Energy Infrastructure Unravelling and Knitting Together
Over the past two years, as crude prices fell, upstream MLPs were hurt the worst, but gathering & processing MLPs also exhibited sensitivity to falling prices. Falling crude prices wore a hole in the fabric of the MLP space, and upstream and G&P MLPs were the loose threads investors couldn’t stop pulling on. Large midstream MLPs certainly felt the increasing tension, but investors have worried what was once a small hole into something much larger. Equity prices have been pulled at so hard that credit ratings are now also stressed. March may have seen a small bounce for MLPs, but it is yet to be seen if the space will unravel faster than it can knit itself back together.
As of the close of business on March 31st, 40 of 118 MLPs were trading in the single digits. That’s not a typo. Despite March being the first positive month for MLPs all year, the smallest MLPs are getting smaller.
Earlier this week, my colleague, Karyl Patredis, wrote about the macro situation with coal, but just to take it to the individual company level: five years ago, industry bellwether Peabody Energy (BTU) traded at $1,079.40 on a split-adjusted basis. At the close of the quarter, it was $2.32. Granted, BTU is not an MLP, but coal MLPs cannot escape their industry. Foresight Energy (FELP) has suspended distributions, suspended guidance, is in forbearance, and may not continue as a going concern. Rhino Resource Partners (RHNO), already OTC, had their general partner bought by Royal Energy Resources (ROYE), another OTC company, and announced a 1-for-10 reverse split. Unfortunately, it will still trade on the OTCQB. As TS Eliot famously penned, “This is the way the world ends // Not with a bang but a whimper.”
Further unravelling the space, Atlas Energy Group (ATLS) is being delisted from the NYSE, and New Source Energy Partners (NSLP) filed for Chapter 7 bankruptcy. Exxon Mobil (XOM) may have the money to go shopping, but we doubt it’s going to buy upstream MLPs.
Once the innovative new idea in energy midstream, crude-by-rail is fading. It rose to prominence as the shale revolution happened so quickly that rigs were producing oil before a pipeline could be built to the play. Upstream companies and their investors were unwilling to wait the minimum 18 months for pipeline completion. Moving that crude on rail cars filled the immediate need. Now, pipeline projects are mostly complete and basin production is declining. Some reports have rates for railcar leases down as much as 80% from their highs.
One counterpoint is that M&A is picking up. When an industry first hits hard times, individual companies may try to raise cash by selling their least valuable assets. It’s like selling the belt that never really went with your favorite dress; now there’s room in your closet and extra cash in your pocket. If you keep wearing that dress, you might find that one day, shoulder pads are out of style. Like arranging a scarf in just the right way, companies will pursue joint ventures. And sometimes that’s all it takes to make an outfit fashionable again—it can even be much better than the original. If times continue to be hard, eventually no amount of accessories will hide the problem, and it’ll be time to repurpose that sweater dress into something new. Eventually, companies will sell even their best assets. Widespread M&A activity concerning profitable assets is often considered the inflection point and can mark the bottom of a cycle.
TransCanada (TRP) just announced a deal to buy Columbia Pipeline Group (CPGX), the parent and GP of Columbia Pipeline Partners (CPPL). After the deal closes, TRP will also own the IDRs of CPPL, which may encourage them to continue to grow the MLP, which will continue to trade. Much of the original investment thesis was based on the dropdown of assets from CPGX, but the slate of organic growth projects is still intact. Management has yet to confirm whether the dropdown story will be continued, but given the independent growth at the MLP-level, analysts expect the previously announced double-digit 2016 distribution growth to continue.
In another Canadian deal, Pembina Pipeline (TSX: PPL, NYSE: PBA) acquired over $500 million worth of gas processing assets from Paramount Resources. In conjunction with the deal, a 20-year midstream services agreement has been inked, including “a substantial take-or-pay commitment”. Concurrently, PPL announced a 4.9% dividend increase. Announcements like this (expansions with very long-term contracts that support distribution increases) were common in the heyday of MLPs. In the midst of counterparty bankruptcy concerns, it’s a breath of fresh air to read a press release so familiar and comforting.
The MLP space may be losing threads as the smaller, flashier MLPs wear off, and even the larger companies may be frayed around the edges. (I know I’ve certainly gotten more gray hair in the past year.) The weakest spots get patched, which maybe isn’t ideal but is better than giving up. At the end of the day, as long as you avoid sunk cost fallacies, utility is all that matters. Hopefully the 8.6% yield will keep you warm.