Summary //
- In the midst of a challenging year, the improvement in midstream equities in November alongside the gains in oil prices and broader energy on positive vaccine developments was encouraging.
- Energy, including midstream, clearly stands to benefit from a potential improvement in the outlook for the global economy and oil demand, supported by the successful deployment of a vaccine.
- While a rising tide lifted all boats in November, midstream companies deserve credit for positive steps being taken with capital allocation, cost reductions, and ESG-related initiatives. All of these strengthen the midstream investment case to more than just a macro recovery story.
Equities broadly enjoyed strong performance in November as the Dow Jones Industrial Average had its best one-month performance since the late 1980s, but the energy sector in particular saw pronounced outperformance for the month. West Texas Intermediate oil prices gained 26.7% in November as vaccine progress supported an improving outlook for an oil demand recovery in 2021. Following oil’s lead, energy equities, including midstream, moved sharply higher. On a total-return basis, the broad Alerian Midstream Energy Index (AMNA) gained 18.9%, while the Alerian MLP Infrastructure Index (AMZI) jumped 23.9%. Though Senate run-offs in Georgia remain, the election being in the rearview mirror was also likely constructive for energy as election uncertainty had been one reason for investors to stay on the sidelines. Today’s note provides a broad midstream update, recapping November performance, what companies are doing to help enhance the investment case, and discussing the outlook for midstream from here.
Taking a closer look at November’s standout performance.
Entering November, energy was by far the worst-performing sector this year (down over 50%) as the pandemic led to a staggering decline in oil demand that sent prices for the commodity spiraling. Accordingly, the energy sector has much to gain from a successful vaccine and a resumption of economic activity and transportation trends closer to pre-COVID levels. This was clearly on display in November. The S-Network Broad Market US Energy Index (SNENER) jumped 14.1% on November 9 as positive news on the Pfizer (PFE) and BioNTech (BNTX) COVID-19 vaccine rippled through financial markets. AMNA and AMZI saw gains of 7.8% and 9.4% on the day, respectively. While short covering may have boosted initial gains on the 9th, subsequent vaccine headlines from Moderna (MRNA) and AstraZeneca (AZN) in conjunction with Oxford University continued to support energy performance, as shown in the chart below.
From a midstream perspective, there are a few notable takeaways regarding performance for the month. November demonstrated that midstream, including MLPs, can rally on a constructive macro outlook and rising oil prices despite the fee-based nature of these businesses. While midstream’s oil correlation has been a frustration as oil prices fell, it is nice to see midstream benefit as oil prices gained. MLPs (AMZI) outperformed broader midstream (AMNA) in the recovery, which would be expected given the relative underperformance of MLPs this year. The performance would also seem to allay any concerns that the MLP structure limits or hinders price gains. Furthermore, the selling pressure that has weighed on midstream, particularly MLPs, since 1Q20 seems to have finally subsided. Money flows for MLP exchange-traded products and other MLP funds seem to be improving. Finally, long-time midstream investors have likely become accustomed to tax-loss selling weighing on performance in November and into year-end, but that has certainly not been the case this year.
Macro supportive but companies also taking positive steps.
While a rising tide lifted all boats in November, midstream companies deserve credit for positive steps being taken with capital allocation, cost reductions, and ESG-related initiatives. All of these strengthen the midstream investment case to more than just a macro recovery story. Stable cash flows and reduced capital spending are supporting meaningful free cash flow generation, allowing companies to reduce debt or buy back equity (read more). Since October, half a dozen midstream names have announced buyback authorizations, bringing the total number of companies with buyback programs to 14 (read more). Dividends have also been largely stable since 1Q20 cuts, with only a few exceptions (read more). Even with the recent improvement in performance, the AMZI and AMNA were yielding 9.4% and 7.3% as of December 4.
Given the challenging macro backdrop, companies have also made significant progress with reining in costs. On their 3Q earnings call, Magellan Midstream Partners (MMP) cited $30 million in annual efficiencies, and management estimated annual savings of potentially $50 million or more by 2022. EnLink Midstream (ENLC) noted a more than 20% reduction in operating and general and administrative expenses relative to 2019 with business operations essentially unchanged. These are just two examples of the belt tightening and cost management prevalent across the space.
On the ESG front, several companies have published inaugural sustainability or similar reports in recent weeks, including MMP, Energy Transfer (ET), Enable Midstream (ENBL), and Western Midstream Partners (WES). Other companies have set ambitious targets for reducing greenhouse gas emissions. Enbridge (ENB) announced a target of achieving net-zero emissions by 2050, matching the 2050 goal set by Williams Companies (WMB) earlier this year. Last week, the Energy Infrastructure Council and GPA Midstream Association released a midstream ESG reporting template, which represents a positive step in standardizing ESG metrics for the midstream space. In short, midstream has been responsive to the growing focus on ESG-related issues. For more on ESG and midsream, read the August update to Alerian’s 2019 ESG white paper.
What could be ahead for midstream?
Energy has probably been an afterthought for generalist investors given its small weighting in broad market indexes and the volatility of recent years. The sector has needed a catalyst to garner more investor interest, and the events of November and resulting energy performance were constructive on that front. Last week, the compromise by OPEC and its allies to only raise output by a modest 500,000 barrels per day reflects continued cooperation by the group and provides helpful short-term visibility. The increase should have little impact on global oil balances, and the collective cut of 7.2 million barrels per day for the group remains significant and supportive for oil prices as demand remains challenged.
Looking ahead to 2021, energy, including midstream, clearly stands to benefit from a potential improvement in the outlook for the global economy and oil demand, supported by the successful deployment of a vaccine. The strong midstream performance in November on the heels of vaccine progress exemplified the potential upside for the space. Furthermore, any shift from growth to value could also be broadly constructive for energy. With oil prices currently around $45 per barrel, the recovery remains in early stages with plenty of room for additional improvement in oil prices and energy equities, including midstream. Independent of the macro backdrop, many MLPs and energy infrastructure corporations are well positioned to generate free cash flow next year even in excess of generous dividend payments. Free cash flow generation and buybacks could be an added tailwind for midstream in 2021, perhaps enhancing the benefits of a potential a macro recovery.
The AMZI Index is the underlying index for the Alerian MLP ETF (AMLP) and the ETRACS Alerian MLP Infrastructure Index ETN Series B (MLPB). The AMNA Index is the underlying index for the ETRACS Alerian Midstream Energy Index ETN (AMNA).
