I don’t want to exaggerate…
But it does seem to happen every year: the MLP sector – Master Limited Partnerships – wraps itself up as a wonderful Christmas present for investors to open in the New Year.
Ok, not every year.
But almost every year… investors buying the sector after heavy selling near the ends of 2015, 2017 and 2018 all had profits of 20% within the first six months of the next year (excluding dividends). (1)
MLPs were built to pay out big dividends – and many of them are. But the stocks have traded down hard in H2 19 – in sympathy with the oil producers, the E&Ps, which have just been crushed.
For investors buying the MLP sector in December it has been like shooting fish in a barrel. Buy in December, sell in June – book your 20 percent profit plus dividends.
2019 is shaping up to be the fourth year out of five that this happens. After the usual first half rally in 2019, the MLP sector has fallen off a cliff in the second half.
Much of the decline has happened since the beginning of November.
Now what we need to consider…
Is the MLP sector another 20% gift waiting to be unwrapped or a big lump of coal stuffed into our stockings?
Why MLPs Are In The Doghouse Again…
Now before we get all “pound the table” excited about another MLP first-half-of-2020-rally coming our way we need to tap the breaks just a little bit…
The investor pressure on MLPs isn’t just annual tax loss selling – although that is undoubtedly a part of it. There are also real concerns that investors have raised with this sector.
First Concern – Elizabeth Warren And The Far Left
I don’t know who will win the Presidency in 2020 – but I do think the election will be much closer than it was 2016.
Energy investors are rightly concerned about left-leaning candidate Elizabeth Warren. It is not a complete coincidence that as the rise of Elizabeth Warren happened in the polls in 2019 the selling of MLPs kicked into gear.
Ms. Warren is openly hostile to anything tied to hydrocarbons. She has blatantly stated that one of her first acts as president would be to ban fracking entirely, while also doubling down to ban all drilling on Federal lands.
That would unquestionably be great for oil and natural gas prices, but terrible for the volumes of the stuff that is being transported through pipelines owned by mid-stream MLPs.
Second Concern – An Increasing View That
The Energy Sector Is Uninvestable
There is a growing belief amongst professional investors that the energy sector has become uninvestable. These folks aren’t reducing their energy sector exposure… they are cutting it to zero.
More than 1,000 different pension funds, endowments and institutions representing $8 trillion of assets have officially declared the sector off-limits. (2)
Those are the capital allocators who have chosen to this for the betterment of the planet – that doesn’t factor in the investment managers who have abandoned the sector for investment performance reasons.
Many managers think this industry has no future.
The feeling from many corners is that we are nearing the end of the age of oil – that a replacement energy source is near at hand. If you buy that view – the implication for midstream assets is that they will become worthless because there is nothing going through them (think of all the LNG import terminals that were built right before shale gas hit it big).
In addition to professional investors seeing green (as in a new era of energy) they are also seeing red… as in the color of their portfolio if they had exposure to shale producers.
It is very hard for a sector to go anywhere but down if there is no interest from the people in charge of allocating hundreds of billions of institutional dollars.
Third Concern – Getting Pipelines Approved
in the USA Is Too Easy!
Oh, the irony…
While Canadian mid-stream companies can’t get a pipeline approved to save their lives – their stock prices are doing great.
Meanwhile south of the border mid-stream companies are having great success getting pipelines approved – in fact far too much success. A surplus of pipeline space is emerging.
Even in the Permian where production has soared there is talk of overcapacity… who would have seen that coming? And now investors are concerned that will lower toll rates and dividends for these US midstream MLPs.
Between EPIC Midstream, Plains All American (PAA:NYSE) and Phillips 66 Partners (PSXP:NYSE) there will be 2.5 million barrels of new pipelines moving oil from West Texas to the Gulf Coast that have been added in the second half of 2019. (3)
Toll rates for oil transport on these lines have come in below expectations, and this is before the impact of a mass reduction of Permian drilling hits production levels.
Typically rates for most Permian pipelines had been ranging from between $4 and $7 per barrel over the past year – but (as reported by Reuters) EPIC just cut its spot rate on its new Permian pipeline to $2.50 because it was more in line with market conditions.
Those rate cuts directly hit cash flow for EPIC and competitors.
That Sound Is Music To Contrarian Ears….
I have to admit, when I hear talk that includes words like “uninvestable” I get more than a little interested.
And not for a second do I buy into the idea that we are anywhere close to the point where global hydrocarbon demand is about to roll over.
I’m excited about the money that can be made investing in renewables in the coming years – but oil and gas will continue to power the developed world for decades.
As to whether it is time to buy MLP operators… unquestionably the MLP sector is about as cheap as it has ever been.
And of course the yields on these stocks are huge right now. The Alerian MLP Index (AMLP) alone is over 10% today – in a world where finding yield is virtually impossible.
How often can you get a 10% yield from a diversified basket of the best operators in a given sector… there is clearly a lot of really bad news priced in here.
Will history repeat itself yet again in 2020 with an MLP rally? Or will the sector be giving investors a lump of coal. I’ll revisit this thesis in May 2020.