Down Is Up, Up Is Down
Lately, I feel like I’m living in Bizarro World. That’s because I’ve been watching otherwise solid MLPs sell off while oil is hitting a two-year high.
Unlike what happened during the energy crash, I think the decline in the MLP space this year has been unwarranted. MLP executives are clearly perplexed by this action as well.
And it’s crazy that some longtime favorites are almost back to where they were when oil bottomed at $26 per barrel in early 2016.
That doesn’t make a whole lot of sense when things are better now than they were then from both a macro- and company-level standpoint.
I’ve considered a number of different factors that may be driving this action. But there’s really no obvious answer.
At first, I thought this action might be due to the three major hurricanes that disrupted many of the major MLPs’ Gulf Coast and Caribbean operations.
But third-quarter results revealed that they didn’t have as much of an impact on cash flows and maintenance spending as had been feared.
There’s also been speculation that uncertainty surrounding corporate tax reform might be weighing on MLPs’ unit prices.
It’s possible that some of the proposals could lower investor demand for MLPs. But from an operational standpoint, the policies Congress is considering appear to be a mild positive for the midstream space.
And the market could be jittery about the upcoming OPEC meeting on Nov. 30. The oil-producing cartel is poised to decide whether to extend its production cuts through the end of next year.
Certainly, the fact that the International Energy Agency lowered its forecast for global demand growth next year gave OPEC a kick in the pants.
Indeed, this time around, OPEC and most of the 10 non-members that are party to the agreement are inclined to vote in favor of an extension. The one non-member that’s been balking is Russia.
With investors expecting production cuts to continue through the end of 2018, anything less than that could cause a short-term tumble in crude prices.
The Smart Money Won’t Pay Retail
More recently, however, another potential factor has started to get attention. During the energy crash, many retail investors abandoned MLPs, and now institutional investors have a bigger presence in the space than they did previously.
The Smart Money is more demanding in some ways than retail investors. For instance, they’re less enamored of distribution growth at all costs, especially when it comes in tandem with dilutive equity issuances. And they’re more interested in seeing midstream operators get their financial houses in order.
Interestingly, one of midstream MLPs’ main Canadian peers is not having this experience. Although it’s organized as a corporation, TransCanada Corp. (NYSE: TRP, TSX: TRP) is a midstream pipeline company with similar financial and reporting characteristics as its U.S. MLP peers.
But as this chart shows, its stock has mostly treaded water this year.
Although TransCanada sold off during the energy crash, its stock also showed far greater resilience than MLPs during that time too.
While plenty of U.S. investors hold shares of TransCanada, I suspect its relative outperformance is due to the fortitude of its Canadian investor base. Perhaps, despite their veneer of politesse, Canadians are a lot tougher in some ways than we are.
Anyway, I think the MLP space should be trading more in line with TransCanada’s performance than what has happened in actuality.
Regardless of the reason, the MLP selloff is not based on fundamentals. And that makes us comfortable continuing to hold them.