For the year through June, the AMZ is down 4.4% on a price basis, resulting in a 0.6% total return loss. This compares to the S&P 500 Index’s 1.7% and 2.6% price and total return, respectively. The Upstream group has produced the best average total return year-to-date, while the Natural Gas Pipeline subsector has lagged.
MLP yield spreads, as measured by the AMZ yield relative to the 10-Year U.S. Treasury Bond, widened by eight basis points (bps) over the month, exiting the period at 528 bps. This compares to the trailing five-year average spread of 474 bps and the average spread since 2000 of approximately 366 bps. The AMZ indicated distribution yield at month-end was 8.1%.
Midstream MLPs and affiliates raised $0.6 billion of marketed new equity (common and preferred, excluding at-the-market programs) and $6.8 billion of marketed debt during the month. MLPs and affiliates announced no asset acquisitions during June.
Spot West Texas Intermediate (WTI) crude oil exited the month at $74.15 per barrel, up 10.6% over the period and 61.1% higher year-over-year. Spot natural gas prices ended June at $2.97 per million British thermal units (MMbtu), up 3.6% over the month and 0.9% higher than June 2017. Natural gas liquids (NGL) pricing at Mont Belvieu exited the month at $35.74 per barrel, 0.9% higher than the end of May and 55.4% higher than the year-ago period.
Devon Sells Its EnLink Position to GIP. Devon Energy (NYSE: DVN) announced the sale of its aggregate ownership interests in EnLink Midstream (115 million units in the general partner, NYSE: ENLC, and 95 million units in the master limited partnership, NYSE: ENLK) to Global Infrastructure Partners, a private equity firm, for $3.125 billion. In connection with the transaction, DVN agreed to extend certain, existing, fixed-fee gathering and processing contracts with EnLink through 2029.
Enbridge Wins Line 3 Proceedings. The Minnesota Public Utility Commission granted Enbridge, Inc. (NYSE: ENB) and Enbridge Energy Partners (NYSE: EEP) a certificate of need and approved the companies’ preferred route for the Line 3 replacement project, allowing the 370 thousand barrel per day pipeline to move forward toward a planned in-service date in 2020.
FERC Commissioner Takes Private Sector Role. The Federal Energy Regulatory Commission (FERC) announced that, after only a year in the role, Commissioner Robert Powelson will step down from his post in mid-August to become president and CEO of the National Association of Water Companies, which represents the private water industry. The FERC will maintain a quorum, allowing it to proceed with decision-making, recent decisions have often split 3-2 along party lines, with Commissioner Powelson in the majority.
Thought of the Month: Half-Way Marker Review and Update
The past six months have been particularly eventful for the midstream sector. As always, we have attempted to keep our investors updated through blogs, white papers, and, most frequently, through our Thought of the Month in our monthly commentaries. Given the congested news flow year-to-date, we are pausing here, at the half-way marker, to provide a brief review and update on some of the topics we’ve covered:
Thought of the Month: Interest Rate Anxiety
Though interest rates appeared set to steadily increase in January, rates have moderated over recent weeks. Trade tensions and muted inflation data have worked to calm inflation fears and the 10-year Treasury yield now rests below 3.0%. However, within this January’s monthly commentary, we provided some historical perspective on midstream equity performance during periods of rising rates.
Thought of the Month: Simplifying Simplifications
We believe the traditional incentive distribution right (IDR) mechanism is too aggressive and allows general partners to easily avoid their implicit role as a risk absorber (also see When Incentive Distribution Rights Fail). Therefore, we applaud the retirement of the mechanism in its traditional form.
Since the publication of this Monthly, a handful of additional MLPs have announced their IDR elimination plans or their intent to address the issue soon. However, most recent announcements have resulted in much less price volatility, serving to lower investor anxiety surrounding simplifications.
White paper: What’s the Catalyst for MLPs?
In this white paper, we provided some historical perspective of previous turning points for the asset class. We noted that such turning points have only appeared obvious in retrospect but that broad investor rotation back into energy is likely a key ingredient. Specifically, at the time of writing What’s the Catalyst for MLPs?, the market-cap weighting of the energy sector within the S&P 500 Index sat at 5.7% versus an average of 10.9% since 1980 and, further, that the energy weighting had been above 5.7% for 95% of the time since 1980. Therefore, some level of rotation from this extreme level seemed plausible and likely helpful.
Today, we have begun to see some improvement with energy now representing 6.3% of the S&P 500. Further, the XLE (Energy Select Sector SPDR Fund which tracks the broad energy industry) has rebounded 12.6% since 3/31/18 and the AMZ has rebounded 9.5% over the same period. As energy market volatility normalizes we believe further rotation is possible.
This blog addressed the policy statement issued in March by the FERC which reversed a long-held policy and appeared to impact the ratemaking process for MLPs. This announcement caused significant market confusion and volatility across the sector.
Since March’s announcement, the sector as a whole has rebounded significantly. However, select industry participants with the largest portfolios of FERC-regulated assets remain impaired. Notably, the FERC has left its comment period open longer than initially planned. Accordingly, OFI SteelPath took the opportunity to formally file comments with FERC regarding its revised policy statement. We also offered solutions to assist the FERC as it considers rehearing requests for the revised policy statement.
The full document may be accessed via the FERC website at: https://elibrary.ferc.gov/idmws/file_list.asp?accession_num=20180621-5034
Thought of the Month: The Death of the MLP Structure Has Been Greatly Exaggerated
A spate of MLP acquisitions by their c-corp general partners in order to eliminate IDRs or as a defensive measure to offset an unexpected FERC policy shift, created questions around the future of the MLP structure. Besides the IDR- and FERC-driven acquisitions which have been announced, some have suggested other MLPs would eventually convert to a c-corp structure to seek a broader investor base and higher equity pricing.
In this Thought of the Month, we discussed this issue and noted our belief that a widespread conversion spree appeared unlikely. Though we consider all midstream operators for investment regardless of c-corp or MLP structure, and recently launched the SteelPath MLP & Energy Infrastructure Fund which is structured to hold no more than 25% of operators’ structure as partnerships, we note that midstream operators utilizing the MLP structure still dominate the asset class. Further, while a number of MLPs have been removed from the investable universe through acquisition, these acquisitions have not added to the universe of midstream c-corps, leaving midstream c-corp options still fairly limited.
Since this commentary, several larger MLPs have announced that although they may have considered conversion, they do not see enough benefit to offset the tax advantages found within the MLP structure.
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Investing in MLPs involves additional risks as compared to the risks of investing in common stock, including risks related to cash flow, dilution and voting rights. Each Fund’s investments are concentrated in the energy infrastructure industry with an emphasis on securities issued by MLPs, which may increase volatility. Energy infrastructure companies are subject to risks specific to the industry such as fluctuations in commodity prices, reduced volumes of natural gas or other energy commodities, environmental hazards, changes in the macroeconomic or the regulatory environment or extreme weather. MLPs may trade less frequently than larger companies due to their smaller capitalizations which may result in erratic price movement or difficulty in buying or selling. Additional management fees and other expenses are associated with investing in MLP funds. Additionally, investing in MLPs involves material income tax risks and certain other risks. Actual results, performance or events may be affected by, without limitation (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) changes in laws and regulations, and (5) changes in the policies of governments and/or regulatory authorities. Investing in MLPs may generate unrelated business taxable income (UBTI) for tax-exempt investors both during the holding period and at time of sale. Diversification does not guarantee profit or protect against loss.
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