September brought energy market volatility that carried over to midstream equity prices. During the month, midstream sector participants continued placing growth projects into place, while also finding creative ways to reduce capital expenditure requirements. Bond investors have taken notice, but equity valuations continued to lag likely due to lackluster fund flows.
MLP market overview
Midstream MLPs, as measured by the Alerian MLP Index (AMZ), ended September down 13.6% on a price basis and once distributions are considered. The AMZ results underperformed the S&P 500 Index’s 3.8% total return loss for the month. The best performing midstream subsector for September was the Propane group, while the Gathering and Processing subsector underperformed, on average.
For the year through September, the AMZ is down 50.5% on a price basis, resulting in a 46.2% total return loss. This compares to the S&P 500 Index’s 4.1% and 5.6% price and total returns, respectively. The Propane group has produced the best average total return year-to-date, while the Gathering and Processing subsector has lagged.
MLP yield spreads, as measured by the AMZ yield relative to the 10-Year U.S. Treasury Bond, widened by 219 basis points (bps) over the month, exiting the period at 1,410 bps. This compares to the trailing five-year average spread of 665 bps and the average spread since 2000 of approximately 412 bps. The AMZ indicated distribution yield at month-end was 14.8%.
Midstream MLPs and affiliates raised no new marketed equity (common or preferred, excluding at-the-market programs) and $3.0 billion of debt during the month. No new asset acquisitions were announced in September.
Spot West Texas Intermediate (WTI) crude oil exited the month at $40.22 per barrel, down 5.6% over the period and 25.6% lower year-over-year. Spot natural gas prices ended September at $1.63 per million British thermal units (MMbtu), down 29.1% over the month and 31.2% lower than September 2019. Natural gas liquids (NGL) pricing at Mont Belvieu exited the month at $19.02 per barrel, 5.0% lower than the end of August and 3.8% lower than the year-ago period.
EPD does more with the same. Enterprise Products Partners (NYSE: EPD) cancelled its plans for the Midland to ECHO 4 (M2E4) crude oil pipeline project, noting they will be able to meet existing customer commitments on M2E4 by moving those volumes to other EPD crude oil pipelines lines. The cancellation of M2E4 will reduce aggregate growth capital expenditures for 2020, 2021 and 2022 by approximately $800 million.
WES and OXY trade debt for equity. Western Midstream (NYSE: WES) announced the exchange of its interest in a $260.0 million, 6.5% fixed-rate receivable from its sponsor, Occidental Petroleum Corporation (NYSE: OXY), for 27.9 million WES common units owned by OXY. Following the completion of the exchange, WES cancelled the common units acquired.
ET Completes Lone Star Express Expansion. Energy Transfer (NYSE: ET) announced the completion of its Lone Star Express Pipeline expansion project, adding over 400,000 barrels per day of natural gas liquids (NGLs) capacity to Energy Transfer’s existing Lone Star NGL pipeline system in Texas. The new pipeline originates in west Texas and connects into the existing Lone Star Express pipeline south of Fort Worth and provides shippers additional connectivity out of the Permian and Delaware basins. The Lone Star pipeline system ultimately connects into Energy Transfer’s Mont Belvieu facility, an integrated liquids storage and fractionation facility along the U.S. Gulf Coast with strategic connectivity to over 35 petrochemical plants, refineries, fractionators and third-party pipelines. Energy Transfer’s seventh fractionator at Mont Belvieu was brought online earlier this year, bringing the partnership’s total fractionation capacity to more than 900,000 barrels per day.
Chart of the month: bond investors appear to view Midstream more positively than equity investors
Bond market investors appear to be expressing a more positive view on the midstream energy outlook than the equity markets. The chart of the month plots the midstream price-to-discretionary cash flow multiple (P/DCF), a comparison of the stock price to the cash flow generated from the business after reserving capital to maintain the assets in place, and the bond market yield spreads for midstream companies with ratings considered investment grade and those considered sub-investment grade or “high yield”.
At month-end, midstream equities were trading at approximately 3.8 times discretionary cash flow (DCF), a substantial (63%) discount to the long-term average multiple of approximately 10.5 times DCF. However, the yield spread between investment grade midstream bonds and the 10-year treasury bond is currently at approximately 250 basis points compared to the long-term average of approximately 203 basis points and near the normalized longer-term pricing bands. The yield spread between high yield midstream bonds and the 10-year treasury bond was recently trading at approximately 586 basis points compared to the long-term average of approximately 400 basis points, outside the normalized longer-term pricing bands, but much less punitive than the equity price valuation dislocation seen via P/DCF and other commonly used valuation methods.
Highlighting this bond/equity valuation dislocation via proxy, in September NuStar Energy (NYSE: NS), a high-yield rated midstream partnership, issued $600 million of bonds due in 2025 at a 5.75% yield and $600 million of bonds due in 2030 at 6.375% while its equity units trade with a 15% yield and expected distribution coverage in 2021 of approximately 1.9x. Further, in August, MPLX, LP (NYSE: MPLX), an investment grade rated midstream partnership issued $1.5 billion of bonds due in 2026 with a yield of just 1.75% and $1.5 billion of bonds due in 2030 at a yield of 2.65%. MPLX’s equity units are currently trading with a distribution yield of approximately 17% and the partnership is expected to produce DCF in 2021 that covers its distribution by approximately 1.3x.
As of 9/30/2020, Energy Transfer LP held a 13.91%, 13.79%, 12.47% and 4.98% weight in Invesco SteelPath MLP Alpha, Alpha Plus, Income and Select 40 Funds, respectively.
As of 9/30/2020, Enterprise Products Partners held a 13.58%, 13.53%, 0.00% and 5.06 % weight in Invesco SteelPath MLP Alpha, Alpha Plus, Income and Select 40 Funds, respectively.
As of 9/30/2020, MPLX LP held a 11.86%, 11.24%, 12.50% and 6.91% weight in Invesco SteelPath MLP Alpha, Alpha Plus, Income and Select 40 Funds, respectively.
As of 9/30/2020, NuStar Energy LP held a 0.00%, 0.00%, 3.82% and 4.30% weight in Invesco SteelPath MLP Alpha, Alpha Plus, Income and Select 40 Funds, respectively.
As of 9/30/2020, Western Midstream Partners LP held a 1.82%, 1.79%, 7.60% and 3.35% weight in Invesco SteelPath MLP Alpha, Alpha Plus, Income and Select 40 Funds, respectively.
No SteelPath mutual fund held Occidental Petroleum Corporation as of 9/30/2020.
Source: All data sourced from Bloomberg as of 9/30/2020 unless otherwise stated.
The opinions referenced above are those of the author as of October 2, 2020. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
The mention of specific companies, industries, sectors, or issuers does not constitute a recommendation by Invesco Distributors, Inc. A list of the top 10 holdings of each fund can be found by visiting invesco.com.
The S&P 500 Index is a stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States.
The Alerian MLP Index is a float-adjusted, capitalization-weighted index measuring master limited partnerships, whose constituents represent approximately 85% of total float-adjusted market capitalization. Indices are unmanaged and cannot be purchased directly by investors.
Index performance is shown for illustrative purposes only and does not predict or depict the performance of any investment. An investment cannot be made into an index. Past performance does not guarantee future results
A yield spread is the difference between yields on differing debt instruments of varying maturities, credit ratings, issuer, or risk level, calculated by deducting the yield of one instrument from the other.
Most MLPs operate in the energy sector and are subject to the risks generally applicable to companies in that sector, including commodity pricing risk, supply and demand risk, depletion risk and exploration risk. MLPs are also subject the risk that regulatory or legislative changes could eliminate the tax benefits enjoyed by MLPs which could have a negative impact on the after-tax income available for distribution by the MLPs and/or the value of the portfolio’s investments. Although the characteristics of MLPs closely resemble a traditional limited partnership, a major difference is that MLPs may trade on a public exchange or in the over-the-counter market. Although this provides a certain amount of liquidity, MLP interests may be less liquid and subject to more abrupt or erratic price movements than conventional publicly traded securities. The risks of investing in an MLP are similar to those of investing in a partnership and include more flexible governance structures, which could result in less protection for investors than investments in a corporation. MLPs are generally considered interest-rate sensitive investments. During periods of interest rate volatility, these investments may not provide attractive returns.
Energy infrastructure MLPs are subject to a variety of industry specific risk factors that may adversely affect their business or operations, including those due to commodity production, volumes, commodity prices, weather conditions, terrorist attacks, etc. They are also subject to significant federal, state and local government regulation.
The opinions expressed are those of Invesco SteelPath, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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