VettaFi recently sat down with Raymond James analyst J.R. Weston to discuss the outlook for energy commodities and the midstream space. During the interview, Weston offered his take on overlooked midstream investment opportunities, as well as his current top picks.
VettaFi: What’s your outlook for oil and natural gas prices this year?
J.R. Weston, associate analyst, Raymond James: We have a pretty rangebound forecast for oil. Our full-year average forecast for 2024 is $75 per barrel (bbl) for WTI. With WTI averaging $78/bbl in 2023, we see WTI pretty flat year over year. For 2025 and beyond, we’re at $80/bbl. Oil markets are still at the mercy of OPEC. For natural gas, we’re forecasting $3.25 per million British thermal unit (MMBtu) for 2024 and $4.50/MMBtu for 2025.
We are a little bit more negative on natural gas supply growth than some others, so that tightens the market all else equal. We think the sentiment for natural gas prices is just far too negative. I think people are choosing to take a negative read on how LNG will impact the market. It does seem like Plaquemines, potentially Golden Pass, and then probably the Cheniere expansion will all actually tie into physical markets in late 2024. Potentially Golden Pass lags out of those three, but at least two of the three should be tightening the market. Meanwhile, LNG facilities are already running at highs relative to 2023 levels, and with less downtime this year, that should also increase the average natural gas input for LNG export facilities in 2024.
Finally, we’re pretty optimistic about natural gas demand from power generation. We think coal is probably poised to lose a good amount of market share here, and what we’ve seen over the last couple of years is that renewables really can’t soak all of that up. And in some cases, renewables are even spurring natural gas demand growth in the power generation space. So, we think gas competes really well there. Between those three things, we have a gas price forecast above the futures strip.
VettaFi: What is your outlook for the midstream/MLP space this year?
Weston: There are some challenges up front, but there are still ways for midstream to win. With more moderate production growth, the supply push may be slightly worse than consensus estimates imply, and that’s not great for earnings power. If you’re in an environment where crude prices are pretty flat throughout the year, then you’re probably not going to see natural gas liquid (NGL) prices do anything too heroic either. On the margins, that impacts earnings power, too. There’s some natural gas price exposure that could be a slight tailwind, but the combination of the high-level macro items, namely the supply and commodity price exposure, is not the best outlook overall.
That said, earnings growth is not going to be zero. The Permian is going to give you growth. The Bakken will provide some gas and NGL growth. One of the things that’s underappreciated is just the disconnect between oil supply trends and NGL supply trends with a shifting mix in natural gas and oil production.
NGLs should have pretty nice supply tailwinds. And so that’s helpful for midstream companies in the NGL logistics space. You’ve probably got some rate tailwinds still on the regulated side, both with liquids pipelines and with natural gas pipeline rate cases.
The Outlook for Midstream Remains Constructive
I think the rest of the picture is all fine. Overall, EBITDA growth will happen, but it’s maybe not massive. The nice thing is that if supply growth is a little slower, then capex does moderate. I think 2025 is the big year for capex to move lower, but on the whole, it should be down a little bit in 2024. So the net impact is larger free cash flow generation. And because we’ve seen at least three or four years of solid free cash flow generation, more and more of that free cash flow can be returned to shareholders and unit-holders. I think it’s a really nice year for that.
Recent examples include EnLink and ONEOK, which increased their quarterly payouts and announced buyback authorizations. In general, that’s a trend that we expect to see more and more of for midstream.
Finally, we’re still at least a turn below historical valuations on an EV/EBITDA basis. Performance in this space has been okay, but it’s mostly been paired with pretty good financial model improvements as well. This is not a space that looks expensive at all on a historical basis. Then in a lower rate environment, the yield that midstream provides probably looks more attractive, too. Taking that all together, there’s some decent earnings growth, better free cash flow growth, and returns to shareholders, and the entry-level price here is not anything outlandish. I think it’s a pretty good outlook, especially within the energy sector. I think midstream competes pretty well with other energy sub-sectors in a range-bound crude oil price environment.
VettaFi: What are you watching for this earnings season?
Weston: There are multiple items that have been topical with investors in recent conversations. One is 2024 guidance, and for a few companies, guideposts for 2025. That’s been incredibly topical even going back to December.
On a more fundamental basis, I would look at the potential impacts of the weather that we’ve just had. It’s probably a 1Q24 earnings item, but we’ll definitely hear some color around potential impacts. For the fourth quarter itself, you have your typical seasonal upside, but you should also have the benefit of some of the upstream headwinds from hot weather in 2Q and 3Q improving. Also, it was a pretty moderate weather quarter up north. Bakken activity should be pretty good relative to a typical 4Q. That setup overall is pretty good. The marketing side of the business could see a lot of seasonal upside. I don’t know that it’s a home run quarter for marketing but could be decent.
There’s also been a lot of focus on gas names — when you can start to play the upside that LNG might cause and just how to think about the timing. There’s still a little bit more work to do for last-mile logistics for NGLs and LNG. I think the gas sourcing for LNG is something that is going to be an issue, and it’s only in 2025 that we’ll start to see a little bit more discussion of that. It should be an interesting quarter with obviously a lot of annual updates and people looking to 2024 and even 2025.
VettaFi: Great. What are some investment opportunities or areas you think are currently being either overlooked or perhaps misunderstood?
Weston: I touched on one earlier for NGLs, with the supply dynamics separate from oil and gas. I still feel like that’s a little bit under-appreciated. We certainly need more NGL logistics solutions, so there should be decent earnings opportunities around that. I think if things play out a certain way and supplying gas to LNG facilities becomes a big concern, then that could benefit some basins beyond the Permian and Haynesville.
If you start looking at some of the other areas that can be influenced by gas prices, you think about the Eagle Ford or the Mid-Continent. Those may be areas where you see a rate of change in 2025 or beyond. In the long term, I’ve been having a lot of conversations about industrial activity and reshoring. That helps in the Mississippi River Corridor, but I think the most interesting place for that if it is to develop, would be more opportunities up in Appalachia. If you have natural gas demand growth from industries in Appalachia, then the pipeline takeaway capacity constraint issue goes away to a degree, and you can get a little bit more value out of Appalachia than might otherwise be appreciated right now.
Another one is the opportunity for long-haul natural gas pipeline operators to contract more with utility customers who may struggle to meet demand on peak days.
VettaFi: What midstream companies are your top picks right now?
Weston: Our ratings category named “Strong Buy” is the highest in our hierarchy. On the C-Corp side, that group includes Cheniere (LNG) and Targa Resources (TRGP). We also have a strong buy on Plains (PAA/PAGP).
We still like Energy Transfer (ET) and Enterprise Products Partners (EPD). The common theme here is that in a year where earnings power is a little bit more muted you probably want to have the integrated players that have more ways to try to make money, whether it’s marketing or competing for market share. In that group, there’s ET, EPD, and TRGP. And then Cheniere resonates with generalist investors the best. LNG is the most well-known theme, and Cheniere is really a pure play on it. That’s a little easier to understand for generalists. Those are the top picks in the group.
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