MLP Market Overview1
MLPs, as measured by the Alerian MLP Index (AMZ), ended August down 2.3% on a price basis, and 1.3% once distributions are considered. The AMZ results underperformed the S&P 500 Index’s 0.1% total return for the month. The best performing MLP subsector for August was the Coal group, while partnerships focused on Gathering and Processing generated the weakest returns, on average.
For the year through August, the AMZ is up 7.0% on a price basis, resulting in a 13.8% gain on a total return basis. This compares to the S&P 500 Index’s 6.2% and 7.8% price and total returns, respectively. The Coal group has produced the best average total return year-to-date, while the Upstream subsector has lagged.
MLP yield spreads, as measured by the AMZ yield relative to the 10-Year U.S. Treasury Bond, widened by 2 basis points (bps) over the month, exiting the period at 576 bps. This compares to a trailing five-year average spread of 413 bps and the average spread since 2000, adjusted for the financial crisis period, of approximately 329 bps. The AMZ indicated distribution rate at month-end was 7.4%.
Midstream MLPs and affiliates raised $0.8 billion of marketed new equity (common and preferred, excluding at-the-market programs) and $0.4 billion of marketed debt during the month. MLPs and affiliates announced approximately $0.8 million of asset acquisitions during August.
Spot West Texas Intermediate (WTI) crude oil exited the month at $44.70 per barrel, up 8% over the period and 9% lower year-over-year. Spot natural gas prices ended August at $2.94 per million British thermal units (MMbtu), flat month-over-month and 10% higher than August 2015. Natural gas liquids (NGL) pricing at Mont Belvieu exited the month at $18.67 per barrel, 4% higher than the end of July and 1% lower than the year-ago period.
Earnings Season Summary. Second-quarter reporting season effectively concluded in August. Through month-end, 81 midstream entities had announced distributions for the quarter, including 32 distribution increases, 48 distributions that were unchanged from the first quarter, and one distribution reduction. Through the end of August, 81 sector participants had reported second-quarter financial results. Operating performance has been, on average, better than expectations with market-cap-weighted EBITDA, or Earnings Before Interest, Taxes, Depreciation and Amortization, coming in 1.8% above consensus estimates, 2.1% lower than the prior quarter’s results, and 11.3% higher than the year-ago period.
DAPL Secures Project Financing and Welcomes New Partners. After receiving Army Corps of Engineers approvals in July, the partners of the Dakota Access Pipeline (DAPL) and Energy Transfer Crude Oil Pipeline (ETCOP) completed project-level financing via a $2.5 billion facility that is anticipated to provide substantially all of the remaining capital necessary to complete the projects. Concurrently, Energy Transfer Partners (NYSE: ETP) and Sunoco Logistics Partners (NYSE: SXL) announced an agreement to sell 36.75% of the Bakken Pipeline Project, which includes the DAPL and ETCOP, to MarEn Bakken Company LLC (MarEn), an entity jointly owned by Enbridge Energy Partners (NYSE: EEP) and Marathon Petroleum Corporation (NYSE: MPC), for $2 billion in cash.
Subsequent to the close of the transaction, ownership of the project will consist of ETP/SXL: 38.25%, MarEn: 36.75% and Phillips 66 (NYSE: PSX): 25%. ETP continues to oversee construction of the pipeline, which is expected to be ready for service at the end of this year. Once in operation, SXL will be the operator.
ENLK Enters Delaware Basin Joint Venture. EnLink Midstream (NYSE: ENLK) and private equity firm Natural Gas Partners (NGP) entered a joint venture to expand natural gas gathering and processing activity in the Delaware Basin. ENLK will contribute an existing gathering system and processing facility, while NGP contributes cash. Together, the partners committed to jointly fund $570 million of future development projects and potential acquisitions, including the Lobo II project that is expected to consist of a cryogenic natural gas processing facility and associated natural gas and liquids gathering pipeline infrastructure in Loving County, Texas, and Eddy and Lea counties, New Mexico.
Thought of the Month
While last month we weighed-in on conflicts of interest that can arise between the General Partner (GP) and Limited Partners (LPs) due to the incentive distribution rights (IDR), this month we highlight evidence of a GP supporting its LPs using the Williams family of companies as an example. Further, we provide a summary of recent Williams company developments, including additional deleveraging progress, a significant reduction to Chesapeake’s (NYSE: CHK) customer concentration, and ongoing board of directors drama.
In early August, in conjunction with both entities’ financial reports, The Williams Companies (NYSE: WMB) and Williams Partners (NYSE: WPZ) announced immediate measures designed to enhance value, strengthen credit profiles, and fund growth CapEx at WPZ. Specifically, WMB plans to reinvest $500 million into WPZ during 2016, including $250 million via a private purchase of common units that was executed in August and with the balance in the fourth quarter via a concurrently announced distribution reinvestment program (DRIP). WMB expects to reinvest an additional $1.2 billion in 2017 via the DRIP. As WMB will be reinvesting the cash flow received via its WPZ holdings, WMB reduced its own dividend payout by 75%.
Subsequent to the companies’ earnings reports and CapEx support initiatives, WMB and WPZ announced an agreement to sell the companies’ Canadian business to InterPipeline (TSX: IPL) for approximately $1 billion. In connection with the sale, WMB agreed to waive $150 million of incentive distribution rights in the quarter following closing in recognition of the value of inter-company contracts. After taking into account this waiver, WPZ will receive net consideration of $817 million and WMB will receive net consideration of $209 million.
Later in August, WPZ and CHK announced a series of agreements that effectively lowered the partnership’s exposure to CHK from 18% of revenue to 15%, but more importantly eliminated the single largest underutilized minimum volume commitment (MVC) in WPZ’s portfolio and, we estimate, reduced overall WPZ’s MVC under-delivery by approximately 75% to 80%. This is important because, as noted in our February blog Bankrupt Producers and Midstream Commitments: The Basics, MVCs are among the types of midstream contracts most at risk for rejection by bankruptcy courts. CHK agreed to convey its Barnett shale assets to Saddle Resources and WPZ announced plans to execute a new Barnett Shale gas gathering agreement with Saddle Resources. Further, WPZ agreed to terminate CHK’s existing minimum volume commitments to WPZ in both the Barnett shale and the Mid-continent region. Taken together, WPZ will receive $820 million in up-front cash to offset reduced annual cash flow from 2016 to 2019 of approximately $240 million. However, the new Barnett shale gathering agreement with Saddle Resources includes commitments for $40 million of drilling annually through 2018 and commodity-linked gathering rates that together should reinvigorate activity and potentially increase volumes on the system.
Finally, in mid-August, WMB announced plans to appoint three new independent directors to its board of directors following several recent director resignations associated with the company’s failed merger with Energy Transfer. This announcement was followed by noise from one of the former WMB board members, an institutional investor, who proposed a non-defined slate of new board members, to be chosen in the future. However, WMB was quick to select three well qualified directors, including the former CEO of one of the largest independent oil and natural gas producers in the U.S., a former midstream CEO, and the CEO of a large energy and utility holding company. We believe these new directors will complement the existing board members well, and we welcome a board of directors more focused on running the company than one populated with hedge fund managers looking to flip the company.
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1 Source: Bloomberg.
The mention of specific companies does not constitute a recommendation by OppenheimerFunds, Inc. Certain Oppenheimer funds may hold the securities of the companies mentioned.
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. The S&P 500 Index is a broad-based measure of domestic stock market performance. 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. Past performance does not guarantee future results.
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. Diversification does not guarantee profit or protect against loss.
The Oppenheimer SteelPath MLP Funds are subject to certain MLP tax risks. An investment in an Oppenheimer SteelPath MLP Fund does not offer the same tax benefits of a direct investment in an MLP. The Funds are organized as Subchapter “C” Corporations and are subject to U.S. federal income tax on taxable income at the corporate tax rate (currently as high as 35%) as well as state and local income taxes. The potential tax benefit of investing in MLPs depends on them being treated as partnerships for federal income tax purposes. If the MLP is deemed to be a corporation, its income would be subject to federal taxation at the entity level, reducing the amount of cash available for distribution which could result in a reduction of the fund’s value. MLP funds accrue deferred income taxes for future tax liabilities associated with the portion of MLP distributions considered to be a tax-deferred return of capital and for any net operating gains as well as capital appreciation of its investments. This deferred tax liability is reflected in the daily NAV and as a result a MLP fund’s after-tax performance could differ significantly from the underlying assets even if the pre-tax performance is closely tracked.
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