, Oneok Partners (NYSE: OKS) said this week it’s met all its 2016 funding needs with a $1 billion three-year unsecured floating-rate loan tied to its credit rating and the London Interbank Offered Rate. The current annual finance charge is a very reasonable 2.73%. This arrangement looks like a slam dunk versus the option of issuing more equity with a current yield of more than 12%.
So the decently capitalized large-cap drillers and the big pipeline owners don’t seem to be having much trouble attracting outside capital at the moment. But foreign oil exporters’ budget deficits continue to grow. Don’t count out shale in this price war just yet.
— Igor Greenwald