Source: Pioneer Natural Resources 2Q Earnings Presentation
The strategy shift upstream has multifaceted implications for midstream. For one, more modest production growth could be supportive of the ongoing recovery in oil prices. Despite fee-based businesses and significant exposure to natural gas, midstream tends to trade more in line with oil prices than seems justified, and oil prices drive sentiment. A more stable oil price helped by producer discipline could be more conducive for midstream equities than higher volumes. Furthermore, improvements by E&Ps may bring more interest to energy in general, which has been largely overlooked as a sector given its 2.5% weighting in the S&P 500 as of July 31. That could potentially extend to greater investor interest in midstream as well. More moderate production growth or maintaining production may seem negative for midstream volumes, but prior to COVID-19 and the collapse in oil prices, US production growth was already expected to moderate. While US production is likely to respond to the price environment with some lag, large producers limiting growth likely helps avoid US production overshooting to the detriment of oil prices in a higher price environment.
What about the election?
The election was a common topic of questions on earnings calls across the energy sector. Several management teams pointed out a disconnect between campaign rhetoric and what can actually be achieved. A broad comment from an executive at Valero (VLO) was that the elected administration will be dealing with a COVID recovery economy, and energy will be needed to drive the economy. EPD management said tax rates look poised to increase for individuals and companies. That outlook and a focus on execution in a challenging environment has put an MLP vs. C-Corp analysis on the back burner, with management expressing contentment with their MLP structure. For E&Ps, commentary focused more on Vice President Biden’s opposition to new drilling permits for federal lands and waters and the ability to navigate changing regulations, including stockpiling federal permits now.
Renewables also discussed more frequently.
Even before BP’s (BP) significant strategic announcement on August 4 outlining its path towards net-zero emissions, renewables were a topic of Q&A on midstream calls. On its August 1 quarterly call, the management of WMB discussed investing $200-400 million in solar projects in the coming years. WMB also discussed sourcing renewable gas and eventual opportunities around hydrogen in addressing a question. TC Energy (TRP) similarly mentioned that hydrogen could be blended with methane flowing through its pipes and left commingled or extracted at the other end of the pipeline in response to a question. TRP is also working on two pumped storage projects. Enbridge (ENB), which has an existing renewables footprint (read more), talked about being well positioned if hydrogen becomes an energy solution decades from now. ENB also noted opportunities in US wind but cited challenges such as a less developed regulatory environment and supply chain. While most tend to focus on the threat of the upcoming energy transition (including Alerian), it is important to note that there are opportunities as well.
Earnings season was particularly eventful this quarter for midstream and broader energy. Operational outlooks were in focus as the macro recovery continues, but renewables and the election were also key topics. While the shift away from growth at any cost for oil and gas producers could seem negative on the surface for midstream, the potential for a more stable oil price helped by producer discipline and the possibility of attracting investors back to energy in general could result in a net positive for midstream.