After Years of Growth, Is Midstream Capex Peaking?

Summary //

• Midstream companies have increased capital spending to build the infrastructure assets necessary to facilitate growing energy production.
• After significant growth in spending since 2016, growth capital expenditures are expected to peak for a majority of constituents in the AMZI and AMEI in the 2018-19 timeframe.
• More moderate growth capital spending should be positive for midstream as free cash flow increases, enhancing financial flexibility.

Capital spending has been a hot topic across energy in the wake of the oil price drop in 4Q18 and in the aftermath of the broader oil downturn from 2014-2016. Investors want to see energy companies demonstrate capital discipline with the goal of achieving free cash flow and improved returns. The challenge for midstream companies continues to be balancing fiscal discipline with abundant growth opportunities. Today, we look at whether growth capital spending in midstream could be peaking and how moderating capex could be a positive for the space.

Midstream companies ramped spending to build the infrastructure needed for growing production.
With oil and natural gas production rising steeply over the past decade, energy infrastructure companies have increased capital spending to meet the need for new transportation, storage, and processing assets. The large-scale buildout of energy infrastructure over the last few years has been a direct response to increasing demand and the need to alleviate infrastructure constraints across hydrocarbons (think of Permian oil and gas pipeline bottlenecks, constraints for natural gas liquids pipelines and fractionation facilities). Production growth will likely continue as the US is expected to account for approximately 75% of the growth in global oil production to 2025 based on projections from the International Energy Agency. Furthermore, according to a report by the Interstate Natural Gas Association of America (INGAA), an estimated $463-579 billion in energy infrastructure spending will be required through 2035 in the US and Canada (read more). Midstream growth opportunities are clearly expected to remain plentiful. Notably, however, INGAA projects that midstream infrastructure spending will peak in 2019.

Are we at the peak of energy infrastructure growth capex spending?
Broadly speaking, 2018-2019 may represent the peak of energy infrastructure capex spending, as significant projects are brought online this year and into 2020. In order to understand the current context for capex spending and better evaluate if spending is peaking, we compiled the growth capex numbers for the past three years for the constituents in the Alerian MLP Infrastructure Index (AMZI) and the Alerian Midstream Energy Select Index (AMEI) as well as forward projections through 2020 based on company guidance and Bloomberg estimates. For companies without guidance, we used the median of Bloomberg estimates for growth capital spending. We caveat that 2020 guidance and estimates are subject to change as companies progress growth plans.

Looking at the historical data for the AMZI and AMEI, growth capital expenditures have ramped significantly since 2016. Nearly 80% of the AMZI and over 70% of the AMEI increased their spending over the period from 2016 to 2018, many of them substantially. About half of the constituents in the AMZI, for example, at least doubled their capex from 2016 to 2018. While some companies (especially those that are less mature) will continue to increase spending, the data suggests that most companies in the AMZI and AMEI are expected to reach peak spending in 2018 or 2019. The majority of constituents in both indices are expected to decrease spending in 2020 relative to 2019 based on company guidance and median growth capex estimates.